Good morning, ladies and gentlemen, and welcome to the Zimmer Biomet Third Quarter 2020 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded today, November 6, 2020. Following today's presentation, there will be a question-and-answer session. At this time, all participants are in a listen-only mode.

[Operator Instructions] I would now like to turn the conference over to Keri Mattox, Senior Vice President, Investor Relations, 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 third 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?.

All right. Great, Keri, thank you. And here now with our third virtual earnings call, it was hard to believe that so much time is already passed as we live inside the pandemic environment. But either way we're here, and I certainly hope that you're listening somewhere safe and socially distanced.

We're clearly taking precautions here and we continue to follow our safety protocols and that's the reason why Keri, Suky and I are in different locations again for this call. As we've seen in the past hopefully we again do not have any jet mishaps, but just know if we do for whatever reason will push fast and make sure that we move forward.

So, 2020 has clearly been unlike any of the year in ZB's nearly 100-year history, as I'm sure it is for every company that's out there right now. And as you know, I think we're all probably too aware, it's not over yet, it's definitely not over year.

And that said, I have to say that look at how we have managed and just really navigated COVID-19 this year and specifically in the third quarter. And I'd say that I'm proud of the team, I am confident about ZB's future, I'm more confident now than they ever have been about ZB's future.

I truly believe we are well positioned for success and our strategy is absolutely working. As you all know, we've been acutely focused on transforming ZB since I joined the company that's almost three years ago now.

We face challenges before and while nothing could have ever prepared us fully for COVID-19, I do believe our ability to rise to those earlier challenges and then truly put us in a stronger position to effectively manage the pandemic situation, the environment that we're in right now. I actually think it's been a catalyst for ZB.

The team is focused on our mission, our strategy, how we show up and execute every day is the strongest it's been since I joined the company. And the way I look at it is the things we can control, we are absolutely galvanized around and executing flawlessly against. So, it feels good right now it's much as it's noisy around as the COVID.

The execution inside the organization is as strong as I've seen. And that said, the unpredictability of COVID means there are several variables and unfortunately they are pretty big variables that are outside of our control. And as a result, the pandemic continues to be challenging. It continues to be fluid.

This requires us to quickly adjust to change given the changing environment. So, ultimately, we can effectively meet the needs of our customers, and very importantly our patients at all times and that's exactly what we've been focused on.

Along those lines, there are really three key areas that I'm going to talk about today that I think are important for you take away, be aware of and also see the progress that we're making inside of each. The first one, you should be pretty obvious, it's our view of the COVID-19 recovery path from here, where we see it going.

And I think importantly inside of that the areas of concentration or execution that we're going to have inside of the COVID recovery path. The second is an update on our strategy to drive long-term growth and through that value for ZB and for you.

And the third is an update on the ongoing transformation of our business, which I truly do believe we're making great progress on. And again I'll spend time on each of these and then I'll pass it to Suky, he's going to give you more detail and color about Q3 on the financials and then how we're thinking about and framing Q4 in our minds.

So, first, let's talk about the recovery and execution we saw in the third quarter. Ultimately, the recovery of the electric procedures going from Q2 to Q3 is encouraging. I would imagine is encouraging for everybody at this point looking at Q2 to Q3. But it's still difficult to predict from here what's going to happen.

The fact is, we've talked about how the key variables impacting procedure volumes needed to remain constant, obviously they can improve, but they needed to at least stay where they were for the recovery to continue and to see sequential improvement from Q2 to Q3.

As you probably remember that we said that these variables included both positive and negative influences on procedure volume. On the positive side, which we pretty obvious, we have the new patient volume and in the backlog of patients that had deferred treatment during the pandemic for whatever reason.

On the negative side, we have the effects from the economic downturn, but most importantly surges in the virus that can drive negative policy decisions and/or increased patient fear.

Those would be the negative influencers, obviously, if I look at the combination of those in terms of recovery in Q3, the variables played out in a way that allowed continued improvement over Q2. So, overall, the full quarter were stronger than expected and we actually returned to growth over 2019 faster than we thought we would.

And this was driven again by these COVID recovery dynamics, but importantly, our team's strong focus on and probably even more importantly execution against our strategy. We've been very focused on moving the strategy forward regardless of the noise around us.

We saw a steeper rate of recovery in July, followed by a more modest recovery or even a flattening of the curve toward the end of the quarter. And this was driven by the shift in the recovery variables that I just outlined a minute ago.

We've seen continued increasing surges of the virus, especially in Europe, Middle East and Africa and in the US, and this is negatively impacting both patient fear and in certain areas policy decisions. And as a result, we exited the quarter with September growth flat versus 2019.

There is not much we can do just end the virus surges, but we have launched a unique and a very large scale direct-to-patient campaign focused on patient fear, right.

So, we can't influence the virus, but we could try to influence patient fear and the focus of the campaign is to educate and support patients about their options to get procedures during COVID and really even beyond focusing on the fear the patients typically have to come and get a procedure.

And what we're finding early on in this campaign is that the feedback has been very positive and in particular associated with the concept of mymobility and its ability to allow for virtual care capabilities during this challenging time. All right. So, those are obviously some of the factors surrounding COVID and its recovery dynamics.

But I also want to make sure that we spend time talking about the things that we have more control over, the execution of our strategy and the performance of our business inside the impact of the pandemic. And even in the midst of this turbulence, we continue to deliver against our goals.

This focus and execution against our strategy is the reason we have performed well over the last two quarters versus the overall market. And specifically, if you look at Q3, our performance in US knees and hips is a great example of this underlying momentum. We grew 3% in the quarter in US knees. We also saw 10% growth in US hips.

Like I said, these numbers are strong even without the backdrop of COVID. So, the question is going to be, what's driving the performance, I'm sure I'm going to get that right away, so I'm just going to answer it now. Our core business is strong really for four major reasons in the way that we view it.

