Zimmer Biomet Holdings Inc (ZBH) 2020 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Zimmer Biomet Second Quarter 2020 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded today, August 4, 2020. (Operator Instructions)

I would now like to turn the conference over to Keri Mattox, Senior Vice President, Investor Relations and Chief Communications Officer. Please go ahead.

Thank you, operator, and good morning, everyone. I hope you are all well and safe. Welcome to Zimmer Biomet's Second Quarter 2020 Earnings Conference Call. Joining me virtually today are Bryan Hanson, our President and CEO; and CFO, Suky Upadhyay.

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 the forward-looking statements due to a variety of risks and uncertainties. Please note, 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.

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

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

Great. Thanks, Keri. And before we get started, I just want to say that I certainly hope that you're safe, your families are healthy and that you're doing everything you can to manage through this very unusual situation that we find ourselves in. Speaking of that, once again, we find ourselves in an earnings call where we're in different places. We're not all together. And my guess is we may have some mishaps potentially anyway when we hand off to each other. So I'm just going to apologize ahead of time for any mishaps that we see through the handoffs here and potential of any background noise we might get.

Obviously, this is an unprecedented time for all of us, a very challenging time as we deal with the pandemic here in the U.S. and around the globe. And we -- as a result of that, I want to talk about the virus today, we want to talk about how we're managing through it, we want to talk about how we're modeling its potential impact, but we really also want to make sure that we spend some time on our underlying strength of the business that we have and our plans for long-term growth.

And along those lines, I'm really going to try to center the conversation around 3 main topics: the first one is obviously, our execution and the financial results in Q2, but really spend time in Q2 on the strength of the underlying business and why we're feeling confident in the things that we can control; the second thing would be around our broader modeling and our assumptions on a go-forward basis associated with the pandemic. It may not be associating as you want there, but we're certainly going to give you the best that we can on how we're looking at it; and then the final piece will be just on our long-term plan for growth. What are the things we're going to be focusing on to be able to get sustained growth in the future.

So first, let's talk about the second quarter. And I want to begin with saying that safety, as I said last quarter, continues to be our top priority: safety of our team members, our customers, our patients, the communities that we serve, and we continue to execute on that comprehensive global pandemic plan that we did develop last year, believe it or not. As I said before, we actually developed that plan before this all happened. And we've been putting that into action at the very earliest stages of COVID-19. And as a result of that plan and our additional safety protocols, we've definitely seen changes to how we work and have learned a lot about how we can more efficiently collaborate across the globe. Significant changes associated with that.

But importantly, these safety-related protocols have not, they have not caused disruptions in our supply chain, in our ability to meet our customer demand and in our ability to serve those patients who rely on our technology and our products to improve the quality of their life. And I'd say I'm really proud of how seriously the entire ZB team has taken our collective safety. And I want to thank each and every one of our team members, especially our manufacturing and commercial teams who have just gone above and beyond during this entire time during a very challenging time. I just can't thank you enough.

So in terms of our Q2 execution and performance, I'm going to cover some broad takeaways. And then I really want Suky, after I finished, to get into more specific detail, maybe more than what we would typically get into just given the current circumstances. So first, the recovery that we've seen to date and really specifically in Q2 is encouraging. It's early, but so far, it's been better than we expected. Based on what we are seeing and really just experiencing in the recovery, there's real reason for optimism. But given the number of unknowns related to COVID, I would say it's more prudent to be cautiously optimistic right now. You're going to hear that theme throughout the discussion today.

We're watching closely and continuing to see rising patient demand, which is key, right? We've got to see that patient demand. And that's resulting obviously in increased procedure volumes. And very importantly, we're also seeing that majority of surgeons and hospitals are ramping up capacity to support that demand. That's a pretty big variable associated with whether or not you can get that backlog patient and the new patient coming in.

And so as a result of this, our Q2 performance was better than we expected across all of our regions. And in particular, we saw strength in the U.S. And I got to say, the U.S. recovery performance is really encouraging to me as this is momentum that we're seeing despite the resurgence of the virus in many of our states. Importantly, this trend is continuing into July even in some of the states that the rising COVID numbers like Florida, Texas and Arizona. So again, even though we're seeing the resurgence of the virus, we still are pretty bullish on what we're seeing in the U.S. so far.

Clearly, and for good reason, everyone is going to focus on the impact of COVID in the quarter and probably even more importantly, its forward-looking impact on our business. And we're absolutely going to talk about that in a minute. But the last thing I want to discuss for Q2 centers more around the things we can actually directly control even during the pandemic and the activities that ultimately will drive durable growth and strength in our business.

So through the pandemic, I can tell you that we have remained maniacally focused on executing against our growth drivers. And that focus is delivering results, and we saw those in the second quarter. So I'm going to just start with what I know everyone wants to hear about: is our progress with ROSA. Obviously, robotics plays an important part of our strategy on a go-forward basis. And importantly, we continue to see very strong demand for ROSA even through the pandemic. And also importantly, we're getting very good feedback from surgeons that are using the system.

And while I can tell you that I'm not going to provide the level of detail I'm about to give you probably ever again, I do want to give you some additional insights into where we are with ROSA and the launch just given the fact that it's being hidden right now with all the clouds, I guess, associated with the COVID impact on our business. So I'm just going to say, so we're now about a year away from the full launch of our business. About a year into that launch. And we now have about 150 ROSA Knee Systems out in the globe. And the good news is we're seeing with those units, very strong utilization per unit.

Now some of those are newly placed, so you're not seeing the same volume yet, but when a system has been out there for a while, we're getting very good utilization per unit. And if I just kind of add it up and I look at the current procedural volumes that we're seeing, we're really on pace to be doing about 3,000-plus cases per quarter. And just to put that into context relative to growth, that's more than double the procedural volumes that we would have seen in the fourth quarter of 2019. And by the way, that's inside of the pressure on elective procedures that we're seeing as a result of the pandemic.

