Zimmer Biomet Holdings Inc (ZBH) 2018 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Zimmer Biomet Third Quarter 2018 Earnings Conference Call.

(Operator Instructions) As a reminder, this conference is being recorded today, October 26, 2018.

(Operator Instructions)

I would now like to turn the conference over to Coleman Lannum, Senior Vice President, Investor Relations and IRO.

Please go ahead, sir.

Thank you, and good morning.

Welcome to Zimmer Biomet's Third Quarter Earnings Conference Call.

I am joined by our President and CEO, Bryan Hanson; and our CFO, Dan Florin.

Before we get started, I'd like to remind you that our comments during this call will include some forward-looking statements.

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

Please note that we assume no obligation to update these forward-looking statements, even if actual results or future expectations change materially.

Please refer to our SEC filings for a detailed discussion of these risks and uncertainties, in addition to the inherent limitations of such forward-looking statements.

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

A reconciliation of these measures to the most directly comparable GAAP financial measures is included within the earnings release found on our website at zimmerbiomet.com, and we urge you to take a look at those.

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

Bryan?

Well, thanks, Paul, and I just want to say thanks again for everyone joining us this morning.

Overall, we feel pretty good about Q3.

We delivered constant currency revenue of 2.3%.

And I can tell you, pretty much across-the-board, when I talk to our team members, we're all encouraged by the progress we're making in a number of areas, and I'll get into those in a second.

But before I do that, with the idea of being fully transparent on the quarter, our results actually look a little better than they actually are for a couple of reasons.

First of all, and I think this is probably pretty clear to everyone, we had a pretty easy third quarter comp, which buoyed revenue growth in the quarter, obviously.

And unfortunately, that will not continue in the fourth quarter.

We have a much more challenging comp in the fourth quarter.

In addition to that, we experienced a notable timing benefit in the quarter with regard to both tenders and capital sales.

On the tender front, it happened both in Asia Pacific for us as well as EMEA.

And on the capital side, it was mainly on our S.E.T.

business.

Either way, those buoyed the third quarter results and will come, as a result of that, with some pressure to the fourth quarter.

Good news is we've banked the revenue, which is the most important thing.

So even though you're going to move those between quarters, I'd much rather have the sales.

So as much as we're happy with the third quarter, I believe it's important to highlight these factors because I think, very importantly, I don't want my team or you to get too excited that we appear to be at a weighted average market growth for the business.

While we are pleased with the progress we are making, we clearly are not declaring victory.

And until we sustainably deliver that performance, we won't.

And I still firmly believe this should be a 2020 expectation.

So I guess, the overall takeaway should be that our recovery timeline remains on track, but we are going to see some atypical quarterly timing and revenue phasing here in the back half.

So my net message is I'm maintaining this sense of cautious optimism, as I expressed in the second quarter, and feel good that we're progressing in the right areas.

So with that, I'd like to provide an update on the short-term priorities that we've been concentrating on since I joined the organization.

Turning first to quality remediation.

What I want to say here is that anytime we think about quality remediation, I want to be clear that the #1 priority we have as a business, and I personally have, is patient safety.

So as we think about our process in remediation, we will always have patient safety first and foremost on our mind.

If I think about the activities, specifically, our ongoing efforts remain on track.

And we continue to keep the FDA updated on our progress.

And as we stated before, at this time, our quality remediation does not restrict our ability to produce or ship products out of our factories and, as a result of that, would not have an impact on our supply recovery sustainability.

And importantly, we also continue to believe that with the work that we have in front of us, this will not put us in a position that will materially impact our financial forecast or projections.

In the area of supply, specifically, we're still not exactly where we want to be, but we're making progress.

And we're going to remain diligent in this area because we want to make sure that our service levels continue to come up.

But our progress in this area continues to increase and, as a result of that, are confident that supply will not be a barrier to accomplishing our 2018 guidance.

And I think, even more importantly, our turnaround time line is higher than ever.

Throughout 2019, though, what we need to do is to start to shift away from our manufacturing folks, focusing on this triaging a product supply and begin to focus more diligently on the rigorous approach to reducing cost in our manufacturing facilities, which will eventually lead to margin expansion for the business.

On the commercial side of the business, we have continued to build momentum.

The combination of stronger sales force engagement, this improving supply that I just talked about, introduction of new products, all those pieces coming together are giving our sales organization the traction they need and the traction that we need to be able to keep the organization on pace with the recovery.

Relative to new product expansion, specifically, we are pleased to see the traction our newly released products are getting pretty much across-the-board with our surgeons.

Notably, we are happy with the growth that the Persona Partial Knee, which is an important space for us, and we're seeing very good uptake on the more recently released Persona TM Tibia, where, by the way, we've now surpassed 1,300 cases in our limited launch process, and we still are getting very positive surgical feedback.

Our 2 largest upcoming commercial projects, which I get questions on all the time, the Persona Revision system and the ROSA robotics knee application, are progressing well versus time line.

And as a matter of fact, both are waiting on regulatory approval.

Regarding ROSA knee specifically, we're excited to be ahead of schedule to perform our first case in Australia.

In other areas of innovation, earlier this month, we announced an exciting new collaboration with Apple and Zimmer Biomet mymobility.

This technology, as you probably have already heard through some of the media launches that we've had on this, is really a digital platform that allows the knee and hip patient to be better connected to their caregivers.

This is throughout the entire episode of care.

And what's unique about it is you can do this by using the Apple Watch and the iPhone that the patient would have.

What we're going to do inside of this is to make sure that we also have a study that would look at the clinical outcomes as a result of using this technology.

This will cross thousands of patients that will participate in the study and, as a result, that this will be one of the largest evidence-gathering clinical studies in orthopedic history.

