Zimmer Biomet Holdings, Inc. (ZBH) Q3 2018 Earnings Report, Transcript and Summary

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 Cole 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 would 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. The 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 will now turn the call over to Bryan. Bryan?

Thanks, Cole 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 talked to our team members. We are all encouraged by the progress we are making in a number of areas and I will 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 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 notable timing benefits in the quarter with regard to both tenders and capital sales on the tender front that happened both in Asia-Pacific for us as well as EMEA and on the capital side it was mainly in our S.E.T. business, either way that 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 have banked the revenue, which is the most important thing. So even though you are going to move those between quarters, I would much rather have the sale. So as much as we are 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 facing here in the back half. So, my net message is on maintaining the sense of cautious optimism as I expressed in the second quarter and feel good that we are progressing in the right areas. So with that, I would like to provide an update on the short-term priorities that we have 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 number one priority we have as a business than 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 have 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 are still not exactly where we want to be, but we are making progress and we are 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 our comprehensive supply will not be a barrier to accomplishing our 2018 guidance and I think even more importantly our turnaround timeline is higher than ever. Throughout 2019 though what we need to do is to start shift away from our manufacturing folks focusing on just triaging of product supply and begin to focus more diligently on the rigorous approach to reducing costs 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, the introduction of new products, all of 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 introductions 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 of Persona Partial Knee which is an important space for us and we are seeing very good uptake on the more recently released Persona TM Tibia. By the way we have now surpassed 1,300 cases in our limited launch process and we feel are getting very positive surgeon feedback. Our two 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 timeline and as a matter of fact both are waiting on regulatory approval. Regarding Rosa knee specifically, we are 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 there are some of the media launches that we have had on this, is really a digital platform that allows the knee and hip patients 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 in the iPhone that the patient would have. What we are going to do inside of this is to make sure that we also have a study that will 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 of this will be one of the largest evidence gathering clinical studies in orthopedics 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 this will set of new standard in digital healthcare 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 help to 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 that 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 have been on an absolute tear relative to this area. We have held mission ceremonies with thousands of our team members over the past six months since we launched the new mission. And I would 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 have met with nearly half of the organization to personally engage with them on the one mission, one culture focus of this business. As much I am 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 don’t clearly have a lot of work ahead of us, we have made great progress, pretty much across everyone of our top priorities. And so with that, I am 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 the foreign exchange. There are also a couple of items below our 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 billion, 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%, Americas 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 non-cash 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 $1.49 billion. 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 have just heard, we are 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 are on track with our turnaround and ultimately positioning the company for long-term value creation. And so with that, I am going to go ahead and turn it back over to Cole and move into Q&A session.

Thanks, Bryan. Before we start the Q&A session, I want to remind everyone once again to please limit yourself to a single question with a brief follow-up if needed in the past, I think that’s worked very well to get as many as people in and as many questions as we possibly can do and that’s our goal today. Obviously feel free to put yourself back in queue afterwards, I promise we will get through as many questions as possible and we get to you if we can. With that operator, may we please have the first question?

Thank you, sir. [Operator Instructions] And our first question comes from Amit Hazan with Citigroup. Please go ahead.

Great. Thanks. Good morning, guys. So just a question maybe start with gross margin considerations for ‘19 and ‘20 leverage, thinking 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 potent 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 costs in manufacturing facilities that you mentioned, can that be a 2019 event? Thanks.

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 costs predominately 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 one-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 is 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. Next question, please.

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

Oh, great. Thank you. Can you hear me okay?

Yes.

Yes, Bob.

Loud and clear, Bob.

Great. Thanks. Thanks, good morning. So, I’ll just lay my questions out here. So quickly for Bryan, I was wondering, if you could just touch on two good things for us. Just maybe for you 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 the full launch of the robotic platform for Total Knee? And then for Dan, the one thing I’d love you 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? Thanks very much?

Alright, great. So, Bob, I want to go and get started on the more than one question that you asked.

We’ll discuss that after.