In addition to that, we've got a number of accounts in our active pipeline. A whole bunch of accounts in the active pipeline. Some of those will fall out, but based on the volume of accounts in that pipeline, we'll be very disappointed if we don't have between 200 and 300 ROSA systems out in the market by the end of this year. So I would just say for ROSA, we continue to see very strong momentum. And remain on track -- actually slightly ahead of our expectations for both system placements and procedures even with the pressure of COVID in this environment. So good news, obviously, on the ROSA front.

Another great example of strong innovation in commercial prowess is the Persona Revision story that we're seeing play out and saw play out in the second quarter. Our launch of the Revision System is well ahead of plan, believe it or not, in receiving very positive remarks from current Persona users, which is important. But even more importantly, we're seeing very positive remarks from competitive surgeons, which is where we want to make sure that we're focusing. And some of the key areas of feedback are really a lot of excitement around the ease of use of the system. Significant excitement around precision and the intuitive nature of the instruments that we have, which is important in this procedure. And also the ability to provide all the benefits of a more personalized fit for the patient that Persona brings to the table and do this in a Revision System, which again, is unique in the marketplace.

So just for perspective, the Persona Revision surpassed our expectations in Q2 and delivered the most successful quarter-to-date since launch. Just kind of repeat that. It's the most successful quarter-to-date since launched in Q2, which is the quarter that's been most impacted by the pandemic. The demand is still very robust even outside of that. We already have doubled the instrument sets originally anticipated for the launch to support that demand. And again, for context, this product is on a trajectory to reach close to $100 million in revenue during 2020. Now some of that's going to be cannibalized, as we see cannibalized revenue. And I would expect the cannibalization rate to be about 60%, 6-0 percent. So again, on track to do $100 million, we're very close to it in 2020 and I would expect about 60% cannibalization of that revenue.

And we also have continued our focus on driving our dedicated commercial team for extremities, as I've talked about quite a bit. And we've been very pleased that our Signature ONE Planner shoulder system continues to gain traction again even in Q2. Now the surge in registrations, just to give you some perspective, for Signature ONE increased nearly 60% on in Q2 sequentially over Q1. And our recent FDA clearance also enables even greater integration of that system with our family of implants and [guidance.] And so that's going to open up even more opportunities.

We've also increased the portability of the system. We really try to make a more open architecture so that you can use it on your computer. But you can also put it on an iPad or an iPhone so that if you're walking in and out of the surgery, out the operating room, you can still use the system, create that portability which surgeons wanted. So we're excited, again, about our shoulder franchise and the impact that this system will have on our success there.

And then finally, mymobility. Our partnership with Apple continues to be a prime example of how research and development investment in tech innovation are going to drive the next wave of telemedicine advances. And we truly believe will change the patient and surgeon experience in our space. And with mymobility, what we're really focusing on is ensuring that we have that patient-physician communication link that's even better than it was before, but allowing this to happen more virtually. The system also helps improve adherence to the pre and post-patient requirements. Because that information is pushed to the patient when they need to actually do something. And very importantly, it's advancing the collection and the analysis of patient-specific data points that ultimately can help the care team make the best and most personalized care decisions for that patient.

In June, we announced with Apple, a new application. It's going to be able to provide now gate-quality functionality within mymobility. And that will happen this fall. And that's a pretty exciting development. And a big step forward, no pun intended in this remote data collection journey. Again, with the idea of collecting data that is personalized to the patient and ultimately, as a result of having that, provide better care decisions. So the mymobility functionality in today's COVID environment is especially interesting because it does allow for the significant demand that we're seeing right now for allowing effective and engaged remote and virtual patient care. So we're excited clearly about mymobility, we were before the pandemic, but certainly, this is giving us some additional steam in the marketplace.

So moving to the second key area of focus for the earnings call. I want to talk about COVID-19 and our modeling assumptions for the rest of this year. And we're encouraged by what we saw in Q2 and are confident in our ability to continue to execute. But we understand, and I think probably everybody does, the near-term uncertainty that COVID-19 brings. Our thinking regarding COVID is obviously changing, it's evolving, it's sharpening as we experience more of its actual impact on our procedures. And over time, we're also seeing the impact on various markets and submarkets.

And so I'd like to think about it, just based on that knowledge that we're getting, we can refine our thinking here and explain it really by talking about 3 major variables that I think we've got to pay attention to. One of those variables would be a tailwind for us created by the pandemic and then two would be headwinds that we've got to pay attention to: so the first, when we talk about the tailwind, would just be the backlog of deferred patients that we have built. These are both the initial deferred procedures that we saw in the beginning and the building backlog that's continuing to happen.

From a headwind standpoint, I really look at it two ways: one would be around those patient-specific factors: patient fear or unemployment, for instance; and then the second one would be around the recurrence of the virus. And I would think about that in 2 ways: the recurrence having an impact on actual bed capacity; and the recurrence having impact on policy decisions that could directly impact elective procedures. Okay. So that's kind of the variables that I think about in determining where we think this is going to go. And relative to the backlog, I think it's really important to note that the approximate value of this backlog, just for ZB, just for this company, is already worth about $700 million to $800 million in revenue. Okay, that's the approximate value of the backlog already created is worth about $700 million to $800 million in revenue -- future revenue. And this value continues to grow. I mean the fact is it continues to grow and will continue to grow until the market returns to normal market growth rates. Okay, relative to the headwinds.

Given that we are currently seeing play out, I would say that patient fear and virus recurrence impacting specifically bed capacity are the two most significant threats, while I would say that policy decisions and unemployment concerns will be less material if at least based on the way that we're seeing policy decisions roll out right now.

So the key takeaway. And I just give you a lot of information on these variables that I'm paying attention to. If the variables that I've really just described continue to play out as they are today, we would expect that sequential improvement seen in Q2 would continue through the back half of 2020 but likely at a more modest pace in Q3 and Q4. Correct? So just to repeat that. If the variables that I just described, continue to play out just as they are today. It's just what we're seeing today, we would absolutely expect the sequential improvement that we saw in Q2 to continue in the back half, but it would be at a more modest pace.

