Zimmer Biomet Holdings Inc (ZBH) 2009 Q1 法說會逐字稿

Good morning.

My name is Regina, and I will be your conference operator today.

At this time I would like to welcome everyone to the Zimmer first-quarter 2009 financial results conference call.

(Operator Instructions).

Thank you.

Mr.

Paul Blair, you may begin your conference.

Good morning.

I'm Paul Blair, Vice President of Investor Relations for Zimmer.

Joining me today to host this call are David Dvorak, President and Chief Executive Officer, and Jim Crines, Executive Vice President Finance and Chief Financial Officer.

This morning we will review our performance for the first quarter of 2009, provide you with an update on certain key matters, present an update on our outlook for 2009 and conclude our discussion with a question and answer session.

We have shortened our prepared remarks in order to take your questions and complete the call within an hour.

Before we get started, I would like to point out that this presentation contains forward-looking statements within the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 based on current expectations, estimates, forecasts and projections about the orthopedics industry, management's beliefs and assumptions made by management.

These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that could cause actual outcomes and results to differ materially from those in the forward-looking statements.

For a list and description of the risks and uncertainties, see the disclosure materials filed by Zimmer with the Securities and Exchange Commission.

Zimmer disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

This presentation also contains certain non-GAAP financial measures.

A reconciliation of certain information to the most directly comparable GAAP financial measures, along with other financial and statistical information for the periods to be presented on this conference call, was included in the press release announcing our earnings, which made be accessed from the Zimmer website at www.Zimmer.com under the section entitled Investor Relations.

A re-broadcast of this call will be available from approximately two hours following the conclusion of today's call through the end of the day on May 7, 2009 and can also be accessed from the Investor Relations section of the Zimmer website.

At this time I would like to introduce David Dvorak, President and Chief Executive Officer of Zimmer.

Thank you, Paul, and good morning, everyone.

We appreciate your joining us on the call today to talk about Zimmer's first-quarter results and how we are positioning the Company to deliver value to healthcare providers, their patients and our stockholders.

I will start by briefly reviewing the first-quarter results which Jim will discuss in more detail in a few moments.

Them we will will take a look at the expectations for the year.

As a quick preview of this part of my remarks, we are reaffirming the full-year outlook that was provided on our last conference call.

I will complete my prepared remarks with an overview of some of the areas we are focused on in 2009 and why we are confident that Zimmer is well-positioned to deliver solid returns and achieve long-term success.

Consolidated sales for the first quarter of $993 million were down 1.5% in constant currency from the prior year first quarter and down 6.3% reported.

Consistent with prior quarter trends, the US dollar remains strong throughout the first quarter, which led to a currency translation effect of negative 4.8% on sales in the quarter.

As we have discussed before, the topline impact of currency fluctuations is largely neutralized on the bottom line due to our hedging program.

In constant currency knee revenues were essentially flat in the first quarter, while hip revenues declined 3.7%.

Among our other product franchises, extremities revenues were up 7.8%, trauma sales increased 5.5%, spine was up 23.7% inclusive of the acquired Abbott Spine revenues, and dental was down 10.6%.

Finally, our orthopedic surgical product sales were down 19% in the first quarter due in large part to the continuing impact of the 2008 suspension of product distribution.

Turning to our bottom-line results, adjusted diluted earnings per share for the first quarter were $0.95, a decrease of 8.7%, compared with the prior year and slightly ahead of the consensus estimates for the quarter.

During the quarter we generated operating cash flow of $185 million.

Our first-quarter performance is a manifestation of the challenges we faced in 2008 and in part the carryover effect of previously disclosed share losses and core product franchises.

With respect to market growth rates, we continue to expect demand for procedures to slow this year by about 2 percentage points worldwide due to the general economic downturn.

We also believe, however, that the market's deceleration and product procedure demand is likely to be temporary as the benefits of knee and hip procedures are indisputable for prospective patients who are suffering the debilitating effects of osteoarthritis.

Looking at the balance of the year, we are reaffirming our sales and earnings guidance.

As we previously stated, our results are expected to improve in comparison to our prior year performance as the year progresses, and we anniversary out of the negative effects of 2008 customer losses and the impact of certain product suspensions.

We continue to expect revenues for 2009 to increase between 1% and 3% on a constant currency basis and full-year unadjusted diluted earnings-per-share to be in a range of $3.85 to $4.00.

2009 is a pivotal year for Zimmer.

At the end of March, we announced that the Deferred Prosecution Agreement with the United States Attorney's office had expired as scheduled.

Thanks to the tireless efforts of the Zimmer team, our enhanced business model is in place worldwide.

Key product development programs are underway, and we have now resolved most of our surgeon payment issues.

More fundamentally we have structures in place to maintain essential collaborative relationships while managing potential conflicts of interest.

We are concentrating on executing initiatives commenced last year that will help drive and support growth.

Recent investments in infrastructure, additional management talent, enhanced medical education and new products offer expanded opportunities for Zimmer.

We believe that we have the tools to leverage our worldwide leadership in knees and hips across the musculoskeletal spectrum.

Those sound like lofty goals.

Let me give you some examples of why we believe we're beginning to reestablish positive momentum in our business.

We will start with medical education, which was largely suspended over one year ago.

The interruption had an impact on our ability to respond fully to the interest in the marketplace for our products, particularly for healthcare professionals who want training on our new products, instrumentation and techniques.

There is no doubt that training and education play a critical role in facilitating positive clinical results for surgeons.

We are addressing the impact of this interruption with two key programs.

One is our new medical education program, which has been redesigned to optimize knowledge transfer.

Secondly, we have broadened our roster of learning opportunities to better match surgeons' individual needs and schedules.

In the United States our bioskills training courses are filling quickly, often as soon as our core schedules are announced, and the courses are being conducted at or even above historic levels.

We will be expanding this program as 2009 progresses to accommodate demand.

Training in Europe and Asia-Pacific is now back up and running as well.