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 bringing up our service levels to our customers. We need to be best-in-class in this area. And I 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 backorder reduction in 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 was the scale. It’s absolutely unmatched. It’s the best portfolio largest portfolio out there, but the promise we have had is it also inhibits our ability to have best-in-class service levels. The fact is we have got to start reducing the size of the portfolio, because it creates a very complex supply chain for us. And I am not going to say that we are 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. And by the way when we do this, not only does it help service levels, it also has peripheral impact to other financial benefits and efficiencies for the organization. So again, I don’t feel like that we are ever going to where I want to be on service levels until we start to call 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 that we have around making sure supply is there, has gotten 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 are ahead of schedule actually and I will 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 is no question, it’s ahead of schedule. First of all, I just want to say that when I referenced ahead of schedule, I want to be clear. That gives me confidence that the overall project is on track 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 have said in the past whether we limited launch in the fourth quarter or the first quarter, it doesn’t really make the big difference to the rollout plan and I don’t think it will have a material impact on our revenue results, but I am pretty happy with the fact that we are ahead of schedule right now, because that clearly tells us we are in the right place and now we are waiting on regulatory approval in the U.S. Also, little more color on the procedures in Australia. We did 5 procedures in one surgical day with one surgeon, so think about that, that’s 5 procedures which is pretty decent low for a surgeon in a typical surgeon, surgery day with one surgeon and that would speak to the efficiency that we are looking to bring to the table with our robotic system and this is the first time if 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 have been saying we are 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 keep us in line with that 2020 turnaround, which is where we are going to be at weighted average market growth consistently. And I think that’s important. One of the things I will say though is that full offense that I am talking about I don’t expect this 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 are going to be differentiated versus our competition and we are going to bring more ammunition to the pipe. At the end of the day, we are not here to play, we are 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 are not providing 2019 guidance on today’s call, we will 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 will be more than 100 bps of headwinds 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 for 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 have discussed and importantly we are going to continue to invest in the business for growth as we have 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 bonus amount. And we will 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 have stated, I would not expect operating margins to expand in 2019, but again we will provide more specifics when we provide 2019 guidance.

Thanks. Next question please.

Our next question is from Josh Jennings with Cowen & Company. Please go ahead.

Hi, good morning. Thanks gentlemen. 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 supply constraints to begin the rationalization of the portfolio, I think you are coming up on the third year anniversary just pass through the anniversary of the Biomet acquisition and just wanted to hear some more details around how you are going to pursue that process and does that risk your return to the weighted average market growth that you are pursuing? Thanks for taking the question.

Yes. Josh I appreciate the question. So it wouldn’t risk our Pursuit of that weighted average market growth if we do it the right way. Here is – first of all we have reduced certain SKUs already, we are just not anywhere near where we need to be. In reality we have got to be cautious at how fast we pursue it because let’s say we have had supply issues as an organization for all the reasons that we have referenced in the past, the worst thing we can do right now when we have been stressing our surgeon partners because of the supply issue is the start taking away products they know and love. And so we do have a 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 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 it would put too much pressure on our ability to service our customers and I think we frustrated customer right now, that’s the reason why we are 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 are going to pursue we just got to sequence it in the right way.

Next question please.

Our next question is from Rick Wise with Stifel. Please go ahead.

Good morning. Let me start with – I will just ask my three questions as well, FDA basically Bryan what’s next, where are we, are you feeling encouraged that the progress you are making there. And maybe a question for Dan, Dan obviously free cash flow, debt pay down as the priority, maybe just help us think in broad terms about free cash flow driving initiatives and how we might think about if u are generating a couple of billion and round numbers of free cash flow this year, what that might look like in ‘19 and beyond? Thank you.

Alright and great, Rick. I will 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 in place. We are on track with the timeline 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 are on track. So and again to the extent that we can we are trying to keep the FDA informed with everything that we are 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 are on track with the remediation timeline and we feel confident with where we are in that process.

And Rick with respect to free cash flow and debt paydown, year-to-date, our free cash flow is $1.049 billion. So, good free cash flow for the first three 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 three times, 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 improvements 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. Operator, next question please.