And another important aspect of this equation, I think sometimes this is lost so it's an important thing to bring up, is that the 2 most significant headwinds become not on variables, once a vaccine is available. And the vast majority of those patients that didn't get treatment for either of these reasons become a tailwind eventually for our business, remembering that this is a progressive disease. And as a result of the progressive nature of that disease, the vast majority of these deferred patients will eventually reenter the procedural funnel and become a tailwind for us.

Finally, I'd like to also spend a portion of my time today talking about the third category, which is our long-term plan for growth. But they're not all going to be invested in or managed the same. We have prioritized the high-growth and most strategically relevant areas of our business, and we're going to make very disciplined investments, there to continue to drive innovation. Innovation centered around proven patient outcomes and also providing for procedure efficiencies.

And to drive our strategic pillar of top-quartile performance in TSR, we have to focus most intensely on driving long-term growth in these key areas: number one, and I said this before, but number one, we must achieve above-market growth in knees. And just given the size and scale of this business for us, we need to be ahead of market here. And we're going to do that by focusing more aggressively in the fastest-growth submarkets of knee: robotics, data and informatics, revision, like I've just talked about; next, we need to see and drive consistent at-market actually at the higher end of the market range for S.E.T. We need to see that happen for our business. And we're going to do that, again, by focusing more of our attention in those most attractive subelements of S.E.T. Also, we need to consistently deliver at market performance at hips in the short term, that's all I'm asking for is at-market performance in the short term, but transitioning to above-market growth with our future robotics launch in this space.

And then finally, while our other businesses, at least at this point, will not receive the same level of investment, and they will be managed differently, we still would expect that these businesses would drive in-line, maybe to the lower end of market growth, for these areas. Okay. So that's the way we think about our businesses and the way that we're going to invest in them. And by focusing on these markets, just as I've described, we believe that over time, our pursuit of consistent and sustainable mid-single-digit organic growth rates is absolutely possible. Now to appeal the investment needed to drive this long-term growth, and at the same time, drive margin expansion over time, we've continued to focus and execute on our restructuring program.

And the last piece when it comes to long-term growth is our M&A strategy, and this is going to be key for us, and it remains consistent with what we outlined in 2019 and earlier this year. We will continue to focus on high-growth areas and areas where we truly believe we have a right to win. And size is going to be a factor here as well, with a preference, at least at the outset, toward tuck-in deals that we can easily integrate and operationalize while also maintaining an investment-grade rating.

So overall, I think it's obvious we feel confident in our business strength and execution in the current pace of recovery from COVID, in our long-term growth prospects. We've already learned so much from COVID-19. While it's a challenge that none of us would really want to face, the fact is we do believe that it has reinforced the strength of our business strategy, and I believe that it's positively impacted our team engagement and our One ZB culture. And trust me, we will focus on leveraging our learnings to accelerate ZB's transformation. Now at the end of the day, there's a lot of short-term variables associated with COVID that demand a level of caution. But make no mistake. We are very optimistic about our path forward.

And with that, I'll turn the call over to Suky to get into more financial details. Suky?

Thank you, Bryan, and good morning, everyone. I hope all of you are well. I'd like to reiterate Bryan's most recent comments that our underlying fundamentals remain strong and our long-term growth profile is compelling. Before jumping into the specifics, I would summarize our second quarter performance of simply being better than expected. Revenue was ahead of expectations driven by faster recovery in most markets, which led to better margins. And we ended the quarter with a strong cash position and ample liquidity. Net sales in the quarter were $1.2 billion, a reported and an operational decrease of about 38% from the prior year driven by the pandemic. We saw the deepest impact on elective procedures and revenue in April, but then saw a rapid recovery with sequential improvement in May and June.

While we're not at normal procedure volume stat, we are encouraged by the trend since April as all of our regions and businesses performed better than anticipated since our first quarter call. We will look more closely at our Q2 revenue trends, starting with regional performance, and then pivot to our businesses. Moving forward, unless otherwise noted, my commentary will be on a constant currency basis.

Beginning with Asia Pacific. The region decreased about 18% in the second quarter versus the same period in the prior year. While China demonstrated sharp V-shaped recovery since April, posting improvement in May and growth in June, most other markets in the region continue to perform below normal run rates. In Japan, our largest market in Asia Pacific, we've seen a different profile as that market never got to the trough levels experienced in China and was stable in Q2, operating at about 80% of normal run rates. Australia and New Zealand, our third-largest market in Asia Pacific, observed a sharp decline and a sharp recovery within Q2 and continues to make progress back to normalization.

Many smaller markets within Asia Pacific continue to struggle with containing the virus and implementing effective policies. And accordingly, procedures were down substantially in the second quarter.

So there's a wide disparity across the submarkets within the region. But as expected, a common theme is that we see improvement in the number of elective procedures when the infection rates are stable or declining and where there's a deference to physicians and hospitals to make treatment decisions based on the local situation. This holds true for other regions as well.

Moving to EMEA. The region decreased 49% in the second quarter. As with other regions, we observed the deepest trough in April and then saw a steady improvement through the quarter across all major markets, with the exception of the U.K., where patients continue to be deferred at very high rates. Overall, developed markets within EMEA are recovering well. By the end of the second quarter, Germany had started to approach prior year procedure volumes. France, Italy and Spain also improved significantly through the quarter and showed the fastest recovery in the region in June. While not yet back to normalized levels, we are encouraged by this progress. Emerging markets in EMEA are improving but generally continue to lag developed markets in that pace of recovery.

Lastly, the Americas decreased 40% in the second quarter. As we talked about on our last quarterly call, the COVID-19 impact ramped up materially in mid-March, with Federal and state governments' guidance to defer elective procedures. April was the trough for the Americas, but we saw stronger-than-expected recovery in May and June as the U.S. states reopened. In the U.S., while there are variations week-to-week, to date, we have seen approximately 50% of states at or above prior year caseload levels, with 80% of states above 90% when compared to last year.