I can tell you through this study, and in collaboration with Apple, we absolutely look at changing the patient journey for knee and hip procedures.

And I think, ultimately, as a result of this, set a new standard in digital health care for our space.

As these and other new products expand our clinical offerings, I feel even more confident that our portfolio's capability will be there to differentiate us from the competition and, ultimately, as a result of that to help drive the future growth of the business.

Because our primary goal is, in fact, driving revenue growth, I want to stress that we will continue to invest in appropriate growth initiatives and that we expect those investments to increase over the next several quarters, not decrease.

These initiatives are already having an impact and will be crucial to achieving the goals that we have for consistent at market or better growth by 2020.

In addition, we continue to look aggressively at active portfolio management opportunities to further diversify our portfolio and, ultimately, as a result of that, bring up the weighted average market growth of our business.

Turning to our culture-building initiatives.

We've been, on an absolute tear relative to this area.

We've held mission ceremonies with thousands of our team members over the past 6 months since we launched the new mission.

And I could say that these are very impactful.

We come in, do a mission ceremony and present in person the mission and guiding principles of this organization.

To date, we'd met with nearly half of the organization to personally engage with them on the one mission, one culture focus of this business.

As much as I'm happy about that progress, I look forward to reaching every team member with this important message over the coming quarters.

So overall, though we still clearly have a lot of work ahead of us, we've made great progress pretty much across every one of our top priorities.

And so with that, I'm going to turn the call over to Dan to get into our financials.

Thank you, Bryan.

To start off, in addition to Bryan's comments about our third quarter performance, I would like to point out a few other items that will impact your models.

First, I want to highlight a couple of headwinds affecting our revenues, including some specific pressure on our other revenue line, in addition to foreign exchange.

There are also a couple of items below operating income that will benefit us over the next several quarters as we expect both our net interest expense and our effective tax rate to come in lower than previously expected.

Turning first to revenues.

Our results will be impacted by disruption related to the pending termination of our U.S. distribution agreement with a bone cement supplier.

This matter is still evolving and is currently in litigation.

At this time, we anticipate the termination of this distribution agreement may have a negative impact of between $10 million and $15 million per quarter on our other revenue line beginning in the fourth quarter.

Importantly, we are actively working to mitigate this issue by transitioning our customers to our internally produced bone cement, but we still expect the net impact will be a revenue headwind over the next several quarters.

Regarding FX, the strengthening U.S. dollar over the last several months will continue to put pressure on reported revenues and earnings.

To put this in perspective, while our organic revenue growth in the third quarter was above our expectations, the negative FX impact was about 100 basis points worse than previously expected, and we expect a similar impact for the next several quarters.

Turning to items below operating income.

As you model our net interest expense, you should expect modest declines from the $68 million that we reported this quarter.

In addition, we have taken advantage of further tax planning opportunities, which is primarily why you see the third quarter tax rate coming in lower than expectations.

Because of this, we now expect the tax rate for the full year to be below our prior guidance range.

While the points I just discussed will likely move some specific line items in your models, we do not expect dramatic changes to 2018 earnings.

In other words, the positive effect of tax and interest will largely offset the negative FX impact that we are seeing in 2018.

Turning now to our detailed third quarter results.

Net sales totaled $1,837,000,000, an increase of 1.3% over the prior year period, which represents an increase of 2.3% on a constant currency basis.

On a similar basis, in the Asia Pacific region, our sales increased by 7.6%.

America sales increased by 1.7%, and our Europe, Middle East and Africa sales were flat.

Moving down the income statement.

GAAP diluted earnings per share for the quarter were $0.79.

Adjusted earnings per share were $1.63.

Adjusted operating margin came in at 25.6%, including an adjusted gross margin of 71.6%.

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

These adjusted results exclude $247 million of expenses in the quarter, approximately $148 million of which are noncash charges, primarily related to intangible amortization.

The adjusted effective tax rate for the quarter was 16.5%, which brings our year-to-date adjusted effective tax rate to 18.6%.

Operating cash flow for the quarter amounted to $484 million, and our free cash flow was $345 million.

Year-to-date free cash flow totaled $1,049,000,000.

We paid down $300 million of debt in the quarter, bringing our year-to-date total debt pay down to $900 million.

With that, let me turn the call back to Bryan.

Thanks, Dan.

As you've just heard, we're pleased with our progress.

And I think, more importantly and more broadly that the entire Zimmer Biomet team is coming together as one Zimmer Biomet.

And I can't stress enough how important that is for us to be able to have sustained performance in the business.

And overall, our achievement in the third quarter, even though it looked a little better than it was, clearly, is showing that we have confidence that we're on track with our turnaround and, ultimately, positioning the company for long-term value creation.

And so with that, I'm going to go ahead over and turn it back over to Cole and move into the Q&A session.

Thanks, Bryan.

(Operator Instructions) With that, operator, may we please have the first question?

(Operator Instructions) And our first question comes from Amit Hazan with Citigroup.

So just a question maybe to start with gross margin considerations for '19 and '20, just leverage -- think about leverage from volumes and costs.

If I adjust the negative price headwinds, it does appear as though you've had some positive volumes really all year in hips and knees.

And if that's so, does that portend better gross margin next year?

Just trying to get a sense of where volume growth needs to be for you to start seeing leverage.

And then relatedly, when do you expect to start seeing the benefit from the rigorous approach to reducing cost in manufacturing facilities that you mentioned?

Can that be a 2019 event?

Okay.

Amit, this is Dan.

Let me first start by saying that we've talked extensively about the pressures on gross margin and the fact that we expect those pressures to continue through 2019, and that the primary driver of that is the same driver, which is elevated production cost, predominantly out of the North Campus facility.

