Zimmer Biomet Holdings Inc (ZBH) 2011 Q2 法說會逐字稿

Good morning.

I would like to turn the call over to Bob Marshall, Vice President Investor Relations and Treasurer.

Mr.

Marshall, you may begin your call.

Thank you.

Good morning.

And welcome to Zimmer's second quarter 2011 earnings conference call.

I'm here with our President and CEO, David Dvorak, and our Executive Vice President and CFO, Jim Crines.

Before we start I would like to remind you that statements made during this call that are not historical may be deemed forward-looking statements.

Actual results may differ materially from those indicated by forward-looking statements due to a variety of risks and uncertainties.

Please refer to our filings with the Securities and Exchange Commission for a detailed discussion of these risks and uncertainties.

Also, the discussion during this call will include certain non-GAAP financial measures.

Reconciliations of these measures to the most directly comparable GAAP financial measures are included within the Earnings Release that was furnished in this morning's current report on Form 8-K.

This information is also available on our website, www.zimmer.com, in the Investor Relations section.

With that, I'll now turn the call over to David Dvorak.

David?

Thank you, Bob.

Good morning, everyone, and welcome to our earnings call for the second quarter of 2011.

This morning I'll review our second quarter financial results, providing commentary on the year's progress to date and highlights from our performance.

Jim will then provide additional financial details.

As in previous quarters, I'll state all sales in constant currency terms and I'll discuss all earnings results on an adjusted basis.

Zimmer delivered a solid performance in the second quarter.

These results were achieved amid ongoing challenging global economic conditions, and reflect the benefits of recent product introductions across our portfolio.

Consolidated net sales for the quarter were $1.14 billion, an increase of 2.1%.

And our earnings per share were $1.21, an increase of 11% over the prior year period.

Impressive performances in our Europe, Middle East and Africa and Asia-Pacific geographic segments supported Zimmer's consolidated results in the second quarter.

Compared to prior year, Americas decreased 0.5%.

While Europe, Middle East and Africa delivered growth of 5.3%, which we believe to be substantially above the market.

And Asia-Pacific recorded sales growth of 6.2%.

The continued strong performances of our international segments reinforced the positive impact of investments we've made to improve sales execution in established markets.

As well as to strengthen our presence in a number of key emerging markets, which provide significant long-term opportunities for growth.

This promise is currently being realized in China, where our legacy and Montagne businesses continue to perform well.

We'll continue to invest in emerging markets including a strong focus on medical education offerings to help train physicians to meet the demands of a growing patient population.

In the quarter, Zimmer continued to deliver against our financial commitments and targets.

I'm pleased that progress in our business transformation initiatives has enabled us to allocate incremental resources to growth drivers, including marketing and selling investments, in support of new product introductions.

Ongoing investments in our sales channels in a number of markets contributed to an above market performance in these regions.

In particular, we've seen the benefits of scale in key markets where Zimmer's service capabilities and broad portfolio of new and established clinically successful technologies have enabled us to secure significant tenders that support continued growth.

Turning to the results of our product categories.

Knee sales for the second quarter decreased year-over-year 0.8%, reflecting positive volume and mix of 0.8%, and negative price of 1.6%.

Our knee franchise continues to perform consistent with a challenging market in the United States, increased utilization of PRI and PSI instruments.

As well as recent product introductions including Trabecular Metal augment shapes and cones for revision surgery contributed solid sales in the quarter.

Outside of the United States, the knee business demonstrated improvement including growth of 8.8% in Europe, Middle East and Africa, compared with the prior year period.

Which is the highest publicly reported growth rate to date for the region in this quarter.

In the EMEA segment, we were successful in securing large tenders in the quarter which leveraged the long-term track record of clinical success of our next gen knee system.

Hip sales in the second quarter increased 1.8%, reflecting positive volume and mix of 3.6% and negative price of 1.8%.

Our hip business continues to benefit from recently introduced customizeable product lines including the Continuum Acetabular system and the M/L Taper stem with connective technology.

In the second quarter, we also launched several exciting new additions to our European hip portfolio at the EFORT Congress in Copenhagen.

The new Maxera cup is a large diameter head ceramic-on-ceramic system that we believe will appeal to surgeons for their younger and more active patients.