While progress in the U.S. has been good, other markets within the Americas continue to struggle and operate well below normal levels. For example, if you strip out the rest of the Americas from the U.S., you will see that the U.S. hip and knee growth was actually about 200 to 300 basis points higher than the total Americas number. So clearly, non-U.S. markets in the Americas are still struggling and creating a drag on overall regional performance. Importantly, in the U.S. and in other regions and markets, we are seeing second waves of steep infection growth. However, we clearly see that the health care systems, in general, are better equipped to address the pandemic, such that we're not seeing an erosion of elective procedures at the same level as observed in April. For example, in some of the hardest-hit counties within Texas, we continue to see procedure volumes at 80% or better to prior year volumes, see a similar pattern in other severely hit states. Since the second quarter, in July, we have seen continued progress and sequential improvement in elective procedure trends.

Next, let's turn to our businesses for Q2. Our global knee business declined 47%. As we talked about last quarter, prior to the pandemic, we saw strong performance in this category driven by improved operational execution and the continued positive impact of the Persona Revision launch. As Bryan talked about a few minutes ago, ROSA Knee continues to be an important growth driver for us in the near term and the long term. And our ecosystem strategy in the knee business and other categories is really starting to take traction. Our global hip business declined 31% in the second quarter. We continue to see our hip business recover faster than the knee business, pointing to somewhat less-elective nature of these procedures. And we continue to see strong traction for our Avenir Complete launch.

Sports extremity and trauma sales declined 29% in Q2. This decline was less pronounced than what we observed in large joints primarily due to the nonelective nature of trauma. However, the trauma market continued to be pressured due to reduced activity levels related to widespread quarantine and stay-at-home orders.

Dental, spine and CMFT sales declined 37% in the quarter. We've seen stronger recovery in spine due to recent new product introductions, including Tether. Also, much like our hip business, spine procedures are seen as less elective by many physicians and patients primarily due to the pain burden. Finally, our other category was down 44% versus the prior year.

Looking beyond Q2. As you know, we withdrew our 2020 full year financial guidance in April due to the uncertainty related to procedure volume uptick. The impact of COVID-19 continues to be fluid, and there are a number of market dynamics and variables that we are unable to reliably quantify at this time. As such, we will not be providing updated financial guidance for 2020, but we do want to share information and insights that may provide shaping of our revenue expectations for the remainder of the year.

To give you a sense of the sequential improvement we saw through the second quarter, remember that on our first quarter call, we noted that revenues were down about 70% in April across the full business. By the end of the quarter, in June, that decline was only 3.6% down. However, it's important to note that there was an additional selling day in June 2020 versus June 2019. After adjusting for the additional day in 2020, June was down 13.5%. There was no day rate impact on the full quarter. So the key takeaway is if the variables that Bryan described earlier continue to play out as they are today, we expect a sequential improvement seen in Q2 to also continue through the back half of 2020 but likely at a more modest pace.

Now let's turn to our P&L and liquidity. We've taken a disciplined and proactive approach to mitigate the earnings impact of the pandemic and to enhance our liquidity profile. Results in the quarter were a little bit better than expected since our first quarter call, and we would expect margins, earnings and cash flow to improve as our revenue profile improves moving forward.

In terms of our second quarter results, we reported GAAP diluted loss per share for the quarter of $1 and adjusted diluted earnings per share of $0.05. GAAP earnings per share in the second quarter were negative and lower than the prior year due primarily to the impact of the pandemic, and I will speak to that as part of our adjusted results. Adjusted earnings per share were lower than the prior year driven by lower revenues and higher cost of goods. Adjusted gross margins were 65.5% for the second quarter due to less favorable mix and lower fixed cost absorption as a result of decreased production volumes. Adjusted operating expenses were lower due to reduced variable selling expense, the continued early impact of our restructuring program and cost reductions we actioned to deal with pandemic. As we previously discussed, we were able to flex quickly on COVID-19-related cost reductions in the first quarter by leveraging the restructuring programs already in place. Overall, adjusted operating margin for the quarter was 5.7%, substantially lower than the prior year, but again, a bit better than what we expected on our first quarter call.

Moving beyond operating margin. Net interest expense of $54 million was down versus the prior year due to debt paydown in 2019. And our adjusted tax rate was 42.8% in the quarter. Our adjusted tax rate was distorted in the quarter due to discrete tax expenses on a small base of pretax income. We do not expect that trend to continue moving forward.

Moving to cash and liquidity in the quarter. While free cash flow was negative $145 million, we ended Q2 with higher cash and cash equivalents of $713 million, further strengthening our liquidity position. Also, we continue to maintain $2.5 billion in additional liquidity through our credit facilities, which remain untapped. We believe we are well positioned from a capital structure standpoint.

In terms of our P&L for the remainder of 2020. We expect that operating expenses will continue to ramp up in the second half of the year when compared to Q2 as we resume higher investment levels in R&D and commercial initiatives in tandem with higher revenues. Interest expense will be a bit higher in the second half of the year versus the first half driven by the refinancing of debt this year and the additional $1 billion facility put in place. For the adjusted tax rate, a full year rate is expected to be about 100 basis points higher than what we originally guided in February driven by a change in geographic mix of income due to COVID-19. Overall, we expect that margins, earnings and cash flow will improve as our revenue profile improves. From a longer-term perspective, we remain committed to achieving at least 30% operating margin in 2023 as we continue to track well versus our restructuring plans.

To summarize, our underlying business and our financial fundamentals remain strong such that as the market continues to improve, we expect our financial performance will also improve. I continue to be extremely proud of how the ZB team has responded and performed over the past few months. We believe we're well positioned to address the current challenges as well as accelerate our growth profile over the long term.

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

Great. Thanks, Suky. In closing, it's clear that the challenge of COVID-19 has been significant to ZB -- to many, obviously. But we're also very encouraged by the early days of recovery, and I think really importantly, our ability to rise to that challenge as a team. And I'm going to leave you with 3 points from today's call that I hope you take away: the first one is that the Q2 recovery clearly happened faster than expected, and we are encouraged as a result of that. But we are still cautiously optimistic about the performance in the back half of 2020 just due to the variables associated with the pandemic that we still have to manage through; and two, while our business has been impacted due to COVID-19, our strategic focus and our progress has not been disrupted. And if anything, this challenge has provided us with learnings that are enhancing strategic components of our business; and then three, we feel very confident about our underlying business strength, our core business strategy and Zimmer Biomet's ability to drive long-term growth and value.