We are also focused on expanding our training on important new products like our Trabecular Metal reverse shoulder, our ML Taper with connective technology and Fitmore stems, as well as our advanced knee products like the Zimmer patella femoral joint and LPS-Flex mobile system.

At the same time, we are developing training for products that we plan to launch in 2009 such as our new natural nail for trauma patient-specific instruments for knees and new acetabular cup offerings for hips.

We are also continuing to make progress with the relaunch of the orthopedic surgical products that we voluntarily ceased to distribute in 2008.

Moreover, we continue to make significant investments in quality initiatives, including programs to apply consistent standards across the Company to ensure the quality is firmly embedded in the DNA of our corporate culture.

With respect to external development, we are extending our reach in spine with last year's acquisition of the Abbott Spine business.

While we are currently working through some disruption in our spine sales as we integrate the two organizations, going forward we look for improved sales performance in spine as the strength and distribution channel leverages a broader product offering.

Finally, we are excited about the level of interest shown in Zimmer and our products by attendees at the AAOS annual meeting in February.

Zimmer's booth was one of the most active and well attended at the meeting, according to independent sources, and there was a great deal of positive surgeon interaction.

We are relishing the chance to get back to driving our business forward and, our experience at AAOS is one reflection of how this is happening at Zimmer.

Overall we're in a far better position to take advantage of opportunities now than we were a year ago.

We have great confidence in Zimmer's long-term future and are determined to handle near-term challenges by keeping patients at the forefront as we focus on customers and results.

Jim will now provide further details on the quarter and our guidance.

Jim?

Thanks, David.

I will review our performance in the quarter in more detail and then provide some additional information related to our guidance.

Sales of $993 million for the quarter reflect a decrease of 1.5% constant currency and 6.3% reported as David indicated.

These results reflect anticipated headwinds from 2008 customer losses and the impacts of a stronger US dollar on translated foreign currency revenues, as well as lower dental and OSP sales compared to the same quarter last year, partially offset by increased sales in spine as a result of the Abbott Spine acquisition.

As a consequence of the stronger US dollar compared with the prior year, foreign-currency translations again decreased revenue by 4.8% or $51 million in the quarter.

Consolidated pricing was down 0.7% for the quarter.

In the Americas price was negative 0.3% for the quarter, while Europe average selling prices were flat compared to the prior year.

Asia-Pacific results include negative price of 3.4%, in line with the last three quarters following reimbursement price cuts in Japan which took effect in April of 2008 and to a lesser degree cuts in Australia beginning from July of 2008.

Turning to our first-quarter revenue growth by major product category, worldwide reconstructive sales, which now exclude dental, decreased 1.4% in constant currency and 6.6% reported.

Knee sales in the first quarter declined .3% constant currency, reflecting negative price of 1.2% offset by positive volume and mix of 0.9%.

As we reported on our fourth-quarter call, during the second half of 2008, we had loss an estimated 1.5 points of market share in knees as a result of various factors, including the implementation of our enhanced global compliance program.

During the first quarter of this year, based on competitive results reported to date and independent analyst estimates for other market participants, we estimate that our results reflect signs of improving stability in our knee franchise with a loss of no more than 10 basis points of additional market share in the quarter.

In the first quarter, knee sales in constant currency decreased 0.7% in the Americas and increased 1.8% in Europe.

In the Americas price was 0.5 point negative, while volume and makes was essentially flat.

The Americas results reflect the carryover effect of 2008 customer losses, as well as some deceleration of procedure volumes in the quarter.

Our Europe results reflect positive performance in a market which appears to be growing at a somewhat lower rate than in the prior year.

In Asia-Pacific we are up against -- we were up against a challenging comp in the first quarter.

In 2008 our knee franchise in Asia-Pacific grew 12.3% in constant currency in the first quarter with volume and mix in double digits and slightly positive price.

In 2009 volume and mix growth in Asia-Pacific is a more modest 3% and is offset by negative price of 5.7%, resulting in negative growth of 2.7% for the quarter.

Worldwide hip sales declined 3.7% in the quarter in constant currency, reflecting negative price of 1.5% and negative volume and mix of 2.2%.

We estimate the cumulative share loss in hips to be in line with the 2 to 2.5 points anticipated in our guidance and reported on our last conference call.

We continue to focus on opportunities to introduce recently launched products to potential new users, including our ML taper with connective technology and our femoral bone conserving stems, again as David indicated.

Those efforts are backed by a medical education program that has been enhanced to better respond to needs for training and education on the safe and effective use of these new devices.

On a geographic basis in constant currency, first-quarter hip sales decreased 3.4% in the Americas, 2.8% in Europe and 7.1% in Asia-Pacific.

In the Americas price in hips was down 1.2%, while volume and mix was down 2.2%.

In Europe price declined 0.7%, and volume and mix was off by 2.1%.

In Asia-Pacific reimbursement price cuts in Japan, which took effect again in April 2008, lead to negative price in hips of 4% for the region, while volume and mix was down 3.1%.

We continue to focus significant product development resources on addressing gaps in our hip product offerings so that we can more effectively counter competitive pressures on our hip franchise.

Extremity sales for the quarter in constant currency increased 7.8% over the first quarter of 2008.

Dental sales on a constant currency basis decreased 10.6% for the quarter.

Dental sales continued to experience pressure on a global basis due to the weak global economy.

We continue to believe the dental implant business has attractive long-term growth prospects and is a good strategic fit for Zimmer.

Trauma sales in the quarter were up over the prior year period 5.5% constant currency.

On a constant currency basis, trauma sales in the quarter decreased 1.5% in the Americas, increased 18% in Europe and increased 14% in Asia-Pacific.

Zimmer Spine reported 23.7% constant currency growth in the quarter.

This growth is driven by the Abbott Spine acquisition, which was completed during the fourth quarter of 2008 and contributed $19.8 million of incremental spine sales in the quarter.

Finally, orthopedic surgical products and other sales declined 18.6% in constant currency in the quarter as a result of the previously announced voluntary suspension in sales of certain patient care products, partially offset by bone cement and accessory sales which grew over prior year.