And recall that we've talked about not only the incurrence of elevated production costs that is tied together with the quality remediation work that we're doing in that factory and the fact that our accounting policy is such that we capitalize those costs and they flow through the income statement as we sell that inventory.

So there's about a 1-year lag between incurrence of variances and getting the full impact in the P&L of those variances.

So that works the same way as we drive cost improvement.

So as we drive cost improvement, it goes on the balance sheet.

And then it takes a full year before that's fully through the income statement.

So that's why there's a delayed impact from benefit and a delayed impact from incurrence.

So as we sit here through 2019, we're still going to be incurring the full run rate of those elevated costs throughout 2019.

Now our new Head of Operations, Ken Tripp, continues to bring in additional resources.

And as that team triages away from focus on supply recovery, the team will start to pivot towards significant cost reduction activity.

We expect that pivot to occur next year.

And so I would not expect any gross margin benefit in 2019 through those efforts.

That's more of a 2020 impact to the income statement.

Thanks, Amit.

Our next question is from Bob Hopkins with Bank of America.

Can you hear me okay?

Yes.

Yes.

Loud and clear, Bob.

So I'll just lay my questions out here.

So quickly for Bryan, I was wondering if you could just touch on 2 quick things for us.

Just maybe be specific on when you think the supply issues will be fully behind you.

And also, I heard some comments on the robot.

But just to be clear, when do you expect a full launch of the robotic platform for total knee?

And then for Dan, the one thing I'd love you to touch on is that when you think about the things you've got affecting the income statement going forward, you've got tax rate and your spending.

And clearly, currency is an impact.

But The Street is modeling roughly 3.5% earnings growth for 2019, do you think The Street is accurately capturing all those moving pieces?

All right.

Great.

So Bob, I'm going to go ahead and get started on the more than one question that you asked.

We'll discuss that afterwards, Bob.

But let me start with the -- with supply.

I think, first of all, I want to be very clear and just kind of reiterate something I've been saying.

I absolutely do not see supply as being a barrier to achieving our 2018 targets that we have and I think, probably, even most importantly, to getting to our turnaround timeline.

So I don't see supply as being a barrier to these things.

At the same time, I'm not happy with where we are.

The fact is we need to continue to focus on bring up our service levels to our customers.

We need to be best-in-class in this area.

And I've got to say, to be able to do that, what I want to hear is my sentiment from the sales organization begins to match some of the back order reduction and the inventory building that we're doing.

And until I get that sentiment at a place where everybody feels confident that they have the inventory they need to go after offensive situations, we're not there yet.

So that's where we are.

In addition to this, we've got to start spending a little more time evaluating the portfolio that we have.

One of the best things about our portfolio is the scale.

It's absolutely unmatched.

It's the best portfolio, largest portfolio out there.

But the problem we've had is it also inhibits our ability to have best-in-class service levels.

The fact is we've got to start reducing the size of the portfolio because it creates a very complex supply chain for us.

And I'm not going to say that we're going to be able to just out of the gate because we still have to focus on our short-term priorities.

But we have got to look at reducing the number of product families we have because the number of SKUs attached to those product families is extremely cumbersome.

So -- and by the way, when we do this, not only does it help service levels.

It also has periphery -- peripheral impact to other financial benefits and efficiencies for the organization.

So again, I don't feel like that we're ever going to get to where I want to be on service levels until we start to cull back the portfolio that we have.

And as Dan mentioned before, it is critical, though, that as we come into 2019, this whole triaging activity we have around making sure supply is there has got to be shifted.

That focus has got to be shifted to cost reduction activities because as Dan mentioned, the capitalization cycle says that once you start those projects, you don't get full advantage of them for a year.

So 2019 has got to be that pivot period for us to be able to get after cost reductions and stop focusing so much on this triaging of product supply.

So on the robot, I mentioned that we're ahead of schedule actually, and I'll give you a little more color on that.

We actually had 5 cases that we were able to do in Australia.

And I want to be clear that this is the beginning now, right, of us getting out and actually doing cases, actual surgical cases.

And this is ahead of schedule.

There's no question it's ahead of schedule.

First of all, I just want to say that when I reference ahead of schedule, I want to be clear, that gives me confidence that the overall project is on track, that we're -- that we don't have a lot of risk in the project.

But I wouldn't get too excited about the fact that it's ahead of schedule.

I've said in the past, whether we limited launch in the fourth quarter or the first quarter, it doesn't really make a big difference to the rollout plan.

And I don't think it'll have a material impact on our revenue results.

But I'm pretty happy with the fact that we're ahead of schedule right now because that clearly tells us we're in the right place and now we're awaiting on regulatory approval in the U.S. Also a little more color on the procedures in Australia.

We did 5 procedures in 1 surgical day with 1 surgeon.

So think about that.

That's 5 procedures, which is pretty decent load for a surgeon, in a typical surgeon -- surgery day with one surgeon.

And that would speak to the efficiency that we're looking to bring to the table with our robotic system.

And this is the first time that the surgeon has used the system in the operating room.

So not only are we ahead of schedule, but that's a pretty good stat that we feel good about.

The thing I do want to concentrate on though in answering your question specifically is I do want to think about this as being kind of a back half full launch of 2019.

This is consistent with what I've been saying.

We're going to have the full product portfolio in the back half of 2019 that then positions the sales organization to go on 100% offense.

And then, ultimately, that keeps us in line with that 2020 turnaround, which is where we're going to be at weighted average market growth consistently.

And I think that's important.

One other thing I will say though is that full offense that I'm talking about, I don't expect us to be in full offense with a similar portfolio offering as everybody else.

I truly do believe, as we continue innovations like the collaboration with Apple, as we leverage the differentiation we already have with things like Persona and we have that full product portfolio, I believe that we're going to be differentiated versus our competition.