The first is pretty obvious, we have truly shifted from this triaging of execution challenges to launching meaningful innovation. Now, I'm going spend a little bit more time on this one in particular, but that's a big one.

Second, our operating mechanism and really the resulting operational discipline has never been stronger, and I would argue probably as good as I've ever seen it anywhere.

And third, our compensation programs have shifted towards disproportionately rewarding growth not just paying you for keeping the business you have but truly disproportionately paying and rewarding for growth. And then finally, and I'm not sure if this was causing it or because of it.

But our commercial confidence is higher than I've ever seen in my tenure here at ZB, the commercial confidence, the swag or whatever you want to call it, is higher than I've ever seen. So, again, those are really the combination of things that is helping create the momentum inside the pandemic.

But let's talk specifically about innovation that as a component of this equation. Broadly speaking, over the last year, we've taken a very dismal, a low single-digit vitality index to a low double-digit number, and that's still not as good as we'd like it to be, but that's a pretty big jump.

And with our current product pipeline, I could promise you that's only going to continue to move in the right direction. And as you know obviously vitality index speaks to the percent of sales, driven by new product launches. So, in other words, those products that have been launched within the last three years.

The revenue associated with them versus your overall revenue. So, again, a real nice jump in the right direction in vitality index and more coming.

But to get a little more specific, I think, go to some of the key launches that you're interested in and I'll start with our knee franchise, our ROSA execution continues and I'm very proud to report that we have already passed the 200 ROSA Knee placement mark in the worldwide placement strategy that we have.

And importantly, our utilization continues to increase and the placement pipeline remains very strong. So, again, remember we're way under penetrated in robotics for our business in across all of orthopedics. So, the tailwind associated with ROSA in our opinion is going to be around for a while and it feels very good right now.

On the Persona Revision side of things, we keep gaining traction in the marketplace with this product launch, Q3 results were even stronger than the last quarter, which had been our best quarter to date post the launch.

And Revision remains on track as I said before to hit $100 million of gross revenue this year, and that's 40% of that will be new growth. In other words $40 million of net of cannibalization revenue this year from Persona Revision by itself.

This is really exciting and not only because it shows strong momentum for Persona Revision, but it also opens the door to more growth. Revision System is truly a tip of the spear product.

When we converted competitive surgeon to our Revision System, we absolutely have the right to hunt for their primary knee business and that's exactly what we're going to do. And if you know about this marketplace, you would also know that the primary business is usually much larger than the Revision business.

So, you can get the order of magnitude of opportunity we have to go after now, so exciting stuff there on the knee side. Shifting to hips Avenir Complete is really, still outperforming our expectations for 2020 that's even with the pandemic impact.

These are the expectations that we have for 2020 before we knew about the pandemic, just to give you some perspective on that on how well it's doing.

And this launch has really helped provide a great implant to leverage the high growth direct anterior approach submarket in hips, that's one of the most attractive sub-markets in hips in US implant [ph], the perfect opportunity for us to take advantage of that attractive market.

And then one more product I'll highlight in the quarter is in our upper extremities business, our Signature ONE Planner, I talked about this last quarter as well. We had another 50-plus-percent increase in surgeon registrations in Q3 and we already have one in four cases using pre-surgical planning for shoulder replacement.

This increased penetration of the system is important in my mind two very important ways.

First of all, there is a real potential for mix benefit where maybe said another way, share of wallet gain in each procedure that you use pre-surgical planning in and it also provides more stickiness with the surgeon, right, on the surgeon's stickiness it's probably obvious when surgeons using our implant and they're also using a pre-surgical planning, it's harder for them to want to move away from that environment because they are used to it.

On the share of wallet benefit, this is may not be as obvious, but it's pretty significant opportunity.

It comes because you get a higher utilization in augments and guides when you do a pre-planned procedure versus those without pre-surgical planning is because you know the anatomy before you get in and you know that if you're going to have an anatomy issue, you've already got your augments ready to go and guys ready to go.

That's great for the patient because they are going to get better outcome, it's great for the surgeon because they have what they need to do the procedure, and it's great for us because we get more revenue for that surgical procedure. And so very exciting stuff.

And so, in short, I would just say that even with the challenges of COVID, we're driving our business forward, meeting our customer needs and improving patient lives as we go. That's the whole missioning [ph] of this organization, right.

And it truly is what we do and wake up for every day, alleviating the pain of patients around the world and improving the quality of their life, and we are doing that during COVID. And as a team, we've dealt with many challenges over the past three years. We've prepared us for this moment.

I've said it before, this fits on when companies and teams can slow down. They can hesitate, they can take their foot off the pedal. Hey, we're being smart and safe, but we are not letting up and it shows. It shows in the ZB performance and in the energy of this team right now. All right.

So, I'm going to move on to cover our strategy to deliver long-term organic growth and ultimately drive more value for ZB and very importantly for you as well. And as we've outlined to drive our strategic pillar of top quartile performance in TSR and truly bring value to you.

And ultimately, to achieve mid-single-digit growth, organically, we have got to focus most intensely on driving long-term growth in our key focus areas. And, first, as we've said in the past, the first and foremost area of concentration is above market performance and needs.

Just given the size and the scale of this business, we need to be ahead of market here and we're going to do that by focusing aggressively in the fastest growth sub-markets of knee, robotics, data and informatics, cementless, and for us revision.

These are the areas of concentration and investment that are going to allow us to sustainably perform above market in knees. And next, we've got to drive consistent at market growth, if not the higher end of market for our performance in S.E.T. And that's focusing on the most attractive sub-elements of S.E.T.

For us that's going to be sports and it's going to be extremities. Also, we've got to make sure that we have a consistent at market performance in hips that's in the short-term, right. In the longer term, when we launch into robotics, we absolutely expect above market growth in hips as well.