Building on the long-term clinical success of our CLS Spotorno stem, we introduced the CLS Brevius stem in Europe.

This stem features a shorter MIS-friendly design that incorporates our connective technology, enabling surgeons to interoperatively address leg length and offset through modular neck options.

In the second quarter, extremity sales increased 3.6%.

Sales of Trabecular Metal products in this franchise continued to be strong.

To return to accelerated growth in this category we're in the process of introducing several products and instruments including our new anatomical shoulder combined adapters.

Our dental business again outperformed the market in the second quarter, with sales growth of 15.5%, comprising organic growth of 8.8% as well as the contribution of the existing Puros and CopiOs allograft products distribution arrangement.

The impressive performance of our dental franchise over the last several quarters reflects the impact of a steady new product cadence in our regenerative portfolio, supported by focused sales execution.

This quarter we announced the introduction of Zimmer curved preshaped collagen membrane, a unique resorbable collagen product that is designed to create an oral environment more suitable for implant placement.

The Company also recently announced an exciting strategic arrangement to provide ZFX Digital Dentistry Solutions.

Which allows Zimmer Dental to enter the CAD/CAM crown and bridge market.

Under the agreement, Zimmer Dental will distribute ZFX open platform laboratory scanners, CAD software and custom-milled components.

We again delivered above market sales growth in all geographic segments for our trauma business in the second quarter.

With sales increasing 13.6% over the prior year period.

The Zimmer Natural Nail family, and particularly the cephalomedullary nail, continues to be a real growth driver as customers learn about its differentiated features including a unique anatomical design.

We also continue to benefit from increased sales of the NCB Periprosthetic Plating System for complex fractures.

Successive above-market growth in our trauma business over the last 2 quarters reinforces the positive impact of our accelerated investments in new product development and sales programs.

Zimmer's spine business reported a sales decrease of 6.3% in the quarter.

In the United States, reimbursement and pricing challenges continue to impact the spine market.

However, recent product introductions are anticipated to contribute to improved performance in the second half of this year, with positive sales contributions from the recently-introduced PathFinder NXT Percutaneous MIS pedicle screw system and TMS Trabecular Medical cervical interbody fusion device.

Zimmer's surgical and other business category again delivered above-market sales growth of 7.7% over the prior year period.

Zimmer's the market leader in tourniquet products.

And we continue to gain share in a number of other categories within our expanding surgical portfolio.

In the quarter, we introduced the REX-Stop bone cement restrictor and the mixing gun single-step bone cement mixing and dispensing system for the European market.

We continue to make progress, increasing the production capacity for our recently-acquired Zimmer surgical power equipment line, which will strengthen our position in this growing market segment.

I'll now provide some commentary on the musculoskeletal market more broadly.

Global economic conditions continue to impact procedural volumes.

Recent economic data, including lowered consumer confidence and continued high unemployment rates, are reflected in sustained rates of procedure deferrals above what would be considered normal.

The patient pool with access to joint replacement procedures remains artificially reduced as a result of the economic recession, particularly in the United States, where unemployment levels are linked to lower enrollment in private health insurance plans.

As global governments work their way back to sustained economic growth, we would anticipate a recovery in procedure volumes toward more normal levels.

With regard to pricing, Zimmer experienced price pressure of negative 0.9% in the second quarter, in line with our expectations.

We believe this is indicative of consistent trends, and we now expect full year pricing to remain at or near negative 1%.

Results across the Company's product franchises reinforce our belief that clinically relevant and innovative product development will continue to command premium pricing that can mitigate price compression.

This analysis is supported by the sales contributions of products that leverage our proprietary technologies, including Trabecular Metal technology, which has demonstrated more than 13 years of clinically-proven performance.

Across our portfolio, products incorporating Trabecular Metal technology continue to provide sustained sales and price premiums.

Through the first half of 2011, and in keeping with our strategic agenda, investments in product innovation and sales programs were facilitated by the benefits of our ongoing transformation initiatives.

These initiatives are enabling us to fund programs to accelerate growth while delivering continued value to our stockholders through industry-leading operating margins and disciplined capital deployment.

I'll now ask Jim to provide further details on the second quarter and our guidance.

Jim?

Thanks, David.

I'll now review our second quarter performance in more detail, before providing an update regarding our third quarter and full-year 2011 guidance.