And we're going to bring more ammunition to the fight.

At the end of the day, we're not here to play.

We're here to win.

And I truly do believe this portfolio is going to position us to do that.

And Bob, with respect to 2019, first and foremost, to be clear, we're not providing 2019 guidance on today's call.

We'll do that in the coming months.

But let me try to provide some color to help folks with their models.

First, with respect to revenue, at current FX rates, as we look to 2019, there'll be more than 100 bps of headwind on reported revenues in 2019 versus 2018.

And I mentioned the bone cement transition.

That also will be a bit of a headwind for the next several quarters, as I said in my prepared remarks.

On the positive side, as Bryan just said, continued supply recovery, the important new launches that we have coming all feed a growing momentum in the base business.

With respect to earnings per share for 2019, again, some headwinds and some positives.

First, with respect to headwinds, just relative to our last earnings call, if you look at the combination of foreign currency and the bone cement issue, together, those represent about a $0.15 per share headwind to 2019, with probably more than half of that coming in the first half of the year.

I spoke to gross margin earlier.

That will continue to be pressured through 2019 as well for the reasons I've discussed.

And importantly, we're going to continue to invest in the business for growth, as we've been talking about.

Now on the positive side, again, relative to our last earnings call, we do anticipate lower interest expense and a slightly lower tax rate through 2019, which will make up for some of that incremental EPS pressure coming from FX and bone cement.

And we'll continue to work through the other moving parts in the 2019 financial model.

And when you put that all together for the reasons that I've stated, I would not expect operating margins to expand in 2019.

But again, we'll provide more specifics when we provide 2019 guidance.

Our next question is from Josh Jennings with Cowen and Company.

I was hoping to just follow up, Bryan, on your comments about portfolio rationalization and just to get a sense of -- have you taken advantage of some of the supply constraints to begin the rationalization of the portfolio.

I think you're coming up on the third year anniversary, just past 3-year anniversary of Biomet acquisition, and just wanted to hear some more details around how you're going to pursue that process.

And does that risk your return to weighted average market growth that you're pursuing?

Yes.

Josh, I appreciate the question.

And so it wouldn't risk, our pursuit of that weighted average market growth, if we do it the right way.

Now, here's -- first of all, we have reduced certain SKUs already.

We're just not anywhere near where we need to be.

In reality, we've got to be cautious at how fast we pursue it because, let's face it, we have had supply issues as an organization for all the reasons that we referenced in the past.

The worst thing we can do right now when we've been stressing our surgeon partners because of the supply issue is to start taking away products they know and love.

And so we do have to sequence this thing appropriately, get to that place where we feel confident that supply is in good shape, that our field sales organization feels the same way as well as our surgeon partners.

And then at that point, we begin the process of removing families that don't make sense anymore with the strategy that we have.

But to do those concurrently would put too much pressure on our ability to service our customers, and I think would frustrate the customer right now.

That's the reason why we're pacing it.

I just throw it out there because it is something we will have to tackle as an organization to be able to get to the service levels that I would expect of our organization.

So that's kind of where we stand with it right now.

It's something we're going to pursue.

We've just got to sequence it in the right way.

Our next question is from Rick Wise with Stifel.

Let me start with -- I'll just ask my 2 questions as well.

FDA, basically, Bryan, what's next?

Where are we?

Are you feeling encouraged at the progress you're making there?

And maybe a question for Dan.

Dan, obviously, free cash flow, with debt pay down as a priority, maybe just help us think in broad terms about your free cash flow driving initiatives and how we might think about if you're generating a couple billion in round numbers of free cash flow this year, what that might look like in '19 and beyond.

All right.

Great, Rick.

I'll start with the FDA.

Really, nothing more than what I had in my prepared remarks.

The fact is we are diligently pursuing the remediation activities that we need to put into place.

We're on track with the time line that we would have expected for that remediation.

We continue to put patient safety, first and foremost, in our mind.

I just want to make sure that I say that.

If we ever feel that we have a risk to patients, that would change the trajectory of that remediation.

Certainly, we don't feel that way, and that's why we feel we're on track.

So -- and again, to the extent that we can, we're trying to keep the FDA informed of everything that we're doing and make sure that we stay as close to them as possible.

But I guess, that's really all I have to say.

We're on track with the remediation time line.

And we feel confident with where we are in that process.

And Rick, with respect to free cash flow and debt pay down, year-to-date, our free cash flow is $1.049 billion, so good free cash flow for the first 3 quarters of this year.

So we're on track to deliver free cash flow in line with the guidance that we provided at the beginning of the year.

And clearly, our priority, as we've been saying, in terms of what we do with that free cash flow is to pay down debt and pay the dividend.

That's really the -- where our focus is.

We've talked also in the past about capital allocation, first and foremost, to pay down debt to get leverage inside of 3x.

We've talked a lot about that.

And we have a host of free cash flow initiatives that we've been executing last year, this year, and we'll continue to do so, everything from basic working capital improvement to productivity of instrumentation, and those will continue.

Certainly, as we look at our cash thresholds, particularly the quality remediation burn rate, we expect that to start to wind down through next year.

That will be a source of free cash flow as well.

So we still feel, as part of the turnaround that we've talked about, that our increased financial flexibility will start to show itself exiting next year.

And Rick, you threw out a number of a couple of billion in free cash flow in line with what Dan just said.

While I look forward to the day when that is the correct number, I just want to clarify here that Dan's comment earlier on our free cash flow expectation for the year, which remains unchanged, is $1.2 billion to $1.35 billion.

Just a little bit south of the $2 billion number that you threw out there.

Our next question is from David Lewis with Morgan Stanley.

So just questions for Bryan and they all kind of center on growth.

So Bryan, I'm just trying to align a couple of messages.