And then finally, while our other businesses, at least at this point, will not receive the same level of investment and will be managed differently, we still expect these businesses to drive in line to the lower end of their market growth. And that's our pathway, that's our pathway for long-term durable 4% to 5% organic growth rates in this business.

Okay. So, next I want to talk about ZB's transformation. You've probably heard me outline the three phases of our ZB transformation, now I'm just going to go over them again just quickly here.

Phase 1, capturing the hearts and minds of the team, truly capturing the hearts and minds of the team and addressing our execution challenges that was really Phase 1.

And with this in mind, we have aggressively shifted to the One ZB mission to One ZB culture, we've added new and very diverse executive talent and we've stabilized the business across all key areas. So, good progress in Phase 1.

Phase 2 was really around shifting to a disciplined strategic clarity for the organization, that's more focused on long-term success, not solving problems but truly long-term success.

This is where ZB shifts to innovation, drives our strategic plan, has our pillar priorities that are very clear to the organization, locks in our operating mechanisms and involves organizational structure to ensure that we can drive a focused approach to execution of this strategy. In Phase 3, is where we transform for the future.

Through active portfolio management we look to change the portfolio complexion to accelerate growth, all right. So, we have made pretty significant and really durable progress in Phase 1. We've laid the foundation for and are absolutely executing against Phase 2 and now we're moving squarely into Phase 3 of the ZB turnaround.

And so for us, when I think about Phase 3, I think about that active portfolio management includes three main components and really should include these same three for anyone who is looking at active portfolio management.

But the first one is disproportionately investing in our priority businesses, in our priority markets and that would be across research and development commercial infrastructure, just mind share being disproportionately invested in those areas.

For number two, being selective in M&A, prioritizing opportunities that are accretive to our weighted average market growth and aligned to our strategy, so selective M&A. And the final one, when appropriate, and in line with our overall strategy divesting non-core assets that are financially less attractive in our core businesses, right.

So, those are the three components of active portfolio management in a way that we see them. As we manage the ZB portfolio, we're going to continue to focus on high-growth areas and areas where we truly believe we have a right to win. No size is going to be a factor here, particularly in the short term.

And out of the gate, here we can have a preference towards smaller tuck-in deals that can be easily integrated and operationalized while also maintaining very importantly our investment grade rating. And I really do believe this philosophy is apparent when looking at the recent transactions we just highlighted in our earnings press release.

Again, while these deals are not material in terms of acquired revenue they are absolutely instrumental in filling some of the product gaps we have at ZB in our ASC in sports portfolios and really they add to our pipeline of new technologies and product launches in markets that are accretive to our growth rates. And these deals are small.

So, they're going to be easily integrated and we're going to be able to validate our new deal process, our new team, the integration playbook that we now have in place. So, I think, great first step in the M&A side of things from a -- looking at the individual deals, if I look at the acquisition of incisive.

This is an OR solutions company in the $1.2 billion integrated OR market. And this is going to provide ZB with a soon to be launched, it's now launched yet, but a soon to be launched surgical booms and lights portfolio that will help us push more aggressively into the attractive ASC market, which is clearly an area we want to go.

We also see some real differentiation, it's not just filling the gap of the portfolio, it shouldn't bring [ph] a differentiation for really two reasons.

First of all, we have a smaller footprint and this focuses on reducing the acquisition cost but also the construction cost, which we know is a pretty important aspect of the ASC market, looking at controlling these costs.

And the second reason why we think it's differentiated is we've really done a really interesting job incorporating an innovative and automated way to capture data in the operating room that ultimately leverages artificial intelligence, and that helps us in the operating room drive efficiency and productivity and potentially even better outcomes.

Again, this is really lending itself to the needs of the ASC setting. So, again, pretty excited about this portfolio opportunity. This idea of a smart alarm and really leveraging data to drive decision support and efficiency is also reflected in our exclusive relationship with [indiscernible].

Through this partnership, we actually see the opportunity to further differentiate our knee ecosystem, which is a major focus of ours right now. Our goal is to launch an intelligent Persona total knee implant that incorporates smart sensor technology.

We feel the combination of active data capture from this smart implant that we already have from mymobility and we already have from ROSA is going to provide an unmatched dataset that ultimately could be leveraged through AI for a decision support related to how best to treat and care for the patient.

This will give us a unique opportunity we feel to create an intersection between the $4 billion total knee market and the telehealth solution space, which is growing somewhere north of 15%, so a very attractive area for us to differentiate the ecosystem and kind of enter into an adjacent space in telehealth.

And the last deal I want to talk about is our acquisition Reline [ph] and this is focused on the sports medicine market, which we know is a $5 billion market and it's growing 5% to 7%. So, again, accretive to our overall weighted average market growth. And this deal clearly helps fill our gaps in arthroscopy capital.

The capital makes up about 30% of the sports market, till now we had absolutely no offering in this space. With this acquisition, we have not only filled the gap, we also see some real differentiation in the portfolio.

They have done a nice job of again innovatively consolidating three tower components into a single comprehensive system, both at the equipment side and on the end [ph] vector side. This is the first in the industry. This system is very early in commercialization stage.

But I would say it's getting very positive feedback early on, and we see this as another great opportunity to drive a successful product launch, leveraging our ZB commercial infrastructure, which we absolutely know we can do.

So -- and I would just say, hey, we've got other portfolio management opportunities in the near term funnel and we're not ready to talk about those yet, but we have [indiscernible] the funnel and we will continue to keep you up-to-date as we make progress here.

And finally, we are fully committed to our margin expansion goal of at least 30% operating margin by the end of 2023.

And Suky is going to talk more about this, but our restructuring plan is on track and the cost savings we're delivering will help drive margin expansion, which has got to be there, but also support reinvestment in the business for growth. It's got to be able to do both. And that was what the whole idea of behind the restructuring plan was.

