Zimmer Posts Strong Quarter

But the company's shares slip as Zimmer trims second-half sales forecasts.
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Zimmer Holdings

(ZMH)

posted strong second-quarter gains Wednesday, but its shares slipped in postclose action as the company trimmed sales guidance due to unexpected dollar strength.

For its second quarter ended June 30, the Warsaw, Ind., maker of orthopedic implants earned $191 million, or 76 cents a share, up from the year-ago $116 million, or 47 cents a share. On a so-called adjusted basis, excluding certain charges, latest-quarter earnings were 80 cents a share, passing the Thomson First Call analyst consensus estimate by a nickel.

Revenue rose 15% from a year ago to $847 million, and profit margins set a company record.

"We had a strong and balanced quarter with 15 percent sales growth in each of our geographic segments and above market performance, with greater than 20 percent growth, in both Spine and Dental," said CEO Ray Elliott. "Almost a quarter of a billion dollars of operating cash flow this period creates the potential to become net debt free again early in the fourth quarter -- only two years from the date of our Centerpulse acquisition."

The company boosted its full-year adjusted earnings guidance to $3.07 a share, beating the Thomson First Call estimate by a nickel, but trimmed sales guidance, saying that "the expected contribution to sales growth from foreign currency rate changes, using current rates, has decreased by $53 million as a result of the strengthening U.S. dollar against most foreign currencies." Zimmer expects sales of $777 million for the third quarter, $11 million short of the consensus estimate, and $3.33 billion for the year, which is essentially in line.

Baird Research analyst Suey Wong was looking for Zimmer to match Wall Street estimates this quarter before pricing pressures, exerted by hospitals struggling to make money on joint replacements, begin to threaten results down the road.

Specifically, he predicted that reconstructive sales -- which account for more than 80% of Zimmer's revenue -- would rise a healthy 16% in the second quarter. He pointed to the company's knee business as a major driver, forecasting a potential 20%-plus jump in sales, as customers convert to more expensive devices. He went on to highlight a new Zimmer knee, which just hit the market in January, as a "significant upgrade opportunity."

Wong projected solid, if slower, single-digit growth for Zimmer's hip division. He looked for two hip stems -- which fueled 28% of the division's expansion in the last quarter -- to remain primary growth drivers but suggested that mandated price cuts in both Germany and Japan would drag down the unit's overall results.

Outside the core reconstructive unit, Wong was looking for improvements as well. He predicted that spinal sales would jump 6.8% as Zimmer's most popular offerings more than offset a downturn in spinal cages. Meanwhile, he predicted that trauma sales would grow by a modest 1.7% -- due in part to "a relative paucity of new product launches" -- before sales rebound on new offerings going forward.

All told, Wong projected that Zimmer would manage to further expand its already high gross margin due to soaring knee sales -- which carry higher margins than hips -- and continued improvements in manufacturing efficiency. Still, he warned, that favorable trend could ultimately come to an end.

"We believe ZMH's ability to rapidly expand margins longer term could come under pressure should pricing pressure in the U.S. related to vendor reduction issues build," wrote Wong, who has a neutral rating on the entire orthopedic implant sector. "Any shortfall to our margin projections this quarter ... could be an early indicator that such pricing pressures have begun."

Late Wednesday, Zimmer shares slipped $2.10 to $81.