You've talked about not being able to sustainably grow 2% to 3% until 2020, but you're also making progress.

So my way of math is next year's numbers should be somewhere between 2% and 3% on the high end.

Obviously, not going to get there, but better than the growth rates you're putting up in 2018.

Could you just talk about the messaging for the fourth quarter?

First of all, is that likely to slow from the third quarter?

And is it a reasonable assessment to think about 1.5% to 2% next year, somewhere between '18 and 2% to 3%?

And then related to that, this particular quarter, spine was the only business, frankly, that didn't take a step forward.

Can you just sort of talk to us about the distributor challenges in spine and how they may reverse themselves next year?

Sure.

Before we get there, I want to remind people, again, guys, one question per caller, please.

Please don't make me come in and do this anymore.

It really helps.

Bryan, please continue.

Okay.

So David, just -- maybe I'll start with the revenue growth discussion.

So in the fourth quarter, you're accurate.

I think what we're trying to get everybody to recognize is that we will likely see less growth -- we will see less growth in the fourth quarter revenue growth rate than we did in Q3.

So your assumption there is accurate.

That is the message we're trying to send.

A lot of that has to do with the timing that we referenced and also the cement issue that Dan talked about.

When I think about beyond that, we haven't given any guidance at this point beyond 2018.

But I want to continue to reference the fact that I do believe that the turnaround would require us to be a net 2% to 3% consistently.

I expect that to happen in 2020.

And obviously, if we're saying that would happen in 2020 consistently, then it would be some number below that in 2019.

We haven't given specific guidance, but when the time is right, we will.

Relative to the spine distributor situation, I think we're progressing pretty well, to be honest.

Just remember, we have a complete restructuring of the channel that is ongoing, as we're delivering the numbers that we are.

So what the risk would have been inside of this is as you're doing it, you actually see a deceleration in that growth.

And the fact that we're maintaining the growth rates that we are tell us that we're kind of driving down the street, changing the fan belt at the same time, and it's working.

And so I'm pretty happy with the progress that the team has put into place.

And I expect, as we work through the end of this year, we'll be in a place we need to be with the sales channel.

And the hope is, from that point, we can begin to accelerate.

But the fact that we're staying where we are, while we're making all of these changes, is actually a positive thing.

So Dan?

Yes, I have nothing to add.

I mean, I agree with what Bryan said with respect to -- just to reiterate the fact that our revenue guidance for 2018 remains unchanged other than updating our FX assumptions.

It's the only thing that I would add to what Bryan just said.

Our next question is from Isaac Ro with Goldman Sachs.

Bryan, just want to try and get a little clarification on your comments at the beginning of the call with regards to the timing benefits you got from some of the tender and capital sales items.

Could you maybe try and quantify a little bit what that meant to the quarter, so that as we look at next year, we have the right comp in mind?

Yes.

So I purposely didn't give a specific number there, but I'll give you some color around it.

Dan referenced the fact that in the fourth quarter, we're going to be challenged a bit on the cement side of our business just given the distribution change that's happening.

He referenced that would be between $10 million and $15 million.

What I would tell you is that when I think about the comps -- not the comps, but when I think about the timing issues for both tenders and capital, if I combine those, it's a number smaller than that, it's a number smaller than that.

So the benefit that we received in Q3 is something under that range.

And the pressure that we'll receive in Q4 will be the same thing, something under that range.

Our next question is from Robbie Marcus with JPMorgan.

Bryan, when you took over the CEO role at Biomet Zimmer, you said that part of the challenge was regaining the trust of your physician users, but also the internal sales force.

Can you kind of give us an update on where both of those stand because they're key components to the turnaround story?

Yes.

I appreciate the question, Robbie.

So I think we're moving well.

The -- one of the things that I referenced in my prepared remarks is we've got a few things working in our favor when we look at the commercial organization and, as a result of that, our surgeon population as well.

We are getting better engagement with the commercial team.

There's no question that, that engagement is increasing and it's being felt across-the-board.

I will say that this is a continuous improvement game.

And we'll never be where I want us to be.

But if I just think of where we are now from an engagement standpoint with the sales organization versus when I started, I think anyone you ask would say that it's better, and I will say much better than it was.

But we will not stop there.

We'll continue to make sure that we improve in that area.

And then, of course, outside of engagement, supply recovery certainly helps put a positive in the sales reps arm.

And new products.

We've been on track with the new products that we've been referencing.

We've been on time.

And when you're on time with new products, that gives the sales organization the lifeblood they need to drive the organization forward.

And I think the combination of those things is really what's changing the engagement and the feeling that you have in the commercial organization.

We're not where we want to be.

We still have opportunity for improvement, but it's definitely moving in the right direction.

And I would say the same with our surgeon partners.

Thanks, Robbie, and thanks for sticking to the one question.

Our next question is from Craig Bijou with Cantor Fitzgerald.

Just want to ask on the recon market.

So if you collectively look at you guys and maybe some of your competitors that have already announced the recon market books, it may look a little bit better in Q3 and recognizing that comps are a little bit easier.

So just wanted to see what your general thoughts on the overall market.

Did you see any improvement in the market?

And anything else, pricing or anything else that you saw for the ortho market in the quarter?

Yes.

It's -- I usually try to stay away from any of these strength or weakness in, from a market perspective, in a quarter.

The fact is we delivered a little better results than we expected in the quarter.

Some of that was due to the timing that I referenced before.

Some of it is just natural momentum in the business that we're getting based on the other things that I've referenced.

But there isn't anything in particular that I'm hearing from my sales organization that would indicate that we saw strength that would be unusual in the quarter.

I really do think that for all organizations, it was a relatively easy comp in the quarter.

That made the market look a little stronger than maybe it actually was.