So, again, Suky will give more detail on that, but it's on track so far. Overall, we are clearly watching the COVID recovery trends closely and completely realize as everybody does the short-term market performance and I want to reiterate market performance is out of our direct control as a result of the COVID recovery trends.

That said and I hope it is very clear, we feel confident in ZB, we feel confident in our business strength in our execution and the long-term growth prospects we have as a business. And as a result of that the value creation opportunity we have as a company, okay.

And with that, I'm going to turn the call over to Suky, again, for more financial details for the quarter and looking forward.

Suky?.

Thank you, and good morning, everyone. To echo Bryan's comments, ZB's underlying fundamentals remain strong. Overall, our Q3 performance was better than expected. Revenue was ahead of expectations as we posted operational growth due to faster market recovery across most developed markets in tandem with strong commercial execution.

Improved revenue performance drove better margins and a solid quarter of free cash flow. I've a genuine feeling of pride in how our 20,000 plus team members have responded to a very challenging environment. Net sales in the third quarter were $1.9 billion, a reported increase of 2% and constant currency increase of 1.1% versus the same period in 2019.

Sequentially Q3 improved over Q2 as expected. Inside of that, we continue to see variability and recovery by market and region as we progress throughout the quarter and we did see a flattening of the recovery curve with September effectively flat versus the prior year.

I'll talk about performance across our regions and then move to our business segments. And moving forward, unless I note otherwise, my comments will be on a constant currency basis. Beginning with Asia Pacific, the region returned to growth, increasing 0.7% versus Q3 2019.

We saw strong performance in China with results well ahead of normal levels and while Japan has not yet returned to prior year volume, so market continues to show stability. Australia, New Zealand made steady progress in Q3, but were negatively impacted by surges of the virus late in the quarter.

Finally, India and other small Southeast Asian countries continue to significantly underperform the broader region. EMEA decreased 5.7% while we saw recovery from Q2, the region did not return to growth in any part of the quarter and we observed a slowing in September due to recent COVID-19 surges and corresponding policy actions.

Developed countries excluding the UK showed the strongest signs of recovery, but decelerated in the latter part of the quarter. The UK in emerging markets continue to be a significant drag on overall regional growth and are lagging developed markets recovery.

Lastly, the Americas region continued to grow, increasing 3.3% with strong growth of 5% in the US. While the recovery was robust in the US, we observed the same flattening in the recovery curve due to increases in virus surges in September.

Similar to Q2, caseloads in elective procedures in hard hit regions are continuing at about 70% to 90% when compared to 2019 volumes. Outside of the US, the rest of Americas continues to lag with numbers well below normal levels.

Turning to our business performance for Q3, the global knee business declined 1.4% versus Q3 2019, a marked sequential improvement from the 47% decline we saw in Q2. The US knee business returned to growth, increasing 3% in the quarter. Overall execution was strong with continued momentum for ROSA.

Additionally, our persona family of primary revision and partial knee continues to get great traction with existing and new customers. Our global hip business increased 4.4%. Another big sequential improvement from the 31% decline we saw in the Q2.

I do want to call out that US hips increased about 10% in the quarter, strong market recovery for sure, but also a great illustration of our commercial team's execution in the backdrop of new product introductions. Sports extremities and trauma sales grew 2.5% over Q3 2019.

Notably, the Americas grew about 6% but that growth was offset by softness in EMEA and Asia Pacific. Also strength in upper extremities was partially offset by slower growth in sports and trauma due to lower social activities as a result of COVID.

Dental, spine and CMFT increased 6.5% due to strong execution, new products including robotics and market recovery. And finally, our other category was down 11.1%. I'll now walk through our third quarter P&L and liquidity and then share more color and insights that may provide shaping of our expectations for the remainder of the year.

So, moving on to the P&L, as we have previously discussed, we move quickly and have taken a disciplined, proactive approach to mitigate the earnings impact of the pandemic, while also enhancing ZB's liquidity profile.

Results in the third quarter were better than we expected at the time of our second quarter call, as we saw margins, earnings and cash flow sequentially improve versus the second quarter, consistent with our revenue improvement.

In the third quarter, we reported GAAP diluted earnings per share of $1.16, and adjusted diluted earnings per share of $1.81. GAAP earnings per share versus the prior year were lower, primarily due to a sizable one-time Swiss tax credit that the company realized in 2019.

For additional details on GAAP results, please refer to today's press release and our 10-Q, which will be filed later today. On an adjusted basis versus 2019, earnings grew in line with revenue growth as lower SG&A spending offset lower gross margins and a higher share count.

Adjusted gross margin was 70.6% for the third quarter and as expected, results were sequentially better than Q2, but lower than 2019.

Versus the prior year pressure from prior period deferred costs and lower volumes due to COVID were partially offset by a favorable regional mix tailwind as we saw stronger recovery in the US and developed markets in the quarter.

Adjusted operating expenses increased sequentially over Q2, driven by commissions related to higher revenues and increased commercial investments. Expenses [ph] were lower than prior year due to the early impact of our restructuring programs and due to moderated investment levels as we continue to navigate pandemic uncertainty.

Overall, adjusted operating margins for the quarter was 26.3%, better than expected and driven by the favorable geographic mix in gross margin and a slower ramp on spending.

Moving beyond operating margin net interest expense and adjusted other income totaled $52 million and the adjusted tax rate of 16.6% was slightly better than expected due to some modest discrete benefits in the quarter. Turning to cash and liquidity, we'll return to positive free cash flow earlier than expected totaling $287 million.

This is lower than the prior year as we used a portion of our better than expected operating cash performance to reduce our AR securitization program. We ended Q3 with cash and cash equivalents of just under $1 billion and our $2.5 billion of credit facilities remain untapped.