I'm just going to take a minute before we close out the Q&A to say thank you to each and every one of our team members around the world. They're doing just a fantastic job. And your commitment and dedication to ZB enables us to deliver the value to our customers, to our patients and to our shareholders.

So with that, I'm going to turn the call back over to Keri, and I'm looking forward to your questions.

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

(Operator Instructions) We'll take our first question from Rick Wise with Stifel.

Bryan, thanks for all the detailed information. Maybe if I could ask even more selfishly, if you could expand a little more -- give us a little more color on how you're thinking about not just the [kicks] but the drivers of recovery from here you highlighted to a bit. But when I look at the second quarter numbers and the weighted averages for the ortho market, for both hips and knees, it looks like to me, Zimmer did outperform declined less than the group averages, both worldwide and U.S. specifically. Maybe help us better understand specifically the drivers. Is it execution? Your execution focus? Your new products for Knees, ROSA, is it all of the above? Where do you think the emphasis points? And just bottom line all this, what's the setup then as we look at '21 and beyond? How quickly can you get to that mid-single digit absolutely possible kind of growth?

All right. Good. Thanks, Rick. That was a lot of questions in there, man. So I'm going to try to tackle this and maybe in two categories. One, I think I'll just deal from your question is what's kind of driving the underlying strength of the business. And I'll give a little more color on that versus what I had in my prepared remarks; and maybe the second piece of it is just broadly speaking about the recovery from COVID, just any deeper thinking there. And then maybe I'll pass it over to Suky to get into some detail on maybe a little more detail even on how we're looking June, July, and what we think that's going to mean on a go-forward basis.

But I would say, first of all, the things that we can control right now are extremely important to stay disciplined on. So I truly do believe that's the reason why our strategy is being executed as flawlessly as it is. And that's really important to us. Some of the major things that are allowing us to happen is, number one, we don't have the supply issues that we used to have. And you remember when I used to talk about this. There was going to be post-traumatic stress disorder from the commercial organization in this category, and they wouldn't believe us for a while that it was actually solved. They do now. They're not wasting time anymore on this. They are fully focused on driving new business. That's a big part of it.

The second piece to that is you've got to have new products, you got to have innovation. Having supply is just basic hygiene. You got to move past that and actually bring new products to the table because that's the lifeblood of a commercial organization. And that's what we're giving them, giving them new technologies that I already talked about, and they are delivering in those areas, sticking to the commitments that we had. The other big one is that we have dramatically changed the engagement between the senior management of this organization and our commercial organization. There was distrust there before. That does not exist anymore.

And the combination of those things, I would tell you, we've got a swagger back in the ZB commercial organization. And that swagger goes a long way when you're talking about getting out in the field and getting things done. On top of that, we've also got a changed compensation program that's more focused on growth. It's biased to paying people to grow and less biased to those that don't. And we also have operating mechanisms with discipline to hold people accountable for delivering that we did not have before. So those are the things that -- the things we can control that are driving positive momentum in the business and will continue to drive positive momentum in the business.

Outside of that when we talked about COVID, I would stick with the variables that I mentioned before. And when we think about those variables, that idea of the headwinds being patient fear and recurrence of the virus, now those are big variables. And they're going to be unpredictable, unfortunately. There's no way to predict what they're going to do in the future. That's why that volatility exists, and we're not giving specific guidance moving forward. But I think sometimes the best way to try to get a sense for what's going to happen is look at what's happening right now because we are seeing the resurgence of the virus in many areas. And as a result of what we're learning in those areas, it would give us some feel for what happened on a go-forward basis.

So maybe with that, I'll just kind of flip it to Suky to be able to talk more specifically about what we're seeing right now and maybe that will give you some color on what we think is going to happen going forward.

Great. Thanks, Bryan, and thanks for the question, Rick. So we clearly saw really good performance and improvements through the back end of Q2. As I talked about for June exits, on a day rate basis, we're down 13.5%. That compares to being down 70%, if you recall, back in April. So clearly, a pretty steep V-shaped recovery in the quarter. Now inside of that, what we saw was Asia Pacific was about that overall company average, plus or minus. Some of the areas we're really watching in Asia Pacific, our second- and third-largest market, China and Asia -- oh sorry, Australia and New Zealand, performing really well, getting very close to where we're at-normal wise run rates. The other big watch out for us is Japan, which continues to operate in sort of that 80% to 90% range, and that is our largest market, so we're keeping a close watch on the recovery in that particular market. And of course, we're still really struggling in a lot of smaller markets in Southeast Asia.

As we turn to EMEA, relative to that overall company average of down 13.5%, EMEA was down significantly more than that. And that's simply because the recovery just started later in the quarter for that particular region, seeing really good uptake with our larger markets, but we've got to keep our eyes on the U.K., which continues to defer at a very high rate. And emerging markets is lagging. That was already a pretty lumpy business with tendering. COVID has just made it that much more difficult to predict a trend. But again, recovery in the biggest market within EMEA has looked really good in the back end of the quarter.

Then you turn to the Americas, and this is probably where we saw the biggest and sharpest return in the second quarter, and as Bryan talked about, a little bit ahead of our expectations. Within the U.S., we're seeing really good traction. We do continue to get hit in some pretty-hard-hit states, as we talked about, Florida, Texas, Arizona, but nothing compared to the first wave. Those particular markets are operating in the 80% to 90% range. And what we're seeing is some of the states that have recovered a little bit later, like New York, New Jersey, some of the Northeastern states, they're operating close to 100% or maybe even some aspects or some parts growing above 100%. So you're seeing that offset some of the harder-hit states.