Zimmer's total revenues for the second quarter were $1.137 billion, a 2.1% constant currency increase compared with the second quarter of 2010.

Net currency impact for the quarter was positive, increasing revenues by an additional 5.4% or $57.3 million.

This included favorable currency contributions from our Euro, Japanese yen, Australian dollar, Swiss franc and Canadian dollar denominated revenues.

For the quarter our adjusted gross profit margin was 75%.

The margin ratio declined 130 basis points compared to the second quarter of 2010.

This reduction was primarily a result of the 180 basis points of headwind related to hedge losses, partially offset by lower obsolescence charges in the quarter.

The Company's R&D expense constituted 5% of sales in the quarter, which represented a 5% increase when compared to the prior year.

Accelerated product innovation is central to our growth strategy, and we expect R&D expenses to grow either in line with or ahead of sales growth as we expand product development and clinical programs.

Selling, general and administrative expenses were $470 million in the second quarter, an increase of 7.2% on a reported basis.

At 41.3% of sales, SG&A expenses were 10 basis points below prior year.

For the quarter, savings from our transformation initiatives were offset by increased spending in our sales channels in a number of key markets, investment in new sales tools and increased cost for local advertising and recruiting.

SG&A as a percentage of sales is now expected to be approximately 41% for the full year, as our outlook is updated to reflect ongoing strategic investments in our global sales channels and field marketing activity as well as a higher mix of revenues from overseas markets.

We expect SG&A expense to increase to around 43% of sales in the third quarter, due principally to seasonality.

Consistent with prior years, slower procedure volumes related to summer holidays results in a higher expense ratio in the third quarter.

In the second quarter, the Company recorded an additional $50 million provision for known and anticipated worldwide claims related to the past voluntary suspension of marketing and distribution of the Durom Acetabular component in the United States.

Special items accounted for $13.5 million in the quarter.

The majority of these costs related to our global transformation and restructuring program including severance and other employee termination related costs.

Integration costs associated with the Beijing Montagne medical device company, SoPlus power equipment, and ZFX digital dentistry solutions transactions also were incurred during the quarter.

Along with forward integration costs for third-party distributors in the Europe, Middle East and Africa segment.

This included $3.4 million of inventory step-up related charges in cost of goods sold.

Adjusted operating profit in the quarter increased to $326 million, representing a profit margin ratio of 28.7%.

This ratio is 110 basis points lower than the prior year's second quarter, reflecting a lower gross margin ratio due to hedge losses partially offset by a reduction in our total operating expense ratio for the second quarter.

Net interest expense for the quarter totaled $9.8 million, compared to $14.3 million in the second quarter of 2010.

This change is primarily due to having swapped a portion of our fixed rate debt to a floating rate.

Adjusted net earnings were $233 million for the second quarter, an increase of 5.1% compared to the prior year.

Adjusted diluted earnings per share increased 11% to $1.21, on 192.7 million average outstanding diluted shares.

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

At $1.06, reported diluted earnings per share increased 29.3% from the prior year's second quarter reported EPS of $0.82.

Reported diluted earnings per share for the second quarter include inventory step-up and special items charges.

And also reflect favorable tax adjustments related to resolution of certain tax matters pertaining to prior period filings.

Our adjusted effective tax rate for the second quarter was 26.5%, which is slightly below our full-year guidance.

And represents an increase of 10 basis points from the second quarter of 2010.

Our reported effective tax rate for the quarter was 18.2%, including the favorable adjustments pertaining to prior period tax filings.

During the quarter, we repurchased 1.8 million shares at a total purchase price of $121 million.

Year-to-date, we have now executed more than 70% of our intended repurchasing plan for 2011.

This demonstrates our commitment to return value to stockholders through disciplined use of capital.

As of June 30, 2011, approximately $849 million remained authorized under a $1.5 billion repurchase program, which expires at the end of 2013.

The Company had approximately 190 million shares of common stock outstanding as of June 30, 2011, down from 201 million as of June 30, 2010.

Operating cash flow for the quarter amounted to $251 million, down 8% from $273 million in the second quarter of 2010.

The decrease in operating cash flow compared to the prior year was a result of a planned increase in accounts receivable of 7 days, as we discontinued factoring in certain European markets.

Net receivables increased to $888 million, from $765 million in 2010, or 16% over the prior year period.