Relative to the deals that Brian referenced earlier, we expect the cash call to be approximately $80 million in the second half of this year and that will be funded through existing cash balances.

Turning to Q4, our consolidated revenue outlook for the remainder of the year has a heightened level of uncertainty, given recent COVID surges that we have seen in a number of markets and due to that backdrop, we will not be providing financial guidance for the fourth quarter.

So far, through October regional trends have been similar to what we saw for the full third quarter except for EMEA. That is Asia Pacific and the Americas continue to grow in line with full Q3 growth rates, albeit with more pressure or risk in the US due to increased virus surges.

On the other hand, EMEA has worsen due to surges in the virus as declines have accelerated in October with some governments in the region taking new policy actions to limit elective procedure.

We expect consolidated Q4 revenue performance to continue to be fluid based on the major variables impacting the recovery, which include the rate of pull-through on the backlog patient anxiety and elective procedure capacity constraints due to COVID surgeons and/or resulting policy actions.

While market dynamics remain uncertain [ph] what I do know is that our commercial and supply execution combined with our innovative new product introductions, will continue to drive strong performance relative to the market.

Looking ahead on gross margin, we expect sequential improvement, but continued year-over-year pressure due to the same drivers we saw in Q3. Adjusted operating expenses are expected to be sequentially higher in Q4 but down versus prior year as we also saw in Q3.

Interest expense will be stable to Q3 and we expect that our tax rate will be slightly higher than Q3 2020. Lastly, fully diluted shares outstanding are expected to step up in Q4, due to the exercise of options as a result of the acceleration of stock price we saw in the third quarter.

Longer term, we remain committed to our target of at least 30% adjusted operating margins by the end of 2023. Our near-term initiatives relative to reorganization, consolidation and zero based budgeting, as examples, are complete or near completion. And we are steadily advancing our longer-term structural initiatives around supply and G&A efficiency.

To summarize, our underlying business performance is strong. Our execution is on point and ZB's transformation is delivering positive proof points even in the midst of the challenging pandemic. We continue to believe that ZB is well positioned to address near term challenges and to accelerate growth over the long term.

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

Thanks, Suky. Before we start the Q&A session, a reminder to please limit yourself to a single question and one follow-up, so that we can get through as many questions as possible during the call. With that operator, may we have the first question please..

Thank you. [Operator Instructions] Our first question comes from Ryan Zimmerman with BTIG..

All right. Thank you. Good morning, everyone. So, Bryan, I want to start on the backlog and the commentary about in September exit rate. And then I have one on ROSA. If you recall back, the last quarter you talked about $700 million backlog for ZB.

And I'm just wondering if you could comment a little bit around that backlog in terms of what do you feel like you achieved against that in the third quarter, and how we should think about that maybe refilling back up in light of some of the dynamics of COVID in the fourth quarter here that you're talking about?.

Yes. So, I appreciate the question. So, what I would tell you is that the -- what we saw in Q3 because we actually saw a positive growth relatively in line, if not a little above say, for instance, in hips in like a typical market growth. That would indicate that we did not build further backlog or deferred patients in a way that I calculated in Q3.

That said, we still have hundreds of millions of dollars of deferred patients that will eventually come back in the funnel. So, I still feel very bullish about the fact that we have these deferred patients. There are patients, as we know for most of our business that has a disease that progresses. It does not get better by itself.

And as a result of that those patients typically come back in the fall. So, I wouldn't say that we built more backlog in Q3, but we certainly still have quite a bit of backlog to go through. So that's my view of where we are from a backlog standpoint.

And again, I think, eventually when we get to the point where we have a vaccine that people have confidence in it or treatment that people have confidence in.

We're going to have that backlog of patients begin to come through in concert with new patients and that should be a really nice headwind for our business, looking forward in that day for sure..

Understood. And then just the second question, ROSA really nice number there, the 200 -- exceeding the 200 placements on ROSA. Just talk a little bit about the visibility on the order book and your expectation for 2021.

Is it unreasonable to believe that you can accelerate beyond that 200 to 300 placement rate you're expecting this year? Thank you for taking the questions..

And for just clarification, just to make sure that 200 to 300 is what we've done from operational standpoint since launch. And there wasn't 200 to 300 that we would expect just in 2020, but it would be since launch, which is just call about a little over a year and a half now since full launch of the ROSA System.

But I'd tell you that, hey, I'm pretty enthusiastic as it the team around the ROSA placements that we saw in Q3, it was the best quarter that we've had relative to the number of installations we did in a single quarter. And I can tell you that that momentum is continuing into Q4.

And even though, I think, it will be slightly better, if it is still slightly better than what we did in Q3, that's what our expectation will be in Q4. And so that pipeline, if I'm just going to call, future customers is robust as it's ever been with our product.

And as I mentioned before in the prepared remarks, I really do believe the under penetration of robotics is it such a point that this is a tailwind for the organization for a long time to come. And it's a very exciting tailwind. No question about it. Because not only is it before us [ph], it's to the patient.

It really is providing a level of accuracy in the operating room that you can see when you're in the operating room with surgeon. Forget studies, we've got those coming, but when the surgeon uses the robotic system in the operating room, you can see the lights go off -- I mean go on.

They clearly understand that they have an opportunity to get better cuts more accurate cuts, but also and very importantly feedback right away in the operating room around tissue balancing.

It's really you need to see actually to have an opportunity to go and see that kind of light bulb go off in the surgeon's mind when they're using it is pretty amazing. Relative to 2021, I don't want to give specifics there.

But what I would tell you is that I would be disappointed if the level of placements that we saw in Q3 and Q4 which were better than the first half of 2020. I would be disappointed if that level of placement didn't continue into 2021, right. And that would indicate in fact that does happen that 2021 should have more placements overall than 2020 did.

So, again, I think real positive momentum, great feedback from our customers and a really strong pipeline of future customers that are out there right now..