Our next question is from David Lewis with Morgan Stanley. Please go ahead.

Good morning. So, just questions for Bryan and they’re all kind of centered around 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 is 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? Thanks so much.

Sure.

Before we get there, I want to remind people again, guys, one question per caller, 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 or we’ll see less growth in the fourth quarter revenue growth rate than we did in, in Q3. So your assumption there is accurate, that is the message we’re trying to send. 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 in that 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, a 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. Dan?

Yes, I have nothing to add. I mean, I agree with what Bryan said with respect just to reiterate the fact that our revenue guidance for 2018 remains unchanged other than updating our FX assumptions is the only thing I would add to what Bryan just said.

Thanks. Next question please.

Our next question is from Isaac Ro with Goldman Sachs. Please go ahead.

Good morning. Thanks. Bryan, just want to try and get a little clarification on your comment to the beginning of the call with regards to the timing benefits you got from some of the tendering 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? Thank you.

Yes. So, I purposely didn’t give a specific number there, but I will give you some color around it. Dan referenced the fact that in the fourth quarter we are going to be challenged a bit on the cement side of our business just given the distribution change that’s happening. You referenced that would be between $10 million and $15 million. What I would tell you was 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 will receive in Q4 will be the same thing, something under that range.

Thank you.

Thank you. Next question please.

Our next question is from Robbie Marcus with JPMorgan. Please go ahead.

Great. Thanks for taking the question. 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 there are key components to the turnaround story? Thanks.

Yes. I appreciate the question, Robbie. So, I think we are moving well. One of the things that I referenced in my prepared remarks is we have 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 is 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 will 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 would say much better than it was, but we will not stop there, we will 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 in new products. We have been on track with the new products that we have been referencing. We have been on time. And when you are on time with new products that gives the sales organization alike to what 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 are 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. Next question please, operator.

Our next question is from Craig Bijou with Cantor Fitzgerald. Please go ahead.

Thanks. Good morning, guys. Just want to ask on the recon market, so if we collectively look at you guys and maybe some of your competitors that have already announced the recon market books may look a little bit better in Q3 and recognizing that comps are 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 many of these strength or weakness 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 are getting based on the other things that I have referenced. But there isn’t anything in particular that I am 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, I think Dan you probably feel the same way that would indicate to us that there is 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.

Thanks guys.

Thank you. Next question, please.

Our next question is from Steven Lichtman with Oppenheimer. Please go ahead.

Thank you. Hi, guys. I just want to follow-up on spine, you talked about the distributor work you are doing. Can you update us on the state of the pipeline there, but you have a number of things coming out in 2019, I think ROSA on spine, perhaps in expandable cages, can you just give us your overall state of the pipeline within spine? Thanks.

Yes. I would tell you as you said, the new products is everything for an organization and that to have the channel in the right structure as we exit this year, we are 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’d tell you when you have a kickoff meeting with an organization that’s ready to go and you introduced new products that 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 are still on track with what we have been saying. We are also waiting on regulatory approval for that spine application for ROSA. And for that reason, we are still on track with what we have been expecting, but yes, we have got new products coming, we have got the channel in the right place and we are going to have our first kickoff in a while with that team coming up here in the beginning of the year.

Thanks, Steve. Next question please.

Our next question is from Larry Biegelsen with Wells Fargo. Please go ahead.

Good morning, guys. Dan, I wanted to ask about the implied Q4 guidance, just maybe you can help me with some numbers here. I am 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 should we be thinking about the midpoint at this point? Thanks for taking the questions.

So, Larry, let me jump in there. I mean, let me be clear on this. We have been clear all year. We are 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 am more than happy to take you through all the different puts and takes that we have talked about publicly here and get you through the numbers. We are not going to speak to specific numbers or answering questions about guiding to a specific number in a quarter, we are just not going to go there.

And I would just add, agree with Cole and we have 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 the number of things that affected the third quarter, will affect fourth quarter. I think directionally we are giving you a lot of color here. And in fact we are giving you a lot of color about 2019 in an environment where we are not even giving specific 2019 guidance yet, but I think we are going to draw the line there and not get anymore specific qualitatively, okay. Next question please.