So again, the U.S. is overall trending pretty well, but we're keeping our eyes on that second surge. I think within Americas, however, we're seeing a pretty big headwind from Canada, and more importantly, from Latin America, as those particular markets continue to struggle. And just to try and kind of emphasize the headwind that we're getting from those markets, if you actually look at our U.S. knee number, for instance, there was about a 200 basis point headwind by including total Americas. And so if you excluded Americas, our U.S. knee number was about down 44.7%. So again, about 200 basis points better. And that's even with a tough comp on ROSA. And then our U.S. hip business had a headwind of about 300 basis points when you include the rest of Americas in it. So clearly, the rest of the Americas is the piece of kind of masking even better performance in the U.S.

So as we think about things going forward in July, sequentially, things got better than where June was. And so that's a good second-leading indicator that. However, July was still down versus prior year, okay? So better than June but still down. And when you think of the composition of the regions I talked about, it's very similar to what we saw in June. America is a little bit better than the overall company average in July, APAC kind of in line and EMEA a little bit behind. So hopefully, that gives you a little bit more color. Sorry for the long answer, but I know that's a question on a lot of your minds, so we just wanted to address it proactively.

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

Just two for me. One, Bryan or Suky, just on recovery. Bryan, you mentioned this $700 million to $800 million backlog. I just sort of wonder how much of that has been worked out. And I'm assuming this dynamic of schedule versus rescheduled patients is why you said recovery is less deep in sort of the back half. But just if you can talk about that backlog and whether you think you can get back to growth in the fourth quarter? And then I had a quick follow-up on ROSA.

Okay. Great. So what I would say is that $700 million or $800 million is still out there. So I would say that's the amount of backlog that is still out for future revenue. And none of that is -- I'm counting as being already captured. I do believe that when you think about the backlog, again, you've got to separate it into 2 different categories: first category would be those patients that were deferred in the very beginning.

So you absolutely know they're deferred patients; and the other portion of that backlog are those -- I'm just going to call them category 2 patients, which are kind of just building right now, and we'll continue to build until we get back to market growth. And so that $700 million to $800 million will be future revenue for us. My sense is that first category of patients, those are deferred initially, will likely be completely run through by the time we get to the end of 2020. Or most of them will. But you're still going to have a pretty significant backlog left for 2021. And I would say the way you could calculate that is when you look at the overall market growth delta between what we actually did in 2020 versus the market growth, whatever that delta is, in those procedures that are elective and also are connected to progressive diseases, a large majority of those patients will come back into the funnel.

So if you just look at that delta, let's say, you had 100 procedures less than typical market, you could take probably 80% of those or 80 procedures and say, "That's my backlog that will come into 2021." And so that's kind of the way I'm thinking about it. The challenge is that you have these big variables that are still moving out there around patient fear and the resurgence of the virus. So it's difficult to say that the backlog coming back in is going to give us that tailwind that we want without the negative impacts of those 2 variables. But what I would say again is if we can move to the point where we have a valid vaccine or an effective treatment, that takes those 2 variables off the table. And then you've got the backlog as a tailwind, which would be significant for us.

And so you could see a pathway, I guess is what I'm saying. If things stay about the same, as you come into a vaccine in to remove or mitigate those 2 negative variables of very strong growth in 2021, the challenge is those variables and I'm saying they need to go away are pretty significant and we just don't know if it's going to happen or not. But certainly, you could see a pathway, just given, again, that backlog volume of strong growth in the back half in 2021. It just depends on how those other 2 variables play out.

Okay. So just a follow-up there. It's hard to be definitive on fourth quarter growth. I think it's what I'm hearing, but just want to get your comment there. And then just -- I'll ask my second question as well. Just on ROSA. Bryan, obviously, that number is probably materially ahead of where the industry was thinking on ROSA placements and thanks for the detail. So did placements accelerate here into the second quarter? I'm just curious, has the selling structure around those placements changed at all as related to usage-based agreements? And can you just give us some sense from a competitive account perspective where those systems are being placed? What percent of traditional Zimmer majority accounts versus competitive share capture?

Yes. Absolutely. So it's a combination. I would tell you that we are absolutely looking at both competitive as well as friends and family. So we -- even though the original strategy was to focus just on friends and family because we've got a huge opportunity just given the amount of implant percentages that we have in the market, we are definitely seeing competitive situations. And we're winning in those areas.

When I think about ROSA in general, I would just say that we continue to see sequential improvement in placements. And believe it or not, even in Q2, there was no disruption in that sequential improvement. That just speaks to the maturity of our commercial organization, the maturity of the pipeline of potential customers that we have and our ability to translate that pipeline into actual sales. And I would expect that to continue. I would say that more recently, as I referenced before, the mix in the way that we're placing these is different.

Most customers previously wanted to buy. Now we're seeing a shift to this opportunity to acquire the technology through volume commitments, which in reality, as I've stated before, is actually the preferred method of placement for us. I would much rather have that annuity revenue that -- linking me to the customer for a longer period of time than have an upfront capital acquisition. And that's what Suky referenced before. If you look in Q2, if you look at our knee performance in the U.S., for instance, we actually had a headwind associated with robotics versus last year. It was actually a slight drag to our growth rate in knees because we had sold more last year than we did this quarter. And so again -- I think, again, the pipeline is strong, excited about the product line we're seeing continued sequential improvement quarter-over-quarter.

We'll go next to Matthew O'Brien with Piper Sandler.

Just a follow-up on the ROSA side of things. When I look at, Bryan, the number that you're thinking that you're going to have in the field this year, that's around 200 compared to how many you had out that you're going to be placing this year versus what you had out last year. So that's pretty similar to what the market leader did as far as system placements last year in this category. So what I'm trying to figure out is, kind of to David's question, what's the split between friends and family versus competitive accounts? And are you seeing a building improvement on the competitive account side as we speak or kind of as you're looking forward? And I do have a follow-up.