Thank you..

Thanks, Bryan..

Sure.

Can we go to the next question, please?.

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

Hey, good morning. Thanks.

Can you hear me okay?.

Yes..

Yes. Maybe great..

Good morning. Thanks. So, first quick question, I appreciate, Bryan, your comments on deals and divestitures and the two deals you announced.

So, quick question there is, one, are those deals that could start to have an impact from a revenue perspective, more in 2022, just kind of how should we be thinking about those launches? And then on the divestiture side, kind of how would you characterize how likely divestitures might be in 2021? Thank you..

Okay. So, what I would tell you is that the deals that we just talked about, obviously, are not super accretive relative to acquired revenue growth just [ph] not much there.

Think about most product launches that we have facilitating product launches in these very attractive spaces ASC, it would also be in sports, which is kind of a combination ASC impact, and then also in the data informatics portion of things. But I would absolutely expect revenue growth to be driven in 2021, I wouldn't say 2022.

I definitely believe that the portfolio being provided by these acquisitions will immediately give us traction to be able to go out and hunt in the ASC marketplace, in the sports marketplace and continue in 2021 to provide more unique offerings inside of our knee category and we talked about that knee ecosystem.

So, it's all three [ph] of the things that we just talked about in prepared remarks, we will provide revenue growth just not acquired revenue growth in 2021 and well beyond by the way. As far as divestitures go, clearly, I wouldn't talk about the time frame, I don't want to give anybody any [ph] expectation here.

But the fact is when we think about active portfolio management that is one of the vectors. One of the obvious ones is M&A. And for us M&A that we're going to focus on will always be to build scale and or innovation that matters in markets that are accretive to our ZB weighted average market growth.

And very importantly, where we think we have a right to win and see a clear path to leadership in those categories that would potentially be on the docket for divestiture. It would in those areas that are not as financially attractive to the business are not as core to our strategy and where we don't really see a clear pathway to leadership.

Those would be the things that we would look at when we think about sharing the business, but I just don't want to give you a specific time frame because I don't want to set that expectation.

But just know that that is part of the equation as we think about active portfolio management with the intent over time to move more of our revenue in higher growth markets, right, as we intend.

If we're going to be a top quartile performer in total shareholder return, we have to have more of our revenue in higher growth markets, I'm just talked about mid-single-digits to upper single-digit growth markets and that's the intent of the active portfolio management process..

Thanks so much, Bob. Bran, can we go to the next question in the queue, please..

Our next question comes from Josh Jennings with Cowen..

Hi. Good morning. Thanks for taking the questions. One on ROSA and then just one on your average Chinese business. Just on ROSA, I was just wondering just kind of parse out just the implant performance in knees in the quarter.

Was there a headwind from third quarter 2019 ROSA upfront purchase revenues, again, versus the placement dynamic has been happening over the course of the pandemic. And just, can you help us as we think about modeling these ROSA placements out in the 2021, and just all robotic solutions out there in the orthopedic marketplace.

And do you think that percentage of systems that are placed that will drive an upfront capital purchase and that upfront revenue is at a 50% bar, is at a 25%, anything you can help us just in terms of modeling out that that system revenue as we think about 2021 and beyond would be helpful..

Okay. Maybe I'll hit that piece first.

What I would tell you is we're definitely seeing it's not dramatic, but we're already seeing a slight shift back towards customers having a desire to acquire either lease or acquire the robotic systems and it almost seems like it's already starting although not nearly at the pace that it was, let's say, last year.

And so I would guess, it's purely a guess, but I would again based on that assume that as we move into 2021 you might see more of a shift in that direction. But I just don't have a good sense for where it's going to land.

I'll say [ph] it right now, it's definitely the larger portion of installations are these placement programs which is truly what we would prefer. I really like having that longer-term contract in relationship with the customer that does require certain volume commitment to the company and we're just building that relationship in a more stable way.

But I would assume that as our customers get more confidence in the market that they may want to shift back to where they were before which is maybe acquiring more. I just don't want to give you a sense for what the percentage would be, but it is moving slightly back in that direction.

Relative to Q3, interestingly enough even though there were some sales of ROSA in Q3. On a relative basis, it was actually a headwind for us. If I think about US knees particularly I talked about 3% growth in the US knees.

If I eliminated ROSA as a part of that and just looked at core knees, and base knees, we actually grew closer to 4%, even a little better than 4% in base knees in the US. So, it was almost 100 bps of -- actually a little more than 100 bps of headwind from ROSA in the quarter. So, hopefully that answers the question..

That's very helpful. Thanks for those details. And then just I heard Suky call out strength in upper extremities in the quarter, are you seeing any disruption from the Stryker-Wright combination, maybe hard to parse out in the middle of the pandemic.

But I just wanted to get your thoughts on the opportunity with the integration next year from second biggest competitor and what that opportunity represents in your mind for the upper extremities business? Thanks for taking the questions..

Yes. Absolutely. I mean, the fact is, when we look at the performance in Wright, they had a pretty good quarter. So, clearly, at least based on that performance one would indicate that it's not disruptive yet. Always hoping for things to happen, I would be very happy if there was disruption when you try to bring those two organizations together finally.

The fact is, most of the time in our industry when they're bringing two organizations together is dis-synergy risk there just is. And that's why I like some of the small deals that we just did, it really eliminates that dis-synergy risk because there are really more product launches versus bring two sales organizations together.

So, I would expect at some point just given the historical views of acquisitions in our space that you are going to see some level of the dis-synergy and hoping that we have an opportunity to take advantage of that. That said, I hope is [ph] in a strategy we have a very clear strategy in our extremities business and we're executing against that.

And I feel very confident in the commercial infrastructure we're putting together, the product pipeline that we have and the traction that we're getting in the marketplace right now with or without disruption from our competitors..

Thanks, Bryan..