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

Hi, good morning. 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 you be in a position to do acquisitions in 2019? Thank you.

Yes. 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 would like to see us with the current pipeline be able to do more than, 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 are 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 getting us in the 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.

Okay, great. Thanks, Bryan.

Thank you, Glenn. Operator, can we have the next question please?

Our next question is from Larry Keusch with Raymond James. Please go ahead.

Thank you. Good morning, everyone. Just two questions here. Just you referenced and this is not the first time obviously, but you have 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 are thinking about that? And then the second question is just how do you differentiate growth 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 am not going to obviously give too any specifics, because I don’t want to make it clear to my competition, where we are going to be spending our time and effort, but it’s pretty consistent broadly with what I have 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 investment when we come into 2019, that’s exactly what I am 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 are increasing the spend in those areas, so that’s what I talk about, those are the areas of concentration and that’s the reason for the increased investment. When I think of ROSA differentiation, we have 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 can get a clue from what I talked about earlier, which is the first surgeon doing procedures with the system brand new, did 5 cases in a typical surgical day. That would tell you something about I know the way that the robotic system will work with the current flow of a procedure. And that will be one of the biggest things that we talk about, 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 robotic system without dramatically disrupting the surgical flow, which is a big deal.

Thanks. Next question, please.

Our next question is from Kristen Stewart with Barclays. Please go ahead.

Hi, good morning everybody. I was just wondering if you could maybe just talk to the big picture from a operating margin perspective. I think on a year-to-date basis you are running around 27.4%, you have talked about seeing some pressure for 2019. I am just curious on how you think about 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 is 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?

So I am wondering who you are talking about over there at Baxter.

Yes, there are a lot of people. You talked about the ex- Goldman Sachs sell-side analyst or who is that okay?

Yes, I heard it all David Roman that was responsible for.

David is doing a great job over there. So obviously, Kristen, given the history that I have with the individual you are talking about, there is similar playbook that we would put in the place here. I don’t know that the opportunities are as readily available as maybe what you have seen there, but there is always opportunity in the business, 100%. And one of the key areas we are going to be concentrating on would be in gross margin. As Dan referenced, we are going to continue to see some pressure as we come into 2019, because all of 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 is 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 are truly doing zero-based budgeting that we understand why we are spending and where we are spending and we will look to be able to reduce costs where it makes sense. One of the primary things it allows you to do that is to get better focused on growth drivers, we are not as focused as I would have liked us to be as an organization in selecting the markets, they 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. With just that mix shift alone and the efficiency we get out of that focus will drive operating margin expansion. So, I am not committing to it overnight that we have already given some color on this, it was going to take some time, but there is 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 will be talking to the people of Chicago and comparing them to the ones in Zimmer Biomet. Next question please.

Our next question is from Richard Newitter with Leerink Partners. Please go ahead.

Hi, thanks. I wanted to ask a question on ROSA, so I appreciate your pending FDA clearance for spine in the application. So I am just curious about when it’s ready for commercial launch, should we be thinking of a spine application and the 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 or comment on your willingness to pursue volume-based contracts as some your competitors have mentioned that they are doing with their robotics platforms? Thank you.

So out of the gate, well, I want to be clear on, we are waiting on regulatory approval for both the knee and spine applications. They are two 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 are already marketing on the brain side. That system is already out and we are actively selling those units. And once we get regulatory approval on the spine side, 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 three applications in one unit. The benefit associated with that is that you are going to get better return on invested capital for accounts, because you are going to get more volume out of the same unit. We are not doing that out of the gate, we are 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 are 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 we are not in the business of robotic sales, we are in the business of market share. And so we are 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 would also like to add just really a shout out to our team that has made this possible, just remember, we acquired MediTech in September of 2016. So in just over a 2-year time period, we are launching ROSA knee with our ROSA spine coming and just tremendous effort by our team. I don’t want to shout them out for the great job that they are doing. We are excited about 2019 on robotics.