Inventories increased slightly in the second quarter of 2011, while adjusted inventory days on hand finished the quarter at 307 days, a decrease of 11 days from the second quarter of 2010, and a decrease of 5 days from the first quarter of 2011.

Depreciation and amortization expense for the second quarter amounted to $89 million.

Free cash flow in the second quarter was $195 million, $19 million lower than the second quarter of 2010.

We define free cash flow as operating cash flow less cash outflows for instruments and property, plant and equipment.

This change in free cash flow is principally a result of the increase in accounts receivable, as noted earlier.

Capital expenditures for the quarter totaled $56 million, including $39 million for instruments and $17 million for property, plant and equipment.

Cash outlays associated with investing activities during the quarter include $13 million for product distribution agreements and certain international distributor acquisitions.

I'll now provide an update to our guidance for the third quarter and full year 2011.

In our Earnings Release this morning we announced that the Company is updating its full year sales and adjusted EPS guidance, narrowing our prior adjusted EPS guidance toward the top end of the range.

We now expect full year revenues to increase between 2.5% and 3.5% in constant currency, when compared to 2010.

In the second half, we anticipate a modest improvement in market growth against easing comps.

Assuming currency rates remain at current levels, we anticipate foreign currency translation will increase our reported 2011 revenues by an estimated 3%.

On a reported basis, our revenues are now projected to be between 5.5% and 6.5% above 2010 results.

We expect our gross margin ratio for the third quarter to be in line with our full year guidance of approximately 75%.

Hedge losses as compared with prior year hedge gains are expected to negatively impact third quarter 2011 gross margins by 110 basis points.

Taking seasonal revenue and expense patterns into account, diluted earnings per share for the third quarter are projected to be in a range of $1 to $1.05.

Full year 2011 adjusted diluted earnings per share are now projected to be in a range of $4.70 to $4.80.

To arrive at GAAP earnings per share, you should subtract total charges for inventory step-up, certain claims, and special items of $140 million to $150 million pretax, or approximately $0.43 to $0.47 per share.

Finally, please note that our guidance does not include any impact from potential acquisitions or other unforeseen events.

David, I'll turn the call back over to you.

Thank you, Jim.

Zimmer's second quarter performance demonstrated continued progress against our strategic objectives and financial targets.

Sales growth, together with disciplined management of the bottom line and capital deployment, enabled us to deliver value to our stockholders.

Before opening the call to your questions, I'd like to take just a moment to recognize the entire global Zimmer team as we celebrate our tenth year as a publicly-traded Company.

In August 2001, Zimmer was spun off from our former parent company.

At that time, the Company generated revenues of approximately $1 billion, with about 35% of sales generated outside of the Americas.

Over the past decade, Zimmer's revenue has grown four-fold.

And now over 45% of our sales are generated in international markets.

While new product innovations and strategic acquisitions have contributed significantly to our emergence as a global leader in musculoskeletal care, nothing has been more important or more appreciated than the hard work and dedication of our employees and our sales and distribution teams around the world.

We want to thank our valued customers for the trust and confidence that they place in Zimmer technology every day, to renew the lives of their patients.

Building on our rich history, we're confident that the Company is now more strongly positioned than ever to take advantage of the future opportunities for growth offered by the exciting musculoskeletal care market.

And now I'd like to ask Sarah to begin the Q&A portion of our call.

(Operator Instructions) Joanne Wuensch from BMO Capital Markets.

Thank you very much.

Could we get into the granular view of the hip and the knee market just a little bit more?

I know a lot of people that we speak to thought that there was going to be a second half recovery, that there's a sense of pent-up demand.

Is that the right way to be thinking about it or has this second half recovery now been moved to the first half of next year?

Or are we going to offer something different?

Is it just a matter of at some stage people will return into the fold?

Thanks.

Thanks for the question, Joanne.

I think that going into the year, the view, and the view that we communicated consistently, was that we anticipated that the first half of the year was going to be a more difficult half of the year for growth purposes, primarily based upon the prior year comps.

And then we saw a slowing down that hit the United States market particularly hard in the second half of 2010.

So as we progress into the second half of 2010, although the economic climate hasn't changed in any material fashion to the positive, we do think that the growth rates could pick up maybe 100 to 200 basis points, largely due to the easing comps in the second half.