Thanks..

Thanks so much..

Our next question comes from Vijay Kumar with Evercore ISI..

Hey, guys. Thanks for taking my question and congrats on a footprint [ph] here. Bryan, maybe a big picture question, if I look at 2021, Street's modeling earnings above 2019, I'm just curious a couple of your peers have called out gross margin manufacturing variance et cetera.

Is there anything you need to be aware from a margin perspective, and should the Street perhaps -- are you guys comfortable with the Street EPS numbers?.

Maybe what I'll do for that one is just pass it over to Suky to provide a little more color there. I know you had some of that in your prepared remarks, Suky, but maybe you can comment on that..

Yes, sure. So, we're not obviously giving guidance on 2021 and I'm not going to speak to Street numbers. What I would say is next year's profile, obviously, it's going to be driven by revenue and a large component of that is going to depend on what happens relative to COVID-19.

From a top line perspective, if we saw situation where the recent surges and [ph] experiences begin to abate or moderate and then stabilize, there could be a pathway to seeing a 2021 revenue profile. That's in line with the 2019 revenues.

And if we got into next year and saw that stabilization moderation, but also on top of that saw vaccine or credible treatment. In tandem with the vaccine, you could potentially see volumes or revenues ahead of 2019 level.

So, that's kind of how we're thinking about it from a broad strokes perspective, but there is look [ph] a lot of runway between here and there relative to COVID and how that's going to play out. So, we're going to pause on giving too much additional color beyond that.

From a margin perspective, it's really going to fall in line with overall revenue and volumes, right, as you would expect. Volumes and revenue is better, so will margins. That's intuitive.

I would say, as we think about our margins going into next year, there are a number of headwinds and tailwinds that we have taken into consideration using sort of second half of this year as a starting point or as a run rate. First on gross margins, we'd actually had a pretty good quarter in Q3.

We expect to sequentially step-up in gross margin into Q4 based on overall volumes and seasonality that we typically see in the fourth quarter. But as we move into next year and as overall regional mix starts to stabilize with a stabilization of COVID, we're seeing a mix tailwind right now that may abate into next year.

So, that could be a slight headwind, as we go into next year. And then we have had some pressure on overall COGS this year because of lower volumes, because of prior-year deferred costs. Those are going to continue into next year. So, there are a couple of headwinds in gross margin that we're closely watching.

Now having said that, we're also very aggressive on our cost down opportunities and cost of goods. So, that could be a tailwind to next year.

But we've always talked about coming out of 2020 as part of our broader restructuring program, the 30% operating margin aspiration that you should expect to start to see a stabilization from 2020 as you move out to 2023 when it comes to gross margin. And then within operating margin, I'll tell you we're going to continue to ramp up investment.

I think, what you see over the last two quarters was our performance relative to market has been strong. One of the reasons behind that is because we've been making really smart investments and our commercial teams have been optimizing those investments and getting quick ROI those.

And so we're going to continue to ramp up that spending because we got a lot of great products. We've got great execution in very strong end markets and so we're going to see a step-up in investment as we move into 2021.

Having said all that we're consistent with where we were before that if we saw revenues at 2019 levels, we would expect -- we'd be disappointed if operating margin within 2021 didn't reach those levels, maybe not for the full year, but within 2021, we would expect to get to those margin levels.

So, hopefully, that gives you a little bit more perspective on how we're thinking about 2021. But, again, a lot more to play out yet with COVID..

Yes. That's extremely helpful. And Bryan one for you on that. Thanks for all the color on the Persona Revision. I guess, when you look at next year, as you guys gain traction on the Revision side, should those, I guess, gains accelerate as you gain a beachhead into the primary side of knee as well..

I'm sorry, could you repeat that, I missed part of the -- the first part of your question, you went out a little bit for me.

Could you repeat that?.

So, on that the Persona Revision knee side, I think, the comment you made was that should allow you guys to go after the primary implant side as well. So, when you think….

Oh, I guess, yes..

$40 million of net gains on the Revision side, should we perhaps be looking at an accelerating share gains for next year as you gain share into -- on the primary side..

Yes, I'd say, it's -- that's the most exciting thing for me on Persona Revision.

And probably it was a little ostomy to take impurities [ph] in the beginning, because I assume the better connection between Revision sets and primary, but what we're finding is that a good portion of that $40 million or so of competitive conversion [ph] where we have the primary business already, we did not have the Revision System.

But a lot of them or the other way around, but we didn't have the primary or the Revision. And so when we pick up that Revision business, it absolutely, as I said before, gives us a right to hunt for the primary business. And it's an order of magnitude larger than the Revision business.

So, if you just look at the market differential, let's call, Revision somewhere in the neighborhood of 10% to 15% of the overall knee market. The rest of it is really primary unit that are out there. And that again once we get the Revision business, we then can go after that primary, the unit that the surgeon is doing.

And it doesn't mean you're going to natural get or automatically get it but you again have a right to go after it and you build the trust and you build the relationship with the surgeon and it gives you that chance.

So, I absolutely expect two things in 2021, continued competitive conversions with primary and with Revision, but also that opportunity to pull in the primary business as well. And it will clearly be one of the catalysts that we use to continue to drive towards above market growth in knees just as we've been saying.

It will absolutely be one of the variables that will drive us in that direction in 2021..

Understood. Thanks, guys..

Sure..

And our next question comes from Raj Denhoy with Jefferies..

Hi, good morning. A couple of questions if I could, so I'm just trying to put a finer point on your comments around the fourth quarter.

So, it sounds like you're suggesting that Asia Pacific and the Americas perhaps in line with the third quarter, but given that EMEA is worsening, I guess, we should assume that the growth rate in the fourth quarter will be below what you posted during the third quarter, is that a fair way to think about that?.