But again, nothing that I saw in the quarter.

And I think, Dan, you probably feel the same way that would indicate to us that there's unusual strength that we could count on moving forward.

Yes, I agree.

And just with respect to pricing, pricing continues to be very stable.

So pricing for Q3 for us was a negative 2.4%, which was in line with, if you look back to full year 2017 was negative 2.5%.

And Q2 was negative 2.5% as well.

So very stable price declines in that 2.5% type range.

Our next question is from Steven Lichtman with Oppenheimer.

Just want to follow up on spine.

You talked about the distributor work you're doing.

Can you update us on the state of the pipeline there?

I believe you have a number of things coming out in 2019, I think, ROSA on spine, perhaps expandable cages.

Can you just give us your overall state of the pipeline within spine?

Yes.

I'd say, as you said, the new products is everything for an organization.

And to have the channel in the right structure as we exit this year, we're going to be able, for the first time, to actually have -- in a while to have a kickoff meeting with the spine organization.

And I tell you, when you have a kickoff meeting with an organization that's ready to go and you introduce new products, there is serious energy that comes out of that, and that's what we expect to be able to do.

One of the biggest things that people are excited about, obviously, is to be able to bring robotics to spine.

We're still on track with what we've been saying.

We're also awaiting on regulatory approval for that spine application for ROSA.

And for that reason, we're still on track with what we've been expecting.

But yes, we've got new products coming.

We've got the channel in the right place.

And we're going to have our first kickoff in a while with that team coming up here in the beginning of the year.

Our next question is from Larry Biegelsen with Wells Fargo.

Dan, I wanted to ask about the implied Q4 guidance.

Just maybe you can help me with some numbers here.

I'm getting to about negative 2% reported, FX about negative 2% and flat constant currency at the midpoint.

And then on EPS, the range is relatively wide, $0.20.

So why such a wide range?

And should we be thinking about the midpoint at this point?

So Larry, let me jump in there.

I mean, let me be clear on this, and we've been clear all year.

We're not going to give specific quarterly guidance nor should you ever assume a midpoint being a more likely number than any other number in the range.

While offline, I'm more than happy to take you through all the different puts and takes that we've talked about publicly here and get you through the numbers, we're not going to speak to specific numbers or answering questions about guiding to a specific number in a quarter.

We're just not going to go there.

And I would just add -- agree with Cole, and we've provided a fair bit of information that should enable you to model Q4 revenue and EPS for that matter, and just to reiterate that our revenue guidance remains unchanged other than updating our FX assumptions for the year.

Yes, Bryan -- I think Bryan specifically had talked about a number of things that affected the third quarter, will affect fourth quarter.

I think, directionally, we're giving you a lot of color here.

And in fact, we've given you a lot of color about 2019 in an environment where we're not even giving specific 2019 guidance yet.

But I think we're going to draw the line there and not get any more specific quantitatively.

Okay?

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

Just wanted to clarify, Bryan.

The 2% to 3% goal weighted -- to get back to 2% to 3% revenue growth by 2020, can you get there through the internal pipeline?

It sounds like you may need some acquisitions to get there.

And if so, will be -- will you be in a position to do acquisitions in 2019?

Thanks, Glenn.

So no, I think that the 2% to 3% is with the current pipeline.

I feel -- that's our weighted average market growth.

It is what we should be able to get to with our current pipeline.

In reality, I'd like to see us with the current pipeline be able to do more than that to be able to take share.

But what you can count on typically is that you should at least be able to be at your weighted average market growth if you're firing on all cylinders, if not higher.

When I talk about active portfolio management.

It's because I don't like the idea of our weighted average market growth being 2% to 3%.

And the active portfolio management would be focused on get us -- getting us in to spaces that are higher growth rate than that, build scale in those spaces and, ultimately, as a result of that, increase our weighted average market growth.

So that active portfolio management would be fully intended to get us above the 2% to 3% growth rate.

Thank you, Glenn.

Our next question is from Larry Keusch with Raymond James.

Just 2 questions here.

Since you referenced, and it's not the first time, obviously, but you referenced increase in investment spending as you move forward.

So maybe just talk a little bit about where that investment is going.

And perhaps, Bryan, some broader thoughts on your innovation engine and how you're thinking about that.

And then the second question is just, how do you differentiate ROSA in the total knee application versus sort of any of the other technologies that are sitting out there?

Okay.

Great.

So when I talk about the investment spending, I'm not going to, obviously, give too many specifics because I don't want to make it clear to my competition where we're going to be spending our time and effort.

But it's pretty consistent broadly with what I've said in the past.

Part of that will go to research and development.

Part of it will go to our selling and marketing organizations to make sure that we have specialization where needed, so we can drive traction in those faster-growth submarkets that we play in and, ultimately, diversify our growth.

So that will continue.

But remember, as we do launch ROSA, as we do try to get additional traction with this collaboration with Apple, that does require spend.

And that will -- when I talk about increasing those investments when we come into 2019, that's exactly what I'm talking about.

To launch those appropriately, to be able to get the traction that we need in the field, we need to make sure that we're increasing the spend in those areas.

So that's -- when I talk about it, those are the areas of concentration, and that's the reason for the increased investment.

When I think of ROSA differentiation, we've been trying to stay away from speaking too much about telegraphing our talk track associated with what our system is going to do versus anybody else's.

But I think you could get a clue from what I talked about earlier, which is the first surgeon doing procedures with the system, brand new.

He did 5 cases in a typical surgical day.

That would tell you something about the way that the robotic system will work with the current flow of a procedure.

And that'll be one of the biggest things that we talk about.

I won't get into other things, but just know that, that will be one of the primary things we concentrate on is being able to use the robotic system without dramatically disrupting the surgical flow, which is a big deal.