Of course, we've been talking about it for a long time.

This market slowdown is not permanent.

This is not a normalized procedure growth rate that we're experiencing.

Due to the macroeconomic conditions, these patients are deferring above normal levels from a time perspective, and they're going to come back into the fold at some point.

But that broader recovery is going to be dependent upon the macroeconomic conditions improving, Joanne.

And then just a second question, if I may.

You're building a lot of cash on your balance sheet.

Your debt to cap is particularly low.

You're repurchasing shares.

What else are we going to be doing with that cash?

Thank you.

Sure, Joanne, this is Jim.

From a capital deployment point of view, first, I would indicate that we intend to return up to two-thirds of our net income to stockholders on an annual basis through share repurchase programs.

Secondly, when and if the right opportunity arises, we are also interested in acquisitions that fit with our focus on musculoskeletal health and have the potential to create value for our stockholders.

We continue to apply rigorous discipline in our evaluation of potential opportunities.

Among other considerations, we'll examine accretion, dilution and earnings and return on invested capital with an expectation that transactions should be accretive in a reasonable period of time on both dimensions with alternative uses of capital.

The internal hurdle rates that we're applying can admittedly be tough to overcome, especially for larger sized transactions.

So our recently completed acquisitions of Montagne Medical and the SoPlus line of power surgical equipment, I think, are good examples of the types of deals that both meet our criteria and align well with our focus on musculoskeletal health.

David Roman from Goldman Sachs.

Good morning, everybody.

I was hoping, Jim, you could go into a little bit more detail on the SG&A line.

In particular in the context of the restructuring you announced earlier this year.

From the comments on the call, it sounds as though those savings are more gross, not net, savings.

And that a good portion of those proceeds are being reinvested into other growth markets.

Is that the correct way now to look at it, that the $180 million to $200 million number is not a net number?

That is in part, David, the way to look at it.

The savings reflected in our second quarter results from those programs were in line with our guidance of $40 million to $50 million to be realized in 2011.

And while we're not yet at a run rate that would get us to $100 million in annualized savings, we still expect to hit that target by the end of the year.

There is yet another issue impacting on ratios, though, that may not be as evident.

We're seeing strong results out of our international markets, and the emerging international markets tend to have higher operating expense ratios.

So the change in the mix of our revenue in the quarter put some pressure on our SG&A ratios as compared with the second quarter of the prior year.

That's something to keep in mind, as well, that wouldn't be quite as evident.

Beyond 2011, while we've not provided a target, we have indicated an expectation that SG&A as a percentage of revenue should continue to trend down.

The opportunity for leverage from revenue growth alone, assuming revenues can eventually get back to, and the market can eventually get back to, at least somewhere around mid-single digit growth in procedures, is very meaningful for us.

Then the efficiencies gained from the restructuring and transformation initiatives will provide additional opportunity for improvement.

Okay.

And then maybe just looking at the full year guidance, David, I think you had said that now you expect pricing to be down in the neighborhood of 1% where I think it's been for the first half of the year, I think the first half is down 0.9%.

That compares to your previous guidance of down 1% to 2%.

But you're overall lowering your full year total constant currency guidance.

That would imply on the volume side that things have on the margin gotten a tad worse from what you initially had contemplated.

Can you maybe just help us think about what's happening just from a volume perspective now versus where things were at the beginning of the year?

And what are your underlying assumptions from a macro perspective for the second half?

Sure, David.

I think the most significant difference relative to expectations going into the year is the US market.

Procedure volumes are lower than what one might have thought.

I do think that we're going to see an improvement in those volumes, at least on a comparison basis in the second half of the year.

But to really get back to a normalized level, as I stated earlier in the call, we're going to have to see some stabilization or improvement in the economic conditions, including unemployment.

So I think that the US volume is probably the area that is most significantly different.

I don't think that it's anything at all that's permanent within the market.

I think it is just an expression of the current economic conditions that we're living through.

And just to clarify that.

Have things gotten worse as you've gone through the year or they just haven't gotten better, to where things are just stable now?

I think that they've been relatively consistent.

Perhaps on a volume basis, a bit better in the first quarter than parts of the second quarter.

But I don't think you should read into that that the second quarter is the beginning of a trend.