Yes. So, maybe, Suky, I'll start, if you want to provide any more color feel free to do so. I would say, generally, what you're saying is accurate, I would say that Asia Pacific which is clearly being less impacted by surgeons in the virus seem to be relatively consistent.

Again, it's early in the quarter based on what we've seen so far, pretty consistent with the growth rates that we saw in Q3, overall, Q3. The Americas, even though it's a positive growth, it has slightly decelerated versus Q3. But the good news is even with the surges that we're seeing in the US, we're still seeing positive growth.

And it's close relative to what we saw in Q3 again, it's early. And the risk feels a little more tenuous right now because the surges are so much more prominent than they were in Q3. But the fact is that US is hanging in there and still has positive growth, but in EMEA, to your point, we are seeing more pressure.

The policy decisions and the reaction to the virus surge is more acute in Europe, Middle East and Africa. No question about it. And I would expect Q4 to be slower growth and it was already negative in Q3 than Q3 was.

And so we're really watching this everywhere, obviously, but right now, Europe, Middle East and Africa is a key area of focus for us to understand what's happening in that region. And then importantly, inside of that storm, if you will, what are we going to do to make sure that we stay ahead of the competition while it's occurring..

Okay. But maybe just....

Anything else you want to add?.

No, I think, you summarized it really well, Bryan..

Thanks..

And really my second question is, I guess, somewhat related, frankly, Suky made a comment that that demand in some areas is still at 70% to 90% of normal.

And I guess I'm curious how to think about that, is that a kind of broad statement that you are still more than 10% below what you would consider normal demand, and it's going to take something like a vaccine or better treatment ultimately to get that to 100% and beyond?.

Well, let me clarify what you're saying there is, what you're saying is that, so take the US, for instance, if you look at a specific state or a county inside the US that is being very hard hit by surges, what he was referencing is that even in those very hard hit areas, the county or the state, you're still seeing 70% to 90% of procedure volumes that you would typically see, say, versus 2019.

So, that doesn't necessarily mean that broad-based, we're seeing 70%, 90% of demand, it's just, let's say that in that hard-hit area, you're still seeing 70% to 90% of typical procedure volume, so that is what he was referencing..

Yes, I think, Raj....

Perfect. Thank you..

Yes, the extrapolation from there is even in the very acute second surges, we're not seeing anything that resembles what we saw in April and May, right. So, clearly, the end markets, the hospital systems with precision, more deference being provided to them, they are better prepared to deal with COVID.

They have better protocols and triage our patients, I mean, they've got incentives to get the elective procedures through. So, that's really the key point of that statement of 70% to 90%..

Very clear. Thanks for the clarification..

Thanks. And Barn, It looks like we have time for at least one, maybe two more questions..

We'll take our next question from Matt Miksic with Credit Suisse..

Hi, good morning. Thanks for taking the questions. I have one on S.E.T. and one on, just to follow up on Raj's question on trend. So, on sports medicine, extremities, trauma, you provide a global reporting line here, it's a 20% or so of your business.

I was wondering, if you could maybe expand a little bit on how the major moving parts of that business are performing and maybe proportions or geographic color would be helpful. And then I actually have one quick follow up..

Okay. We don't really provide a breakdown beyond the S.E.T. overall category. But what I would tell you is that the US and I think that Suky referenced this in your prepared remarks, you said I think that the overall S.E.T. category. The US was definitely the strongest performer in the world. I think, we have somewhere neighborhood the 6% in US S.E.T.

performance from a growth standpoint. So, that would indicate that we clearly had lower growth in other parts of the world, which isn't surprising when you think about our S.E.T.

category, say, for instance in Asia Pacific, a bigger part of that category would be trauma in that region plus other [ph] regions, just given the dominance or the significant portion of revenue in each [ph] specific that China has. And even though we're seeing less surges of the virus in that part of the world, we still are seeing less activity.

And that typically will drive lower volumes and/or lower revenue growth in sports, it would drive lower revenue growth in trauma. So, just when people aren't moving as much and they are not doing as much, we typically see those two businesses with inside of S.E.T. get hurt.

And I would tell you that as we talked a lot about, we've had pretty significant focus in extremities obviously upper extremities is one of the key areas of focus for us. And I would just say, our growth rate there is promising. And that's probably all the detail I provide below S.E.T.

But overall, if I look at the category, the US region -- the US or the Americas was definitely the strongest growth region..

Thanks for that. And then just on -- Suky, your comments just now on trends and what we could expect and not expect potentially around surges. Is there anything -- there was a pretty tight period, I guess, this summer in Arizona, Texas when there were some very narrowly focused constraints by county and other.

I just wondering if you could talk a little bit about what you saw there? How quickly it rebounce back and sort of what we might learn from that as it pertains to maybe the next few months in some other areas?.

Yes, I think, we actually commented on that on our second quarter call. And some of those very hard hit counties within the states that you mentioned were operating somewhere in that 80% to 90% range. So, we've seen a very consistent pattern coming out for a few months where we've seen heightened surface.

So, I think, that's again another positive inflection that we're not going to return back to those periods of April and May, even with acute surges, at least based on what we're seeing today.

The time to abate, it really -- it's variable, right, there is no broad statement, it depends on the specific market, the specific sub-market that you're talking about or territory and the number of surges and how quickly -- how big that population is, and how quickly those surge rates come back down. So, it's tough to say.

But in some of those hardest hits where we were at 80%, 90%, we've seen a path in some of those where they've gotten back to normal or perhaps a little bit above normal within a few months. But, again, it's really variable from market to market..

Thanks..

And that concludes today's question-and-answer session. I'd like to turn back to Keri Mattox for additional or closing remarks..

Thanks so much, and thanks everyone for joining us. I know we'll be in touch today, if you have questions, please don't hesitate to reach out to the IR Team. And we look forward to continuing the conversation..

All right, great. Thanks, everyone..

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