.

Our next question is from Kristen Stewart with Barclays.

I was just wondering if you could maybe just talk to the big picture from an operating margin perspective.

I think on a year-to-date basis you're running around 27.4%.

You've talked about seeing some pressure for 2019.

I'm just curious on how you think about the much longer-term outlook.

Your old colleague over at Baxter clearly has done a great job of improving operating margins.

Do you think that there's a similar opportunity here as you look out across the different levers to really generate significant operating margin expansion over maybe the next 3 to 5 years?

Yes.

So I'm wondering who you're talking about over there at Baxter.

I don't know.

Yes.

There are a lot of people at -- are you talking about the ex-Goldman Sachs sulfite analyst?

Or who is that?

Okay.

Yes, yes.

I heard all David Roman that was responsible for it.

David is doing great job over there.

So obviously, Kristen, given the history that I have with the individual you're talking about, there's a similar playbook that we would put into place here.

I don't know that the opportunities are as readily available as maybe what he'd seen there.

But there's always opportunity in the business, 100%.

And one of the key areas we're going to be concentrating on would be in gross margin.

As Dan referenced, we're going to continue to see some pressure as we come into 2019 because all these costs that we have haven't quite capitalized in yet.

But as we turn the machine on and we start to get after cost reduction in our manufacturing facilities, there's no way that, that doesn't begin to translate into margin expansion.

That will be one of the primary areas we concentrate on.

So it will come.

In addition to that, we will look at stuff below gross margin, OpEx to make sure that we're truly doing zero-based budgeting, that we understand why we're spending and where we're spending.

And we'll look to be able to reduce cost where it makes sense.

One of the primary things that allows you to do that is to get better focused on growth drivers.

We're not as focused as I would like us to be as an organization in selecting the markets that are going to matter most to us, getting our path to leadership inside of those markets and then differentially spending in those areas.

Once we do that, that will, by default, allow us to decrease spending in areas that don't fit those growth driver categories.

And just that mix shift alone and the efficiency we get out of that focus will drive operating margin expansion.

So I'm not committing to it overnight.

We've already given some color on this that it's going to take some time, but there's clearly opportunity in the organization over time.

And I would just add that in addition to all of that, as the revenue growth accelerates, that natural opportunity to leverage our fixed overhead structure is a big opportunity as well.

So plenty of opportunity over time, as Bryan just said.

Pretty soon, you'll be talking to the people in Chicago and comparing them to the ones at Zimmer Biomet.

Our next question is from Richard Newitter with Leerink Partners.

I wanted to ask a question on ROSA.

So I appreciate your pending FDA clearance for spine and the application.

So I'm just curious about when it's ready for commercial launch.

Should we be thinking of a spine application and a knee application potentially available at some point in the same skin of the platform?

Or are customers going to have to buy separate robots for separate applications?

And then also if you could, within that answer, comment on your willingness to pursue volume-based contracts that some of your competitors have mentioned that they're doing with their robotics platforms?

Sure.

Yes.

So out of the gate, I want to be clear.

We're waiting on regulatory approval for both the knee and spine application.

They are in 2 different units today.

So with spine, that will be in the same chassis, if you will, with brain.

So our brain application and spine application will be in the same robotic system.

I think probably everybody knows, but we're already marketing on the brain side.

That system is already out, and we're actively selling those units.

And once we get regulatory approval on the spine side, then that unit will also have the capability to do spine procedures as well.

Out of the gate, the knee system will be separate.

There is an opportunity clearly for us to be able to combine all 3 applications in 1 unit.

The benefit associated with that is that you're going to get a better return on invested capital for accounts because you're going to get more volume out of the same unit.

We're not doing that out of the gate.

We're going to be assessing the value of doing that in the future.

And if it makes sense, we could certainly make that happen.

Relative to the way we're going to commercialize the robotic system, I don't want to get too much into our plan here because I don't want to telegraph anything.

But just know, we're not in the business of robotic sales.

We're in the business of market share.

And so we're going to approach the platform in a way that brings the most value to our customers and brings the most value to Zimmer Biomet.

I'd also like to add just a -- really a shout-out to our team that has made this possible.

We just -- remember, we acquired Medtech in September of 2016.

So in a -- in just over a 2-year time period, we're launching ROSA knee.

We've got ROSA spine coming.

And just tremendous effort by our team, and I want to shout them out for the great job that they're doing.

We're excited about 2019 on robotics.

Great point.

Thanks, Rich.

Our next question is from Matthew O'Brien with Piper Jaffray.

Just as far as when I look at your performance, the Americas hip number was quite good.

But S.E.T., when you back out, I think, the benefits that you got from the order in the quarter might have been a little bit lighter than I might have thought given how good that market is.

So is this a function of the productivity at the North Campus getting a little bit better on the hip side, still maybe a little bit pressured on the S.E.T.

side of the business?

And if that's true, is this the kind of snapback we can expect once you get back to more regular productivity out of that facility?

So let me try to hit this.

So on the hip side, we're -- a couple of things there and you called it out.

We had a pretty easy comp that benefited the number, but we are seeing progress.

We have supply recovery, which is helping our field sales organization.

We have a great hip line.

And being able to have that supply, have our sales organization utilize the supply has translated into -- it's a benefit in hip for us.

Certainly, in the quarter, you don't expect those quarters moving forward because it was an easy comp that made it look as good it was, but we are seeing momentum in hip.

On the S.E.T.

side of the business, what I would say is it is probably a little more hindered on the supply side than our -- than hips and knees.

But in reality, we're still on our trajectory to be able to get improvement in S.E.T., particularly versus first half and second half.

We need that improvement, that overall growth rate improvement.

I'd like to see it every quarter, but I'm going to look at it as a task because you always got timing between quarters.