Derrick Sung from Sanford Bernstein.

Hi, good morning.

Thank you.

I wanted to touch on your Asia-Pac results here.

And 2 things related to that.

First, last quarter, I think you communicated an expectation that perhaps the Japan disaster might impact 10% of revenues.

Was wondering where you thought of that now, given what you've seen.

And then, secondly, with respect to the anniversarying of the reimbursement pricing cuts in Japan, how much of that is embedded in the sales growth numbers that we're seeing?

It looks like, still, Asia-Pac slowed sequentially.

So does that suggest that the sequential slowing was even worse if we take out the impact of or the benefit of the reimbursement cuts?

Derrick, this is Jim.

First of all, with respect to Japan, our results for the second quarter were stronger than we anticipated.

That market has bounced back in a pretty impressive way relative to our expectations that we outlined on the prior call.

Now, I would tell you that with respect to the full-year guidance, we're still cautious as we project out for the balance of the year.

We understand that hospitals will continue to experience, particularly through the very hot summer months there, rolling blackouts.

That may have some impact on procedure volumes, particularly over the course of the summer months.

So we still have a semi-cautious view, I would say more optimistic than we outlined on the last call, but still a somewhat cautious view with respect to the balance of the year.

As far as the pricing goes, as you pointed out we anniversaried out of the step-down in pricing that went into effect in April of 2010.

So you'll see when we file our Q and the detail that we provide, average selling prices were down a little over 3% in the first quarter.

They'll be down still in the second quarter but down under 1%.

So that's in part what has led us to tighten the outlook on pricing for the full year, where we were saying coming into the year we would be at minus 1% to minus 2%.

We're now obviously forecasting an expectation that we'll be at minus 1% for the full year.

Okay, thank you.

And 1 follow-up, if I could, on your Gel-One product and the upcoming launch there.

That's a product that your partner, Seikagaku got FDA approval on it in March.

And what I'm wondering is what is causing the delay in the launch timing of that product?

Is it a supply issue?

Does it have to do with the IP issues, litigation surrounding that product?

Or what's causing that delay?

And what are your expectations for launch?

And then also could you comment on the economics of that product, if anything?

Will that net-net be a higher or lower margin product than Company average?

Sure, Derrick.

The work that we're doing since the approval of the product is really production based.

We weren't going to build quantities of inventory prior to that approval coming through.

Seikagaku has immediately moved forward on production orders and we're doing all the preparation work that we need to for a launch, looking at initiating that launch towards the end of this year.

So while it won't have significant impact in profitability or our revenue opportunities for 2011, we are excited about entering that space going forward.

And I think that margin opportunity is consistent with the rest of our orthobiologics businesses.

So they're attractive margins.

And this is a big, new market that is a new category for us, so it's all offense once we launch that product and start generating the sales.

And we're excited about that opportunity.

Mike Weinstein from JPMorgan.

Thank you, good morning.

David, I just want to get a better read on how you're thinking about the Americas business in light of the slowdown from 1Q to 2Q and your guidance for third quarter and the back half of the year.

So basically what should we expect for Americas in 3Q and what's embedded in that guidance?

You should expect to see some improvement in the Americas performance.

Again, Mike, I do think that we start looking at the prior year comps in the second half of the year and that really is the time period where the economic recession most impacted the US business.

Obviously, there's been a suppression of these procedure rates for the last couple of years but we do think that a good number of people fell out of the insured pool and as a consequence, no longer were able to access care in the second half of the year once the COBRA extension period ran out.

So it had a profound effect on the second half of the year, most significantly our Q3 and the market's Q3 of 2010.

So I think that you're going to see anywhere from 100 to 200 basis point step-up in that market if our projections are correct.

Now, all of this is premised upon at least an economic climate that doesn't worsen.

And obviously I think there would be upside beyond that if it were to improve.

Okay.

The European hip business is a business that stood out this quarter for sequential improvement.

Can you maybe just explain that a bit more?

The acceleration was pretty noticeable.

The acceleration in Europe that was most significant was knees.

I'm sorry, I meant to say knees, I apologize.

Within our franchise.

That's right.

I will tell you that part of that was timing because of success with tenders, but beyond that, we're doing a nice job of executing the sales of the next gen knee systems, as well as our other knee systems in that market.

