OKLAHOMA CITY -- Zimmer ( ZMH) can't stop the pain. Shares of the giant orthopedic device maker plunged Thursday after the company endured another miserable quarter -- with its crucial top-line results falling short of Wall Street targets -- as the company struggled to regain its footing following a government crackdown on its business practices. Third-quarter sales rose just 5% to $952 million, missing the $964 million consensus estimate, and would have inched up a mere 2% without help from foreign currency rates. The company, which routinely boasted double-digit sales growth in the past, now expects sales to rise just 7% to 7.5% over the course of the full year. Zimmer posted weak profit as well, as the company spent large sums to overhaul its compliance program. While net income rose nearly fivefold to $215 million in the third quarter, due to the absence of a year-ago settlement fee, adjusted earnings crept up a mere 1.4% in the period. Zimmer did post adjusted earnings per share of 97 cents that beat the consensus estimate of 89 cents, but the market took little comfort in that. "We are pleased with the considerable progress that we have made on our previously announced operating, infrastructure and compliance initiatives," Zimmer CEO David Dvorak stated early Thursday morning. "Although this transition is negatively impacting our operating results at this point, we are confident that our actions will position us to capture future growth opportunities represented by the markets we serve."
Meanwhile, Zimmer has trimmed its full-year guidance for the second quarter in a row. With sales expected to grow by no more than 7.5%, the company now predicts that it will earn just $4.03 to $4.08 a share this year. Shares of other device makers, including Stryker ( SYK - Get Report) and ArthroCare ( ARTC), lost some ground as well Thursday. Deutsche Bank analyst Tao Levy had hoped for better news. Levy had a buy rating and a $64 price target on Zimmer's stock ahead of the company's third-quarter update. He promptly cut his rating to hold, however, after the company revised its outlook. Levy's firm seeks to do business with the companies that it covers. "The news from this morning's conference call is an increase in defections and disruptions of surgeon customers as the company implements new compliance programs," Levy wrote on Thursday. "Management's expectations are that this will impair business until the second half of 2009. "Given the longer-lasting headwinds facing Zimmer," he concluded, "we believe it is more prudent to move to the sidelines." To be sure, Zimmer has its hands full. Ever since it withdrew its popular Durom hip from the U.S. market earlier this year, the company has struggled to hold onto its share of the market for artificial joints. Zimmer lost some serious ground in the past few months. On a constant-currency basis, sales growth in the company's core reconstructive unit fell by nearly half -- to just 4% -- between the second and third quarters. Only the company's small "extremities" division, which accounts for less than 3% of its overall sales, posted solid double-digit sales growth in the latest period.
While Zimmer's hip unit has struggled for a while, the company's knee division is now losing some ground as well. Sales growth in that unit shrunk from almost 10% on a constant-currency basis to an even 7% from July to September alone. "Results are ... indicative of losses in both hips and knees," Credit Suisse analyst Kristen Stewart stressed on Thursday. Meanwhile, "gross margins (are) collapsing." A year ago, Stewart noted, Zimmer posted a gross margin of 77.9%. By the third quarter, she said, that margin had narrowed to just 75.2%. Although Zimmer attributed part of that deterioration to hedging losses, she added, "there are likely other factors in play as well." Stewart has an underperform rating on Zimmer's stock. Her firm has investment banking ties to the company.