The remediation efforts at our Dover, Ohio facility continued to progress, and production and distribution of the vast majority of the OSP products has resumed.

I will focus now on the rest of the income statement.

Our adjusted gross profit margin of 77.2% for the quarter is up 120 basis points from the prior year first quarter.

Foreign currency hedge gains as compared against hedge losses reported in 2008 largely account for the improvement in gross margin in the quarter relative to prior year.

Looking ahead to the balance of the year, we have temporarily slowed manufacturing at our principal implant production facilities as part of a coordinated effort to reduce inventory levels of standard line products.

Gross profit margins are expected to be lower in quarters two, three and four as a result.

Moving down the income statement, R&D expense as a percentage of sales increased to 5.2% and at $51.8 million for the quarter is 8.5% above prior year.

As a result of expanding our product development efforts to take on new projects, R&D expense is expected to remain at or above Q1 levels for the next three quarters.

Selling, general and administrative expenses increased to $424 million in the first quarter and are up 1.4% over prior year.

At 42.7% of sales, SG&A expenses are 330 basis points above prior year and include monitor fees and expenses, as well as a significant increase in spending for our enhanced global medical education programs.

Similar to product development, medical education is a targeted area for investment, and we expect additional increases in our level of spending in this area as the year progresses.

Acquisition, integration and other amounted to $7 million in the quarter, comprised of costs pertaining to the Abbott Spine in prior period acquisitions, including facility consolidation costs, legal fees and retention and termination payments.

Adjusted operating profit in the quarter decreased 14% to $291 million.

At 29.3% our adjusted operating profit to sales ratio decreased by 270 basis points from prior year as a result of lower revenues and an increase in SG&A expense over prior year first quarter.

Interest expense for the quarter amounted to $3.7 million, principally resulting from financing the Abbott Spine acquisition and share repurchases.

Adjusted net earnings decreased 14% compared to prior year at $210 million, and adjusted diluted earnings per share decreased 8.7% to $0.95 on 222.1 million average outstanding diluted shares.

These adjusted earnings-per-share are inclusive of approximately $0.06 of share-based compensation.

At $0.91 reported diluted earnings per share include certain non-recurring costs connected with the Abbott Spine and prior period acquisition and as such decreased 10.8% from prior year first-quarter reported EPS of $1.02.

Our effective tax rate for the quarter was 26.9%, reflecting certain adjustments within the quarter that reduce the effective tax rate below our projected full-year effective tax rate of 27.5%.

During the quarter we repurchased 8.6 million shares at a total purchase price of $301 million or an average price per share of $34.94.

We used $247 million of debt financings and $54 million of cash to acquire the shares under a $1.25 billion repurchase authorization which expires at the end of 2009.

Approximately $833 million remain authorized under this program.

The Company had approximately 250 million shares of common stock outstanding as of March 31, 2009, down from 223 million as of December 31, 2008.

Operating cash flow for the quarter amounted to $184.6 million, down from $242.7 million in the first quarter of 2008.

In the quarter we continue to resolve outstanding payments to health care professionals and institutions resulting in substantial cash outflows compared with prior year.

We settled a large number of (inaudible) claims, and we invested in the buildout of pipeline inventory for certain new products we're in the process of launching or preparing to launch in 2009.

Adjusted inventory days on hand finished the quarter at 373 days, up 29 days from prior year-end as a result of a significant investment in new products.

Our adjusted trade accounts receivable days sales outstanding finished the quarter at 61 days, an increase of two days over the fourth quarter of 2008.

Depreciation and amortization expense for the quarter amounted to $79.6 million.

Capital expenditures for the quarter totaled $76 million, including $45 million for instruments and $31 million for property, plant and equipment.

Cash outlays associated with investing activities during the quarter also include $8 million for acquired intellectual property.

Finally, free cash flow was $108 million for the quarter.

And I would like now to turn to our guidance.

In our press release this morning and as David indicated in his comments, we are reaffirming our sales and EPS guidance, expecting full-year revenues to increase from 1% to 3% in constant currency when compared to 2008 with total revenues anticipated to be flat in the second quarter and improving thereafter.

In the second quarter, knee and hip comps get a bit tougher due to year-over-year differences in billing days and strong volume and mix results reported in the Asia-Pacific region in the first half of 2008.

As a result, we anticipate some softening in knee and hip growth rates in the second quarter relative to the first quarter, offset by stronger relative performances from our other franchises.

We continue to assume that foreign currency translation will reduce our reported 2009 revenues by an estimated 4% for the full year.

Therefore, on a reported basis, our revenues are projected to be in a range of negative 3% to negative 1% compared with 2008.

As the US dollar was at its weakest point in the second quarter of 2008, currency translation effects are expected to be most pronounced in the second quarter of 2009.

Regarding the overall market, our assumption coming into the year for global knee and hip market growth for 2009 anticipated the deceleration of about 2 percentage points from the high single digit growth reported for full-year 2008.

That translates into an assumed rate of constant currency growth for the market of about 6% for 2009.

Based on the earlier reported results from certain of our competitors and independent analysts' estimates for other market participants, we estimate first-quarter 2009 market growth for knees and hips to be about 5% with a bit more pronounced deceleration in knee growth in the first quarter.

We continue to hold for a full-year assumption of about 6% given that worldwide prizing comps for knees and hips get a bit easier going forward as we anniversary out of 2008 reimbursement price cuts in the Asia-Pacific region and procedure comps also get easier in the back part of 2009.

Full-year adjusted diluted earnings-per-share are projected to be in a range of $3.85 to $4.00 with negative growth in the second and third quarters followed by positive leverage growth in the fourth quarter.

Negative growth in the third quarter is expected to be more pronounced due to the significant gain recognized in the third quarter of 2008 on the sale of certain investments.

David, I will turn the call back over to you.

Thank you, Jim.

And with the steps we took last year to strengthen our Company, we have the foundation for musculoskeletal leadership.

Our near-term priority is to use our considerable strengths to continue to rebuild momentum in our business.