Okay. Yes. So I would say -- without giving specifics, I would say that the competitive accounts are probably greater than 50% of the placements. And again, that's even increasing as we're finding more customers looking at this opportunity to bring in the system based on volume commitments. So almost by default, to be able to get a system place like that, you've got to have a competitive situation so they can commit that volume to be able to get the robotic system placed. So I'd say it's north of 50%. And it looks better right now because of the placement strategy shift, not from us but from our customers.

Okay. That's helpful. And then on the revision side, and I didn't hear much on cementless. I may have missed. It, but when I look back historically, you've lost, I think, somewhere around 300, 400 basis points of share on the revision side. Cementless is anchored, primaries in total, I think there was a couple of hundred basis points. So there's a lot of users out there that are familiar with Zimmer. Are those the ones that you're getting back the quickest right now? Or are you even going into new accounts that you hadn't really been present before because of those new systems, because of ROSA? And to sum it all up, you feel comfortable, again, understanding there's some variability about outperforming the knee market, broadly speaking, over the next couple of years?

Yes. I'd say on the cementless side, we continue to get traction. I think we're -- our product is being well received. And as we see more penetration of robotics in our accounts, you're going to see -- by the very nature of robotics and the capability to do cementless more comfortably, you're going to see a continued increase in the cementless percentage of our business. What I would say on the Revision side, it is absolutely a tip-of-the-spear product. And we're clearly going into accounts that have been using Persona and have not been able to use our Revision system. And we're picking up those accounts. Those are the obvious ones. But it's such a good Revision set that we're getting competitive surgeons that want to move to this. And as a result of that, we'll get primary pull-through as well. So as much as that's an exciting product, when I talked about the close to $100 million opportunity there for this year, that's not including the pull-through that we would get when we have competitive conversions on the primary knee.

We'll take our next question from Robbie Marcus with JPMorgan.

Maybe just a quick clarification. In the script, you said that at the end of June, the decline was only 3.6%, but adjusted for selling days, it was down 13.5%. Is that just more the exit rate of June versus the full month, or is there something else going on there?

Hey, Robbie. That was the full month of June as opposed to the final weeks.

Got it. Okay. And then maybe, Bryan, it sounds like if I go back to dental and maybe spine, when times are tough, it's easier to revisit different parts of the business that might not be some of your top performers have the best growth rates going forward. How are you thinking about some of your businesses that have been underperforming lately? And how are you thinking about potentially improving or monetizing them in this environment where there are a lot of willing buyers out there with recently raised capital?

Yes. So I think the first focus is, as I said in the prepared remarks, we have certain businesses and sub-businesses that will be the primary areas of investment. But what I want to make very clear is that does not mean that the businesses outside of that are not important to us. And it does not mean that I don't expect results in those businesses. And they are getting investment just not the same level. So I fully expect my businesses in dental, spine, CMFT, that I did not name as areas of extreme focus, I expect them with the investment they're getting to perform. And if I think about spine specifically, we've got an opportunity there to do that.

Now it's got to happen in a few different ways. We've had a lot of flux in our commercial organization. That is now stable. Well, that stable commercial organization has to turn into a productive commercial organization. We have Mobi-C, which is the best cervical disc in the marketplace. We got to get traction with that. We have -- that is a tip-of-the-spear product that we have not been taking advantage of, and I need to see that. And we have Tether that Suky mentioned in the prepared remarks, that is a innovative change that dramatically changes the patient experience in scoliosis patients. That is an exciting product that we need to be able to use. And we have ROSA. So we've got the components of success in spine.

With the investment level that we have, I need to see it transpire in the same way that we saw with the similar investment level, dental, perform. And so I just want to make sure that it's clear that just because I don't have those businesses as one of the primary growth drivers of the organization, it does not mean they're not important to us, it does not mean that we're not going to continue to invest at some level and it does not mean that I don't expect results.

We'll take our next question from Philip Chickering with Deutsche Bank.

The first one is I wanted to follow-up on David's question on $700 million to $800 million of backlog. I understand that the backlog is out there, but any chance you can give us the color as to procedures you guys saw in June or July? Where is the split between deferred procedures that happened versus newly diagnosed cases that were done? I'm just trying to understand the price of recovery and the sustainability on that recovery.

Yes. What I'll tell you is that although we do collect data on this, it's becoming more muddled. And the reason why is because you've got a complete mixture now of what is a deferred patient. If you look at just those folks that we knew were deferred, then I can get a sense for how many of those are coming through. But when I look at truly this growing backlog of deferred patients, it's difficult to know which one of those is a new versus a deferred that's created as a result of COVID. So it is becoming muddled.

I think the easiest way to look at it is, again, is to go back to in those areas that we have: large joints, shoulder. Those areas are elective but are connected to a progressive disease. I would just look at the delta in market growth, and just know that 80-plus percent of those patients are eventually going to come back in. And I would stop worrying as much about what is a deferred patient, what is a new patient. I just look at the total deficiency to market and know that as history shows, those patients eventually come back in the funnel at a pretty high rate. So that's the way we're thinking about it. I think spending too much time now trying to understand the deferred to new patient mix. Is just -- it's too muddled. It's too challenging to understand what that actually means.

Okay. A follow-up there. August is typically a pretty slow month, certain state vacations. Any color from your sales force about how they see surgeon demand in August? And do you think that docs are motivated to work through their backlog and provide good growth on easy comps?

I'd tell you, it's interesting because, particularly in Europe, you see August being a challenging month because a lot of holidays. But even in parts of Spain, what we're hearing is that people are going to take fewer weeks of vacation to be able to deal with some of the backlog. And that is an area that you typically don't hear that type of response. And it's the same pretty much around the world. The general feedback that we're getting from surgeons and hospitals, that they're going to take fewer days of vacation to try to work through the backlog. Everyone recognizes there's a bolus of patients that need to get served. And my general sense is that you're going to see people try to work through that backlog. The only time that you would see maybe a -- something that would look different than that is in the public health system in Europe, where you just don't have the same incentive to be able to work through it and potentially, sometimes even the budget to be able to work through it. But generally speaking, I'm getting very good feedback on the desire to work through the summer, work through this backlog and take care of patients.