We need that improvement to continue.

We expect that it will.

So we have other product launches in the S.E.T.

categories that we would expect to continue to help us.

And as we've said before, some of that investment that we've been making is specialization in those areas, which, again, should allow us to continue that improvement of revenue growth as time moves on.

I'm not happy with where we are.

Even -- let's call it, even if we're looking at the growth rate in the quarter we're in that was buoyed by comps, we're still not at market growth rates.

So we have real opportunity here, real headroom that we need to make sure that we continue to take advantage of.

Thanks for that, Matt.

Our next question is from Vijay Kumar with Evercore ISI.

So maybe one quick one on the distributor termination you guys spoke about.

Dan, I just want to make sure I heard the numbers correct.

So this is $0.10 to $0.15 impact from next year, but there was also some impact for Q4.

So is that -- does it mean that the $0.03 to $0.04 impact in Q4 in the low end of the guidance, which implies $2.14 EPS for Q4?

You are reiterating that $2.14 number, inclusive of these incremental headwinds.

Let me start by, Vijay, on the guidance numbers, I would refer you back to the press release where we clearly stated which numbers we're reiterating, which ones we're not.

What we're not going to do is interpret or interpolate additional numbers based on that.

Again, more than happy to take you through the math offline, if needed.

But we're not going to go through specific numbers like that on the call, as I said earlier.

With that, let me turn it over to Dan if there's anything he wants to add.

Sure.

Yes, I would just reiterate that what I said is that for the fourth quarter, you should expect the bone cement issue to be sized between $10 million to $15 million of negative impact in revenue in Q4.

And that, that will continue until we anniversary out of that.

Now we're doing a lot to mitigate against that number, but that's our best estimate at this point in time.

The second thing I would just reiterate is when I talked about 2019, I said that the combination of FX and the bone cement would be a $0.15 headwind on 2019 that we're looking to...

On 2019 earnings.

On 2019 earnings, that's right, yes.

And that's relative to our last earnings call, right?

So $0.15 per share next year that we'll work to offset to the extent possible.

Thank you, Vijay.

Our next question is from Bruce Nudell with SunTrust.

This is Stan Fediuk on the line for Bruce Nudell.

Given the competitor's recent move into robotics and spine, do you share the view that a closed system robotics and spine will result in greater pull through of the entire product line, greater ASP and stability and put pressure on lower-tiered players, who don't have a robotic system?

I would personally never say it that way.

But I do think that having a robotic system, whether it be in spine, whether it be in brain and whether it be in orthopedics, you know, recon, I think is a must-have.

I think if you're going to be a real player in any of those spaces, you better ensure that you've got a robotic platform that brings some value to the equation.

I think it'll be a table stakes to play, in my opinion.

Our last question will be from Chris Pasquale with Guggenheim.

Hips was a bright spot again this quarter.

Can you talk about the sustainability of the strength there and maybe contrast the acceleration we've seen in U.S. hips with the shallower recovery in knees?

Is the difference in momentum there related to the portfolio, the bigger impact of robotics?

Or would you point to something else?

I don't know that I have any more specific comments on the hip side of the business.

I think we saw -- we're seeing traction.

Our supply recovery is in place on the hip side.

We have a great portfolio.

Sales organization is getting traction as a result of it.

But just wouldn't expect Q3 to be a number you're going to see any time soon because the comp was a real benefit to us.

Yes.

And I would just add to that, that the strength of our portfolio deserves above-market growth sustainably.

And we've just not -- we've not been delivering that mainly due to supply.

And as supply is recovering, you're seeing that in the hip number.

But again, just to reiterate, Q3 was up against an easier comp.

But as we look to the future, we're very -- feel really good about our hip portfolio and what the team can do with that.

Yes.

I did want to -- because I didn't get a chance to, but the cement thing, I do want to spend just a little bit more time on that.

We've quantified it, obviously, in the $10 million to $15 million range in fourth quarter, and that's going to continue into 2019.

Sorry, about the train as a background here, folks.

But I just want to give some additional color on that.

I mean, it's really frustrating that it's happening right now because the fact is our recovery is in full swing.

The momentum we have in the business feels right.

And to have something like this come in that creates a material headwind is beyond irritating.

As Dan said, though, we're not going to just sit idly by and let this thing just leak from us.

We do have an internal bone cement.

We will be, and already have plans in place to be able to try to pursue this business and stop that leakage.

But until we actually get traction on that execution, we wanted to be very clear, this is a real headwind for us that we're going to have to deal with.

The good news is it's a relatively small category, so I don't expect any peripheral impact associated with this.

In other words, cement is not going to have this kind of negative pull-through effect on our recon business.

That's just not going to happen.

As a matter of fact, eventually, the size and scale of our recon business is probably an opportunity for us to recapture some of this business if -- that we lose over the short term.

And

I think, probably the most important thing I want to call out here is, regardless of the negative impact we have on losing this distribution right here, the fact is, is we're still on track with the recovery.

And though it may be a pain point for us in 2019 and in the fourth quarter of 2018, it is not going to get in the way of that recovery that we've talked about in 2020.

It's a finite thing.

It has a beginning and an end.

It's a distribution agreement that's lost.

It's going to hurt us.

And then it's going to annualize out, and it's gone.

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

I'm frustrated by it.

It's a real headwind for us, but it is something that will start and finish.

And it's not going to get in the way of the recovery.

So with that, everyone, thank you.

I know it's in the middle of earnings season, and it's a Friday.

Really appreciate your time this morning.

Appreciate you joining us.

As a reminder, a replay of the call will be available later today for review on our website, zimmerbiomet.com.

Have a great day, great weekend.

Talk to you soon.

Cheers.

Buh-bye.

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

You may now disconnect.