We are confident that our commitment to meeting our own high standards day after day will translate into long-term success.

Now I would like to open the call to your questions.

(Operator Instructions).

Tao Levy, Deutsche Bank.

So just simply if you look at the overall market -- thanks for all the data you guys have provided -- if you look at the volumes, mid-single digits and again you look at pricing for you guys, it seemed like maybe it was down a little bit more than what we heard from competitors.

Given that backdrop, what are you looking for for pricing going forward and also with the volume specifically in the second quarter?

Are you seeing any trends now that make you feel better about where that 5% was in Q1 or maybe a little bit worse, and then you are thinking more of that recovery into the 6% takes place in the second half of the year?

Just on pricing, I would say where we are on pricing is really pretty consistent with what we saw in the back half of last year.

And, as I indicated in my comments, we see that the opportunity for that to improve for us certainly going into the balance of the year given that we anniversary out of the reimbursement price cuts in the Asia-Pacific region that took place in April of 2008.

So we understand, and we would acknowledge that it's certainly a challenging environment on the pricing front, but it has been for the past couple of years.

Those conversations really have not changed, and you're seeing the effect of what is happening in the field and what we are reporting over the past several quarters.

And then I would tell you with respect to the overall growth in the market, it is pretty much in line with what we anticipated coming into the year, notwithstanding the fact that may be a bit more deceleration in the knee procedure growth in the first quarter.

But as we look at mix and volume opportunities over the balance of the year, as we said -- as I said in my comments, we do believe that the market is likely to grow in 2009 at the sort of 6% level as the procedure comps get a little easier in the back half of the year and those price comps get easier in the balance of the year.

Mix opportunities we think in our particular case improve as we go to the balance of the year, and we have these medical education programs up and running at full tilt.

I know that you asked questions that were framed out with a shorter term interest in mind, but every time we talk about the procedures we ought to come back to reiterating that if anything this is short-term.

These are deferrals.

The need for these knees and hips is not going away.

These patients are going to find other solutions in interim, and if anything, it could lead to a bolus of procedures on the backend as the economy begins to recover.

So there is no long-term change in our view of the prospects of this market.

In terms of -- in Q4 you talked about losses of some of your surgeons.

How does that transition from Q4 into Q1 and kind of what you are looking for in terms of the balance of '09?

Yes, it is very much in mind with what we had reflected in our guidance.

Actually it is better than what we had reflected to the extent we talked about our guidance incorporating risk of up to an additional 50 basis points of share loss in both hips and knees.

In knees, as we look at the first-quarter results at this point, I would tell you -- our estimate is that we have lost no more than an additional 10 basis points of market share in the quarter on top of the 1.5 points loss of market share that we experienced in the back half of last year.

Actually I was talking -- referring more to actual surgeon defections.

You commented in Q4 about surgeons who had left the Zimmer family, and I was just wondering if you could comment on how that trend has looked.

That trend is stabilizing is the answer.

I think that Jim is quantifying that --

Market share.

Yes, and any of the subjective measures I would tell you that that trend is stabilizing as well.

The things that we pointed out last year are the right things for us to have been focused on.

We brought in enhanced leadership in that area.

Our communications are much, much more proactive.

We are cleaning up some of the past issues with respect to deferred payments that were owed to those surgeons.

As well, programs are back up and running.

So the general tone, and I mentioned it in my comments as well, as evidenced by activity at the AAOS event in Las Vegas was very positive.

So I think all those trends are positive for us.

Mike Weinstein.

JPMorgan.

A couple of comments or questions here.

If you could just spend some time on the inventory build.

You have over a year's worth of inventory on hand now.

If you could help us understand the time period you think it will take to work that down and what should be the appropriate level at the Company?

And then on pricing dynamic, which Tao touched on, but it looks like your pricing in the Americas got a little bit more challenging.

Can you give us your thoughts on price and not mix as we go forward?

Okay.

On the inventory build, the focus there on the one hand will continue to be to fully support any new product launches that we have planned for 2009.

Some of what you are seeing in the first quarter as an example is an investment in inventory associated with the new natural nail, the new line of intramedullary nails are going to be launched within that trauma franchise.

We have an opportunity over the balance of the year to reduce inventory days on our standard line products after having made some significant investment in 2008 and putting more inventory out in the field as we were working our way through this transition, put our distributors in a position to ease some of the burden, some of the pain they were experiencing in managing -- getting the inventory in and out of hospitals on a day-to-day basis.

We have targets in mind here in terms of what we are looking for and will be able to provide updates on a quarterly basis on these calls as to where we stand relative to those targets.

With respect to pricing, I don't know that the general dynamics in those discussions and negotiations have changed much over the last couple of operating periods.

It is true that within the US that trend has turned a bit, and I don't think that is anything that we expect to become more profound in the go forward periods.

One has to also keep in mind that on the other hand the European pricing environment has stabilized relative to where it has been for the last operating period or two and the Asia Pacific difficulties begin to anniversary out this quarter in Japan and then next quarter in Australia for us.

So again, our overall assumptions and the guidance that we provided embed those expectations in, and I think that what we are seeing to date is consistent with what we assumed in the model.

Last question just relative to what you're thinking about the market.

Our math with you guys Zimmer reported this morning should market growth constant currency in hip and knees at pretty equivalent the first quarter both in the range of 4%, 4.5%.

So is your thinking that market growth improves from here to get to that 6% for the year, or share with us your thoughts because I think we're coming out a little bit lower than you are?

Yes, I don't think that we are going to see a greater decline in the procedure rate.

I think that that will stabilize and improve as the year progresses.

And then I think also when you roll up those numbers in their entirety, if it is just on dollars, then, as Jim referenced in his comments, we start to see the anniversary out of some of that pricing.

Okay.

I will let some others jump in here.

Bruce Nudell, UBS.

Our calculations, similar to Mike's, show about a 4.5% market.

And so that's like a 2.5% or 3.5% shortfall, depending upon whether you think the market would have been 7% or 8%.

How much of that do you think is volume shortfall as opposed to the inability to improve ASPs at the standard 2% to 3% level?