We'll take our next question from Matt Taylor with UBS.

So it's really interesting to hear the color on the ROSA System placements and utilization there. And I wanted to focus on utilization for a second. I haven't asked as much about that. You saw pretty strong lease despite these payment conditions. And I guess, I was hoping you could provide some outlook for that and maybe benchmark it versus other systems that are out there, where do you think utilization could go in the coming quarters for these ROSA systems and at maturity?

Yes. My sense is we could see continued increases of utilization per system. And again, remember, go back to the tenants that we had in place as we designed the system. One of the primary things we focused on was to make sure that it did not disrupt the surgical flow. It did not change the time to do a procedure. And that's what we're finding actually happening. So the good news on that is that the surgeon can digest it more easily because it doesn't change what they do as much. It just makes it better. But what it also allows is more surgical volume, right, using robotics because we don't slow the procedure down. And so I would expect as people get more comfortable with it, and they see the difference in outcome for patients that use robotics versus not use robotics, I would expect it to continue to go up per unit. And then obviously, as we place more units, I see those procedural volumes increasing pretty quickly.

Great. And another follow-up. And people have alluded to the deposits surprise here you being able to push that forward in a tough environment. Do you think that hospitals are benefiting from stimulus? Or how have they been able to continue to make these kind of capital investments or other arrangements despite the disruption and pressure on their budget?

Yes, I really do. We were very concerned out of the gate that we wouldn't be getting paid by hospitals, let alone seeing this kind of traction. And I think the stimulus did help. I think it took the pressure off. And it made hospitals feel more confident and comfortable to be able to continue to move their strategy forward. And so our receivables, for instance, never really got significantly damaged during all this because I think they felt comfortable with that liquidity. And we really haven't seen much of a change in demand. I mean, initially, for sure. I mean people didn't know what was going on. They didn't know for sure what was going to happen. So there was a month period of time where it was a little bit of chaos. But as you work through that and people felt more confident and comfortable in liquidity, things got back to normal pretty quick. I say normal. Clearly, that's not actual normal.

We'll go next to Richard Newitter with SVP Leerink (sic) [SVB Leerink].

Maybe just on ROSA. I think what are your competitors, the leader in the markets that they saw a high proportion of placements, better-than-expected placements into the ASC setting. I'm just curious if you could comment at all on whether you might have been seeing ROSA get in place into the ASC. And within the context of that question, how Zimmer maybe a position to benefit from, or to fill an impact on, the accelerated trend through the ASC setting more broadly?

Yes. I mean, clearly, you would see a natural desire from patients, I would think, to be in a nonhospital setting, just given the issues around virus fear. So it's not surprising to me that we're seeing some additional pace moving to the ASC from a procedure volume standpoint. And we are absolutely ensuring that commercially, we're going to be ready for that. We've already focused on it, obviously, but we're going to put that on steroids now.

And I would say from a robotic standpoint, it plays quite well for us. Remember that you do not have to have a CT scan to be able to use a robotic system for ROSA. And that helps us quite a bit in the ASC setting. And I also will go back to this idea of throughput. These are business people in the ASC setting. Volume is very important to them. They have to get the throughput of patients to be able to get the same reimbursement and to be able to get the business dynamics that they want. And that ability to use our system without a change in time really matters to them. So again, I think it bodes well for us quite frankly. And I'm very happy to hear that our competitor also saw a surge in robotic placements. It tells you that the demand for robotics is real, and the penetration of robotics is still very low. And that to me is an opportunity for everyone who has a real robotic solution.

Got it. And then, Bryan, just for my follow-up. I'm curious on the M&A front, I appreciate you're going to start off smaller tuck-in. I'm just curious, in the wake of COVID, has that in any way changed, maybe where you likely initially focused on the types of acquisitions or anything that now, just on a go-forward basis, might fit more strategically into the business as you look forward?

Yes. Let me -- I'll answer that very specifically, but let me pull up this for a second because I think it's helpful context because we are in a phase now where I feel much more confident and comfortable moving into active portfolio management, and we will absolutely move in that direction. But it was important to get there because I kind of think about this positioning this company or transforming this company for success in 3 phases: the first phase was kind of obvious to everybody. We had to triage the patient, right? We had real problems around culture, mission, connection just wasn't there. We didn't have the top-level talent that we needed to be able to move the business forward. We had supply issues, quality issues. We had a DOJ monitor in the house.

So we had all these things that we had to fix. And I'm not saying that we're not going to continue to focus in those areas because it's going to evolve, but that was kind of Phase 1. We had to fix those things; Phase 2 was more around shifting to innovation. Had to get new products out in the market. We had to be able to crystallize our strategy and our focus and our strategic pillars, and then make sure we have the right organizational structure to drive that. So all those things kind of happen in Phase 2, and we've got to have the operating mechanisms to make sure that we deliver on those things; Phase 3 really comes around portfolio transformation. And that's exactly what we're going to be focused on.

And yes, I would tell you that the insights that we're getting from COVID, because we're learning every day, and we're applying those insights into the way that we're going to manage our strategy, didn't fundamentally change the strategy, but it's augmenting the strategy. And I would tell you that we will have a focus as we look for diversification and being able to get better penetration in the ASC to be able to continue to focus in those subcategories in S.E.T. that we know are going to be attractive and to be able to think about acquisitions now to get us away from our dependence on elective procedures. So there's a lot of different vectors that we're considering now in the way that we're going to look at potential opportunities for acquisition. I would still say, as I said before, there are going to be smaller tuck-ins for now because our access to liquidity isn't quite the same just given what's going on right now. And we want to make sure that we stay investment-grade, but we are clearly focused right now on active portfolio management.

That will conclude our question-and-answer session. I'd like to turn the call back over to Keri Mattox for any additional or closing remarks.

Thanks, Katie, and thank you all again for joining us this morning. If you have questions, please do not hesitate to reach out to the IR team. You can also find a replay of this call on our website, zimmerbiomet.com. Thanks so much and have a great day.

Thank you again for participating in today's conference call. You may now disconnect.