Zimmer ( ZMH) is limping again. The orthopedic device maker on Wednesday reported that sales grew by just 4% to $882 million in the second quarter -- missing the consensus estimate -- but topped profit forecasts nonetheless. The company posted net income of $201 million, up 5.3% from a year ago, with adjusted earnings per share of 83 cents coming in a penny ahead of expectations. At the same time, however, Zimmer lowered its earnings guidance by a penny for each of the next two quarters. It blamed legal fees, rather than any slowdown in business, for the shortfall. Zimmer also offered the most detailed explanation yet of a criminal probe of the orthopedics industry. Zimmer suggested the possibility of a limited probe, sparked by a single hospital, and insisted that the company itself had done nothing wrong. More specifically, Zimmer said that it had learned that the hospital had solicited bids from Zimmer and similar companies for orthopedic devices. In response, Zimmer said, a competing distributor had recommended that all of the companies adopt a "uniform pricing strategy" that could violate antitrust laws. However, the company said that it did nothing of the sort. "When Zimmer learned of the competitor's proposal, the company advised its local independent distributor to reject it on behalf of both the distributor and Zimmer, which the distributor did," the company announced. "The written rejection stated emphatically that neither Zimmer nor its distributors will participate in pricing discussions with competitors, and that Zimmer's policies insist on full compliance with the antitrust laws." For its part, Zimmer says that it continues to cooperate fully with federal authorities. But the company's stock, after rising 5% in regular action Wednesday, dropped 3% in postclose action.
Zimmer is hoping that new products -- especially its gender-specific knee -- will fuel sales growth in the second half of the year. The company maintained its full-year sales growth guidance of 10% to 11% while lowering its profit forecast slightly. Orthopedic investors, cheered by Stryker's ( SYK) positive update last week, had been hoping for new reasons to celebrate instead. Zimmer simply needed to clear a low bar for the second quarter and to sound convincing when it promised to jump much higher in the latter half of the year. BMO Capital Markets analyst Joanne Wuensch had assumed that the company could pull off both. For her part, Wuensch expected Zimmer to post revenue growth of 5.9% for the quarter -- at the high end of recent company guidance -- and match the consensus profit estimate exactly. Looking ahead, she predicted that upcoming catalysts would drive Zimmer toward its double-digit sales growth target for the year. "We believe investors will be focused on how Zimmer will meet its revenue guidance for the full year, which will require considerable growth acceleration," she acknowledged. But "easier year-over-year comparables, new product launches and more favorable market conditions -- as noted in Stryker's 7/20 conference call - and foreign exchange should aid the company." Wuensch has an outperform rating and a $76 target price on Zimmer's stock. Her firm has no business relationship with the company.
Like Wuensch, however, Hsu sensed that the second half - and its dependence on new products like the gender-specific knee - will matter the most in the end. He continued to steer investors clear of Zimmer and most orthopedic companies in the meantime. "Due to the lack of obvious short-term positive catalysts, we do not see any reason to buy Zimmer, Smith & Nephew ( SNN) or Biomet ( BMET) despite valuations which are close to 10-year lows," he wrote earlier this month. "Stryker remains our only outperform-rated ortho stock due to the diversified revenue base, potential for (profit) margin expansion and potential for 20% EPS growth over the next few quarters." Bear Stearns does and seeks to do business with the companies it covers.