So of the 2.5% to 3.5%, how much do you think was basically volume in terms of shortfall?

We cannot speak for obviously what is reflected in our competitors' numbers.

I can tell you with respect to our own performance the difference really isn't procedure demand.

What we are seeing in terms of mix benefit is consistent with what we saw coming out of the fourth quarter of last year.

Pricing is consistent with what we saw coming out of the fourth quarter of last year, so the difference really isn't procedure demand at least with respect to our numbers.

And again, I cannot speak to whether or not that is also the case obviously with respect to competitor results.

Okay.

You think that it is not inconceivable to you that volumes across the market could be down 2.5%, let's say?

I'm not sure why our experience would be different than the broader market with the market share that we have.

I will tell you that our intelligence and field checks on this are relatively consistent with that.

So I don't think there is a material differences between what we are experiencing and what the others are experiencing in that regard.

And with regard to that, we have not really hit peak unemployment yet.

What gives you the confidence that we have seen the worst of the slowdown?

I just think that when you have sort of behavior modification incentive to cut in different directions, there are people that want to accelerate these procedures because they are afraid they are going to lose their employment opportunities and potentially their insurance coverage.

Right?

And then you have others that want to defer it because they are afraid that being out of work at this point in time is not a good idea and that their job security and stability is not what they would like it to be.

So I just think that it is tough to use that unemployment rate necessarily as a leading indicator for what these procedures will do.

But the trends that we saw in the fourth quarter and that we saw in the first quarter would indicate that we are going to be stabilizing this as the year progresses.

And if we're off by a bit in that regard, I would tell you that our own guidance that we provided would assume a bit of a margin of error in that number and, of course, would be countered by other things that are assumed into those models.

So irrespective of that, we are comfortable with our guidance at this point.

Terrific.

My final question is, it looks like sequentially -- I know there is seasonality in your share in the various geographies -- but it looks like in hips and knees in the US, you actually may have stepped up slightly sequentially with a little bit of erosion ex-US.

Is that correct, and in aggregate how much more share globally do you expect to cede this year?

Well, I think that you saw greater stability in our European business than you did in the US business but the beginnings of stability in the US business, so positive trend in that regard.

Matthew Dodd, Citigroup.

First, on the surgeon defections, have you seen any come back, potentially have buyer's remorse and they went somewhere else and have since come back to you?

That is one, and then two, on the manufacturing just to tail Mike's question, so this was really a one quarter phenomenon where you knew that the volumes would be coming lower but you wanted to build inventory, and now we are ratcheting down the manufacturing for the rest of the year at a relatively steady clip the next three quarters?

Yes, with respect to the surgeons, I think that what we have seen there rather than anything significant in the way of surgeons returning is just the stabilization on that side.

And there have been instances where some business has returned, but at this point in time, I would not describe that as at all material to the overall trend.

I think that there have been more instances where conversations have opened back up, and so that is a good sign, and there is potential for some of that business to come back.

But our assumption is that those returns in this year are going to be relatively modest.

This is Jim.

The manufacturing slowdown really started to take effect in the back half of last year as we experienced the share loss that we reported out.

So it is something that has been reflected in our plans coming into 2009.

It is something that is reflected in the guidance that we provided for 2009.

Because we are not providing quarterly guidance, it is just not something that we had spiked out.

It does nonetheless cause some sort of volatility in those quarterly gross profit margins because if you slow down those production facilities, put less volume through them, you have higher unit cost, that inventory is getting put to the shelf, and then it gets sold through in subsequent quarters.

That is what is causing the margin to begin to step down in the second quarter of this year, and, as I indicated, that is a trend that will continue through the balance of the year.

Right.

The gross margin guidance you gave at the beginning of the year, that range still is okay?

Yes.

Matt Miksic, Piper Jaffray.

Not to beat a dead horse here on the market and in your experience so far, I guess I'm looking at this since we are going quarter to quarter on trends and procedure trends and demand in the consumer environment and how it might be affecting the business.

Looking at quarter to quarter deceleration that we have seen across the rest of the group, it has been about two -- as you have talked about, I think 2% to 3% from the other major players.

You guys actually came in a little bit better than that in terms of maybe only about a percentage point worldwide recon deceleration.

Does that -- I guess is it fair to think about not only stabilization in the US in terms of share losses, but are there any geographies where you are actually picking up share?

I guess the way we would characterize it is clearly stable -- we see the share situation stabilizing, particularly in the knee franchise.

In the US and Europe for sure, we've talked about the very challenging comps.

We had in Asia-Pacific I indicated that volume mix growth in Asia-Pacific for knees for us came in around 3% for the quarter.

It may be the case.

I cannot say for sure that the market in Asia-Pacific for knees may have grown a little bit higher than 3%.

If it did, our results would reflect maybe some modest additional share loss in the Asia-Pacific region within the quarter.

That is something that we are addressing with a substantial amount of effort that is going into getting the training and education programs back up and running in that part of the world.

Again, the way that we think about it things have really -- our results for the first quarter indicate that things have really stabilized with respect to share.

Okay.

And just a follow-on, I had a couple on your smaller businesses.

But on the training programs, interactions with surgeons and your global compliance program, I guess I was a little concerned heading into the beginning of the year outside the US when you rolled out the global compliance that that might just start to have a follow-on share impact like we have seen in the US.

It does not seem like it was as bad as we were expecting.

Do you think we are on the other side of that now, or is that still in front of us?

Do we still have more risk in front of us than global compliance, or is it sort of stable and upside from here in terms of the impact of that program?

I think that it will stabilize from where we are.

Frankly, our training and education programs are staying up at a rate that causes you to be correct in your characterization that there is a bit of a lag outside the US.

I would also tell you that I think the deficit and backlog of beating those needs was not as profound overseas as it had become in the United States.

So we are really at what I would characterize to be a fairly full clip now in the US, and I would suspect that as the second quarter progresses, I would be able to characterize the OUS training and education similarly, but I just think that they are working out of a little bit less of a whole than what we had in the US in that regard.