I think that that's a team that has really stabilized and gaining momentum in the marketplace, taking advantage of opportunities that they have within that marketplace.

And I expect them to enhance their performance in the other product categories including hips going forward, Mike.

Adam Feinstein from Barclays Capital.

Hi, thanks very much.

This is Dan in for Adam.

A quick question.

So as we think about hips, obviously you guys had some great momentum with Continuum exiting 2010, coming into 2011.

Looks like the business slowed a little bit this quarter, down to 2% ex-FX, while I think your peers were actually relatively stable in the quarter.

So just wanted to hear how we should think about that.

I know you guys obviously came out in 4Q '09.

So we're roughly 18 months into the launch.

Is that how far we are and that cycle contributes to maybe a little bit of slowdown there?

It does contribute a bit to it, just because you have your initial mix opportunities with your existing customer base.

But I will tell you, we continue to be very optimistic about our prospects within the hip category.

We have a full portfolio at this point in time.

We're doing well with these customizeable solutions.

We have differentiated technologies on both the stem and the cup side.

So we expect to continue to outperform the market going forward.

Okay, that's helpful.

Just looking at SG&A, you guys are tracking slightly above what was the guidance that you ticked up today to about 41%.

And then looking at what you said for 3Q, I think you said around 43%, if I heard you correctly.

So, not to get too nit-picky, but would that assume going below 40%, towards 4Q, the end of the year, to get to where your guidance is?

Is my math correct there?

We have updated the guidance, as you pointed out, now expecting SG&A to be at around 41% for the full year.

I would acknowledge that, yes, your math is correct.

Bob Hopkins, Bank of America-Merrill Lynch.

Good morning.

So David, just to start out with you, and a little bit more on the success in Europe.

Could you be specific on the tenders in Europe?

How big were those and how much did they contribute in the quarter?

I'm not going to break that out because it very much is normal course business in that market.

That's how many jurisdictions operate and that's the sales process, Bob.

But I will tell you that we outperformed the market without the tenders, or the unique tenders that were recorded in that quarter.

So it's a good performance by our European team, irrespective of the tenders that we enjoyed in the quarter.

Okay.

And then just to follow up on the balance sheet, and on the question of capital allocation, you guys are, as you mentioned, 70% the way through what you've assumed for this year.

Astra Tech has come and gone.

My question is, as we look to the back half, why wouldn't you be more aggressive with your buyback relative to the $500 million?

And if you aren't more aggressive with the buyback, should we assume that there are other transactions potentially that could take place of a meaningful size?

Just trying to get a better sense of priorities as we look at the rest of the year, given the balance sheet.

Yes, as you pointed out, Bob -- this is Jim -- we were able to accelerate share repurchases in the first half relative to our guidance for the full year, which contemplates $500 million in total share repurchases for the year.

But that guidance remains unchanged at this stage.

As you know, as we've disclosed in our periodic filings, approximately 75% of our cash and short-term investments are held in jurisdictions outside the US.

And as we indicate, are expected to be indefinitely reinvested for use in our foreign operations.

We certainly, as I pointed out, are interested in continuing to look for opportunities to grow.

And our emerging businesses and opportunities to grow in emerging markets, I think we're seeing some of the benefit of those investments we've already made in both the emerging businesses and emerging markets.

But again, those opportunities, can't predict when they'll hit, but we are active and we'll continue to be active in looking for those opportunities.

So is the read through then that you're less likely to buy back more than you've suggested this year, given that those opportunities are out there?

As I said, at this stage the guidance is unchanged and I think I'll just leave it at that.

David Lewis from Morgan Stanley.

Good morning.

Just a couple questions on SG&A, maybe one for Jim, one for David.

Jim, just thinking about your third quarter guidance, at the low end of that earnings range it puts your earnings cyclicality versus historical years at the lower end of the third quarter range.

You talked about the SG&A spending.

Maybe talk about your confidence that that SG&A spending increase for the third quarter is more discrete.

You also mentioned emerging markets' selling costs being higher.

A lot of other global med-tech companies believe that selling costs in emerging markets can actually be lower.

So if you could just talk us through those dynamics.

Sure.

Again, as we pointed out, we went through this last year as well, the increase in the ratio in the third quarter really is a function of seasonality.

