After years of pleasing spoiled investors, Zimmer ( ZMH) now finds itself battling just to relieve its followers instead. Suddenly, just beating profit expectations is no longer enough. After all, Zimmer did just that late Wednesday and still saw its shares slip Thursday, continuing a slide that began in early September. That's around the time when Zimmer CEO Ray Elliott
started spooking investors with candid discussions about price cuts for orthopedic implants. Since then, Wall Street has focused on very little else. True, some investors rushed to celebrate Zimmer's latest profit growth -- which came in 4.5% higher than Wall Street expectations -- by purchasing the stock on an upswing during after-hours trading on Wednesday. But the stock's gains proved to be short-lived. The stock fell 2.6% to $62.10 by the time the market closed on Thursday, when investors had better digested Zimmer's quarterly results and found little to comfort them in the company's follow-up conference call. They spotted clear trouble instead. Even the profit upside started to look shaky. Of the 3-cent cushion, some noted, 2 cents came from a sharp cutback in selling, general and administrative expenses that could prove unsustainable. And the final penny came from a lower tax rate. Still, investors didn't need to hunt between the lines for issues. They could see, quite clearly, that Zimmer's quarterly revenue growth had just slipped into single-digit territory for the first time in recent memory. Even worse, sales growth for the company's main products -- artificial hips and knees -- had plummeted sharply even with help from price increases that, by next year, are expected to go away. Anticipating future price cuts, Zimmer went ahead and scaled back expectations for revenue and profit growth next year. The company now hopes to grow revenue by 8% to 9% and profits by about twice that much in 2006.
Some experts actually had been bracing for as much. "We would characterize ZMH's 3Q results and 2006 guidance as no worse than what were already low expectations," wrote Lehman Brothers analyst Bob Hopkins, who has an equal-weight rating on the stock. "The issue, however, is not the current quarter or even the next quarter, but rather where pricing will end up in 2006, 2007 and beyond, and what impact that will have on the top and bottom
line growth outlook for all the ortho companies." By now, of course, the orthopedic stocks have taken a hit in anticipation of a slowdown. Even so, bearish investors still foresee additional pain ahead.
Without those changes, he said, Zimmer would be looking to generate around 40 cents more in profits and approach its original 25% growth target for next year. Still, TheStreet.com was already warning about pricing pressures in the U.S. market during the so-called "older times" four months ago. Back then, TheStreet.com reported, at least one hospital system had managed to negotiate price cuts of 45% on artificial hips and secure similar discounts on artificial knees as well. A few bearish analysts had started focusing on implant pricing, too, and many others have steadily followed suit. But in the end, it seems, the market waited for signals from Elliott himself. It was only after he grew noticeably cautious, after all, that ortho stocks really began to sell off. For his part, Elliott seemed to challenge the idea that some had offered earlier warnings and question their "bizarre rush" to claim that they had. "They weren't even saying that a month ago," he said. "We say, 'Check the record.'"
Lee Memorial Health System, one of the busiest hip-replacement centers in the country, has already told TheStreet.com that it cannot make money under that scenario. "We actually lose money on what is a massive growth business for us," Lee Memorial CEO Jim Nathan said
back in early April. "It's a significant issue." But Elliott claimed on Thursday that hospital consultants simply make such arguments because they "want to make a point" when negotiating prices with the industry. "It's pretty easy to take apart," he insisted. "I'll stand by what I said." Elliott attempted to shoot down three other "myths" as well. Despite what some may say, he said, the current situation is no replay of the sharp downturn that hurt the industry more than a decade ago. Nor, he said, is the "magic of diversity" -- away from joint reconstruction -- a favorable option. And ultimately, he declared, ortho stocks are not "a bad place to be." "That's fact vs. fiction," he said when explaining one myth. "That's Zimmer reality."