Okay.

A quick one here on spine and dental.

Spine, by my math, looked like excluding the Abbott impact you did something like a mid-teens number in Spine, which is nicely above where the market is.

I was just wondering if you could add any color on kind of whether it's products or geographies or synergies of Abbott or what might be helping that business to do better than it has in the last year or so?

Yes, if you look at the pro forma numbers, Spine actually went the other way in that quarter.

I will tell you that the legacy Zimmer business has seen more competitive pressures in certain product lines, as well as the fact that we are going to go through and face some dis-synergies on both sides of the equation, the Abbott and the legacy Zimmer side until those distribution channels are fully cross-trained on the products.

So what you see there is all positive growth by virtue of the acquired revenue.

Going forward, as that distribution channel comes together and our training efforts on the salesforce side begin to find some traction, we should see some accelerated growth rates as the year progresses.

Okay.

But it is still slower than the market in Spine?

That is right.

And then last one here on dental, you mentioned you continue to look at that as an important strategic business for Zimmer.

Given your financial wherewithal and the environment we are in, any interest strategically in adding to your franchise in that business and that market?

It is an area that we would consider on a business development front, and we have stated that in the past.

I think the area would be more geographic footprint oriented as far as our interest goes than anything else.

But it continues to be a business and a market that we think is strategically sound and consistent with our mission as a Company.

Bob Hopkins, Bank of America/Merrill Lynch.

A couple of quick ones and then one big picture one.

What was the Spine pro forma growth in the quarter by your math?

It was down about midteens.

Down midteens pro forma for the deal?

Okay.

And then Jim, you mentioned that you thought you lost roughly 10 basis points incrementally in knees.

I did not catch what that same number was for hips.

About 2/10 of a point.

Okay.

Then the next little one is you are forecasting 6% growth for the overall market.

Just from a stress test perspective if you will, how low can that market rate go before your earning projections become at risk in your view?

Well, as David pointed out, we are very comfortable with the guidance, particularly given where we are with the share issue.

We talked about our guidance incorporating risk on hips and knees additional share loss of up to 50 basis points for the year, and clearly looking at the first quarter we are well below that.

So with that and particularly with the comps getting a bit easier, as we get into the back half of the year, the training and education programs getting back up and running and having opportunity to increase penetration with these new products --

Right.

No I -- (multiple speakers)

That growth rate could decelerate; it could remain.

I guess the best way to answer the question, it could remain at the first-quarter levels, and we would still be very comfortable with our guidance.

Okay.

So somewhere -- I agree with the previous math, it works somewhere between 4% and 4.5% this quarter.

So as long as we don't go much below that I guess, to put words in your mouth, you still feel comfortable with the guidance?

I would agree with that.

And then lastly, just to play devil's advocate a little bit on the pricing questions that have been asked, I'm just curious, David, if you could talk to why should we not see pricing get worse in hips and knees?

We have got an unprecedented economy and pressure on hospitals.

You've got physician relationships that have been altered as a result of the DOJ relationships.

You have got other markets in cardiovascular that were pricing as down anywhere from 3% to 10% depending on the categories.

I'm just curious.

I hear your comments about we are not seeing any change right now, but I'm curious as to what gives you the confidence that we won't see incremental pricing pressure as we go forward?

I think some of those dynamics have existed.

They may be more profound now than what they were in prior periods.

But the discussions and tone that those discussions take and the relative positions of the players in those discussions I don't think have changed that profoundly at this point in time.

If you're asking if there is something more significant that comes from healthcare reform that could change those dynamics, sure, that is always a possibility, and the proposals that are out there now are so big that it is difficult to even speculate about that.

But even in that environment, we have different pricing environments throughout the globe, and our go-to-market strategies are different throughout the globe as a consequence of that.

Notwithstanding those environmental factors, we have very profitable businesses as well.

Okay.

So I will talk about it further off-line I guess.

But just lastly, on OSP when do you expect a more pronounced rebound there?

Well, you should see a more pronounced rebound beginning in the second quarter because obviously we have anniversaried out of that suspension at this point in time.

By the end of this quarter, we would expect to have most all of those products back in the market place.

Now recovering those sales is going to take time, but the positive trend should really begin in the second quarter.

A little bit of an offset to exists obviously because we do have a bit of a capital appointment component.

Not all that much, probably midteens as a percentage within that business, so obviously that is a little bit of a drag going through the economic period that we are in right now.

But the answer is in the second quarter, Bob.

Raj Denhoy, Thomas Weisel.

I wonder if I could ask a little bit more on the Spine business.

If we do the math, I think much like you guys, it was down roughly 17% the core business in the quarter.

I think even the Abbott Spine business, given your comments from last quarter, deteriorated from I think $22 million to just below $20 million this quarter.

I think your comments sounded like you expected some resumption of growth here at least for some stability.

I'm curious why you think that is going to happen.

We are only two quarters into this acquisition.

Are we looking at another couple of quarters of dis-synergies here before we see a turn, or do you have plans for a faster turn than that?

Let me answer that question on two different fronts.

I think talking about the legacy Zimmer business, there are some competitive pressures.

Our Dynesys system is one of the areas.

Obviously with competitive offerings being introduced, there is some pressure on that business.

Trying to work through some of the reimbursement issues that relate to that product present other challenges, and so that is some of what you are seeing.

But also on the second front, we are combining these independent distributor networks and choosing the strongest distributor in each of those geographies.

As a consequence of that process, you're going to lose some historic revenues on both sides of that equation.

So that is happening.

You're really at a point where those decisions have been made.

Our distribution channel within the United States has been fully formed.

So all of the disadvantages of going through that selection process are embedded in the first-quarter results.

None of the advantages of that stronger channel and a broader product offering are being seen.

So from here, we should start to see a very natural progression towards improved performance.

How profound that will be in the second quarter, we are not going to give that kind of specific guidance.

But we ought to be able to methodically work towards improved performance from where we are now.

So the $65 million in the first quarter is kind of a low watermark then?