Operator, next question. Thanks, Rich. Next question please.

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

Good morning. Thanks for taking the question. 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 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 facilities?

So let me try to hit this. So on the hip side, we are couple of things there, if you call it out, we had a pretty easy comp that benefited the number, but we aren’t seeing progress. We have supply recovery, which is helping our field sales organization. We have a grade hip line and being able to have that supply, have our sales organization, utilize the supply is translated into benefit in hip for us. Certainly, in the quarter, you don’t expect those quarters moving forward, because it wasn’t an easy comp that made it look as good as 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 hips and knees. But in reality we are 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 like to see it every quarter, but I am going to look at it as, because you always got time in between quarters. We need that improvement to continue and 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 have said before some of that investment that we have been making is specialization in those areas which again should allow us to continue that improvement of revenue growth as time moves on. I am not happy with where we are even let’s call it even if we are looking at the growth rate in the quarter we are in, that was buoyed by comps, we are still not in market growth rate. So we have real opportunity here, real headroom that we need to make sure that we continue to take advantage of.

Thanks. Operator we are coming up on the bottom of the hour, we would look to try to get at least two more questions if we can. Next question please.

Our next question is from Vijay Kumar with Evercore ISI. Please go ahead.

Thanks for taking my question. 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 for next year, but there was also some impact for Q4, so is that – does that mean that $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 this incremental headwinds? Thank you.

Let me start Vijay, on the guidance numbers I would refer you back to the press release where we have clearly stated which numbers we are reiterating, which ones we are not. What we are not going to do is more interpolate additional numbers based on that, again more than happy to take you through the math offline if needed, but we are not to go through specific numbers down the call as I have said earlier. With that let me turn over to Dan, I think...

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 size of between $10 million to $15 million of negative impact in revenue in Q4 and that will continue until we anniversary out of that. Now we are doing a lot to mitigate against that number plus that’s our best estimate at this point in time. The second thing I will just reiterate is when I talked about 2019 I said that’s the combination of FX and the bone cement would be a $0.15 headwind on 2019 that we are looking to 2019 earnings, that’s right, yes. And that’s relative to our last earnings call, right, so $0.15 per share next year that will work to offset to the extent possible.

That’s helpful guys. Thank you.

Thank you, Vijay. Next question please.

Our next question is from Bruce Nudell with SunTrust. Please go ahead.

Hi, this is Stan Fediuk on the line for Bruce Nudell. Thank you for taking my quest. Given the competitors 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 tier 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 would be in spine, whether it would be in brain, whether it would be in orthopedics, recon, I think is a must to have. I think if they are going to be a real player in any of those spaces, you better ensure that you have got a robotic platform that brings some value to the equation. I think it will table stakes to play in my opinion.

And operator, I think we have got time for one more question. Let’s try to do one more question before we wrap up.

Our last question will be from Chris Pasquale with Guggenheim. Please go ahead.

Thanks. Good morning guys. I appreciate you squeezing me in. Hips was a bright spot again this quarter, can you talk about the sustainability of the strength there and maybe contrast the acceleration we have seen in the 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 hips side of the business. I think we saw – we are 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. I just wouldn’t expect Q3 to be a number that you are going to see anytime 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 as we have just not – we have not been delivering that mainly due to supply and as supply is recovering, you are seeing that in the hip number, but again just to reiterate Q3 was up against an easier comp. But as we look for the future, we are very – feel really good about our hip portfolio and what the team can do with that.

Yes. I did want to, if 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 have 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 in the background, 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 are 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 want to be very clear this is a real headwind for us that we are 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 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 we are still on track with the recovery and though it maybe 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 have 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 am 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 early season and it’s a Friday. We really appreciate your time this morning. Appreciate you joining us. As a reminder, a replay of the call will be available later today to review on our website at zimmerbiomet.com. Have a great day and great weekend. Talk to you soon. Cheers. Bye-bye.

Ladies and gentlemen, thank you again for participating in today’s conference call. You may now disconnect.