I believe that is the case, obviously subject to the seasonality within each of the quarters for any of these businesses.

Okay.

Then just one broader question on leverage.

I think in your comments, you mentioned that we should start to see it return in the fourth quarter.

I'm curious what are the sources of that?

What are the expenses that we are looking at that you have incurred over the last several years that really start to wane in the fourth quarter, or it is really being driven by better topline performance?

Just how do we start to drive that earnings number?

I think as we get into the fourth quarter one of the more significant drivers is clearly going to be the effect of the share repurchases over the past several quarters.

And from what we did as well in terms of accelerated what we -- getting out ahead a little bit of what we had in our original plans this year by drawing on a credit facility and buying back over 8 million shares in the quarter.

So clearly that is probably one of the more significant drivers.

We had talked about the investments we are making that are going to be showing up in SG&A over the balance of this year as we continue to focus on the training and education programs and having those run in a way where they are meeting pent-up demands in the marketplace.

We intend to maintain investments that are above current levels on R&D and indicated what our expectations were with respect to -- or what our expectations are with respect to the gross margin.

So if you look at all of that, clearly the principal driver is going to be down below the line in the fourth quarter at this point.

And just sequentially, too, if you think about the revenues improving in the second half of the year and the point that Jim made in his comments about the third-quarter event of the last year, obviously you have got improved topline performance and then the third quarter one-time event from last year.

So, as you get into the fourth quarter, all those things start working towards your advantage on bottom-line performance as well.

Okay.

If I think back to several quarters, maybe even a year, when you first started laying out your spending plans, you talked about $100 million of incremental spending.

That was bumped up to $120 million.

The thought was that at some point half of that spending could be leveraged in a sense I think things around quality IT, those sorts of spending programs could start to come off and could start to flow to the bottom line.

From your comments, though, it sounds like that is not expected to happen here in 2009, that most of the leverage is maybe coming from other below the line items like you said.

I mean it is just something that maybe we're pushing out into 2001 when we really start to see kind of the operational leverage flow-through?

Yes, I think that is fair.

Because remember, we also talked last year about significant disruption in things like the medical training and education.

We talked about disruption in product development, and so we had a stepdown in spending in those areas in 2008.

We've talked about the focus we are putting back on those areas to get that spending, and that spending as a result is coming back into the P&L, and it is offsetting maybe some of the savings in those other areas that you referenced.

So I think you are right.

We are not obviously giving guidance beyond 2009, but clearly as we get into the back end of the year and begin developing plans for 2010, we will be looking for opportunities to return operating leverage above the line.

Sure.

So again, I guess your point about a lot of that savings that we had expected is getting piled back in now as you try and correct some of the share losses.

But in your mind though, then just to be clear on this for 2010, if some of that starts to maybe get leveraged, then we could really see the bottom line start to show some benefit?

Particularly in SG&A, yes.

Kristen Stewart, Credit Suisse.

One of your competitors had noted that they received an IRS notification on transfer pricing.

I was just wondering if you could comment if you have seen -- if you have been notified of any similar things?

We have not received a notice of proposed adjustment with respect to cost sharing arrangements.

Thanks.

Then --

Yes, go ahead.

You can finish.

Sorry.

And again, any material issues with respect to positions that we have taken on our tax returns that have been filed would be described in our periodic filings.

What would those material issues be that you have disclosed on the position side?

Well, there are -- without getting into too much detail, I guess there would be some issues with respect to the Centerpulse transactions that are described in our income tax footnote.

So that in the context of the disclosure sort of requirements that are outlined in [FID] 48 muck, we talk about the reserves that we have on the books to cover those exposures and the possibility that the IRS could come back and challenge any of those positions that we have taken on the tax return.

That is probably the most significant thing that you would see if you go back and have a look at the income tax footnote to our financial statement.

Okay.

Then just on the overall market growth, a year ago you were all talking about Easter having a negative impact on the growth rates.

That would kind of infer that this quarter would have easier comparisons.

Would you generally agree with that looking at selling days and physician holidays and everything else that we had talked about last year as being a contributor to some of the more depressed comps a year ago?

Yes, we would agree with that.

I think last year we talked about that impacting growth rates in hips and knees by about a point, so we would have lost a point in the first quarter last year and picked that up in the second quarter.

That is what leads us to comment on the comps with respect to hips and knees being a bit tougher as we move into the second quarter of 2009.

And as a consequence, as we indicated, expect some softening in hip and knee growth rates in the second quarter of '09 as a result.

Your 5% growth that you had estimated within the market I think you had said, is that really effectively more like 4% if you take out that 1 percentage point impact on Easter?

The 5% is for the full year -- well, for the first quarter and then 6% for the full year.

So the 5% is probably a little closer to 4% effectively?

For the market I would talk about our own results and how that impacted us.

I cannot speak for the competitors, so I don't know if it is a point or something less than a point.

Okay.

And then the last question is just, if you could comment on your GPO contracting, how much of that comes up on an annual basis and what sort of price levels are you seeing on new contracts?

Yes, we talked in the past about how those GPO arrangements have terms of anywhere from one to five years.

They anniversary out periodically, and the pricing that we end up with on those contracts is reflected in what we are reporting out on a quarterly basis.

So if you look at the modest erosion in average selling prices we are reporting out for the Americas, that provides you with some indication of what is getting reflected in those arrangements.

Is it fair to say that the New York contracts have less favorable pricing terms than the other ones?

Not necessarily.

Because there's quite a few significant number of individual pricing agreements in place as well.

So I would not necessarily generalize.

Ben Andrew, William Blair.

Just maybe a bigger picture question, as you have been through I am sure a very comprehensive analysis of your sales process and model, if you think qualitatively and I guess if we could quantitatively about the percentage of the Company's revenues in the orthopedic implant business that goes back to surgeons whether in the form of royalties or consulting agreements, can you characterize that before the DPA process and after and how much it may have changed?

Yes, I think the most we have out in that regard would probably be the website disclosures that were mandated by the DPA.

And so you can get a sense as to with respect to the US hip and knee business what those numbers look like over the course of that time period then.

But as a general answer to your question, I don't think that there is a material change in that regard.

So, as you think about kind of 2010/2011, you would anticipate maintaining similar types of spending as opposed to rethinking that model more broadly?

I don't think that the fair market value justifications that were put in place with the oversight of the monitor materially altered the way those arrangements are structured or the compensation that is generated by those structures.

So it is all activity and needs based.

But assuming that we are going to continue to do what we plan to do on the training education side and they are obviously healthcare professionals that are a very important part of those efforts, as well as on the product development side, I don't see that there is going to be a material adjustment to the trends in that area.

Joanne Wuensch, BMO Capital Markets.

I would like to go back to gross margin.

I mean you have implied that there is a step down coming in the second, third and fourth quarter.

But could you help me understand are we going back down to the 76/77 type level?

How much of a step down are we looking for here?

I'm not going to get to that level of detail.

You had the guidance that we provided on earnings-per-share.

We provided some very specific comments with respect to what our expectations are in R&D spend, on SG&A.

I think you will be able to get to a pretty reasonable estimate of what that margin is going to look like that gets you within the range of $3.85 to $4.00 a share on the top-line guidance that we provided, along with the additional color that we provided on SG&A and R&D.

Okay.

Can you give us an update on where you are on hip resurfacing?

On the hip resurfacing side, our status has not changed since the last quarterly call there.

There was a question that was posed on the last quarterly call about what that product would look like, and our response was, it is likely a next-generation product.

So provided the solution within the United States market is internally developed, that is a longer time horizon than what it would have been prior to last year with respect to the Durom cup.

Could you give us an update on your sales force?

I know you probably had some adjustments last year.

Where are you on revamping that force?

That force -- I mean the question that has come up consistently in that regard is concerns about turnover.

I would tell you that the trends there have not changed.

The stability of the organization continues.

Any turnover is well within any kind of industry standards and our past experience in that regard.

The biggest adjustments that have been made is we have augmented our sales management team at the senior level of the organization with Jeff McCaulley's addition.

And I think that that transition has gone very well.

There has been continuity with the prior leadership as well, so we feel good about what is happening in that regard on the US hip and knee side.

But have we started adding people?

Sure.

And those adds really take place within the US market at the independent distributor level, and then outside of the United States, we have many markets that are direct.

So we are always strategically adding sales force within those markets.

All right.

Because what I'm trying to get at and is what I'm hearing is a more stable environment, a more stable relationship with the physicians, a stable salesforce.

I'm looking for that inflection with new products for you to be adding to the salesforce, and I'm not hearing you say that.

Again, those salesforce adds are really in conjunction with the areas that we are emphasizing.

But the employee additions take place at the independent distributor level within the US structure.

Okay.

Just a final question.

You talked about coming back in the OSP area.

Could you flesh that out a little bit on the timing of a product and what it might look like?

Sure.

Thanks for the question.

We have most of the patient care products back up and running, and then bone cement accessories are a priority both for the first quarter and the second quarter.

And so we would expect to have most all of those products back in the marketplace.

And so blood management would be the remaining set of products that would come out, and it is our expectation that as this quarter progresses, we will make some significant progress in that regard.

All of that obviously gets us to the point where we can go back and start to compete for that business, and we will keep providing quarterly reports as to what the success rates look like in those different components of the OSP business going forward.

Regina, in the interest of everyone's time, let's take one more question.

Rick Wise, Leerink Swann.

A couple of quick ones.

Just on the gross margin, I don't know whether you would be willing to quantify the amount of the hedging gain in the quarter, so we could see what the underlying margin is?

I would just look at the improvement in the margin from year over year.

That largely is a consequence of the hedge -- well, the hedge gains this year relative to the losses that we had last year.

Okay.

Two final bigger picture questions.

Always appreciating that it is dangerous to extrapolate from individual conversations, just a bunch of recent checks with hospitals and doctors suggests just more interest it seems to us than usual in pushing vendor consolidation, more aggressive contract renegotiations than, therefore, these folks are saying to us.

Does all that equal even greater upcoming pressure on price?

Is that something that you are seeing or we should be incrementally concerned about?

Well, you know as I said, I think that has been in play for some time.

I would agree that certainly over the course of last year we saw that pressure intensify a bit, and as a consequence, you saw our ASPs -- some erosion in ASPs in the back half of the year.

And that negative price go from where it was maybe flat in the Americas to between half a point and a point negative in the back half of the year.

And again, that is what we saw as well in the first quarter.

So it has intensified a bit, but again at this point, that is what you are seeing reflected in the price erosion that is being reported.

So it is not getting incrementally worse at this point anyway?

They are tough conversations without a doubt, and our independent distributors working together with our contract management people are working hard through those negotiations.

We are providing as much support to try to get those conversations focused on clearly the benefits that these products offer to patients and with respect to the new technology, which is sometimes where those conversations are focused, the clinical benefits that those new technologies offer.

Okay.

Last, just appreciating during this transition period, you're using this time to invest aggressively in the future.

Any updated thoughts on those strategic front acquisitions?

Are there acquisitions or technologies or products that are on your front-burner, or are you basically done for the moment?

Thank you for the question.

Our strategic direction on the internal development side has not changed from prior conversations that we have had.

There are particular areas that we are looking at, and we're not going to be explicit about those.

We are always looking to license technologies that we think can augment our existing product portfolio or address unmet clinical needs on a go forward time period.

And then, of course, with respect to the smaller business units, there are some specific things we would like to achieve on the external development side to augment their growth rates and be able to execute our strategic plan just to develop critical mass in those areas.

And so that story has not changed, and our area of focus has not changed.

And I would not describe our activities as anything but continuing to be active in that regard.

Well, thanks again, everyone, for joining us today and for your continued interest in Zimmer.

We look forward to speaking to you on our second-quarter conference call at 8:00 AM on July 23.

So I will now turn the call back to you, Regina.

This concludes today's conference call.

Thank you for your participation.

You may now disconnect.