We have significant market share, particularly in markets outside the US, where there are extended -- surgeons, patients are taking extended holidays.

And so there's a significant slowdown in surgical procedures over the course of the summer holidays.

And we have a certain amount of our SG&A expenses that, as you understand, are fixed and so we end up with a higher ratio.

It's not really a function of increasing the level of discrete spending in the third quarter relative to the first half of the year.

Now, with regard to the emerging markets, it's really, in our case, a function of just the stage of their development.

We're early, if you will, in investing in the build-out of principally direct sales channels in those markets.

And I think, just given, again, the stage of their development that leads us to have higher selling, higher operating expenses in the near term.

Over time, we're going to be able to bring those operating expenses down as we achieve more critical mass in those markets, if we continue to see growth in revenues at the level we're currently seeing.

And in some cases continue to take market share.

Very helpful.

David, just a quick question on SG&A, but more from a strategic perspective.

Zimmer's been in a pretty enviable position over the last several quarters with less exposure to metal-on-metal.

And obviously custom knee solutions that others have not had.

As some of those other competitors lap those metal-on-metal issue and we see some custom knee relievement for some of those other competitors, are you confident that your existing levels of spending will allow you to maintain share or slightly gain share as the other competitors get a little stronger here over the next 2 to 3 quarters?

We are comfortable.

We have detailed plans as to some of the things that we want to do.

And in instances that means repurposing some of those SG&A dollars.

And so we have very active programs.

We refer to those as the transformation initiatives.

And that's allowing us to drop some of that money to the bottom line.

Increasingly we'll be able to do that as the procedure rates pick back up.

But in the meantime, it's been a great funding mechanism to do things that we need to, to make investments in the sales channel and on the marketing side.

So I think we're well positioned to be able to fund that and continue to improve the ratio, notwithstanding those funding needs.

Matt Miksic from Piper Jaffray.

Thanks, good morning.

Just a follow-up here on price.

Some of the price trends you're seeing, I'd love it if you could expand a little on the dynamic you're seeing in the marketplace.

It's about 1% to 2%, it looks like, in hips and knees, negative.

Which I assume, as it's been over the past 2, 3 years, is an aggregate of some contracts being reset significantly lower and then some contracts flat or potentially up, we would hope.

But do you get a sense that most of the big low-hanging fruit has been picked here in terms of big downward adjustments in price and we're getting to a stage where maybe adjustments are smaller?

Any color would be great.

And I have a follow-up.

Sure, Matt, this is Jim.

I think we have said in the past the compression of average selling prices, particularly in the US market, would continue to play out over the course of this year, to some level, even carry over into next year.

Although we're not going to be providing guidance on pricing for next year at this stage.

But at some point we would expect it would begin to moderate to the extent that it is just what we describe.

It's accounts that find that at their high end of the price curve relative to our mean average selling prices, are requesting or demanding an adjustment.

We're working through that.

We continue to work through that.

I think we're comfortable still with the statements we've made in the past in this regard.

And particularly when you look at the trends on a global basis over the past several quarters, we go back, for example, to the third quarter of last year, average selling prices for hips and knees were down between 2% and 2.5%.

That's stepped down a little bit in the fourth quarter, stepped down again in terms of the erosion not being as severe.

So it's right around 2% in the fourth quarter.

It was under 2% in the first quarter, at least in knees and right at 2% in hips.

And here we are in the second quarter and it's under 2% for both knees and hips.

That's how this is being managed.

We would expect, as we begin to anniversary out of some of those big adjustments, particularly in some of the larger accounts in the US, that the price pressure that we've been experiencing would moderate.

Great.

And then one follow-up here on Dental, just very impressive results again this quarter.

Just wondering if you could give us a sense of, within that growth rate, where things like implants are growing.

Or to what degree some of the new products or biologics are driving that growth.

Sure.

So as we pointed out, the growth rate that we're reporting this quarter and last quarter, as well, includes the benefit of having changed the distribution arrangement with respect to Puros and CopiOs regenerative products.

That's accounting for 7 points of the 15.5% growth that we're reporting.

So you take that out and you get a sense of what's happening with the balance of the portfolio, including implants.

So that 7% you think is a good representative number for roughly where your implant business has grown?

I think it is representative of where the balance of that portfolio is growing, yes.

Charles Chon from Stifel Nicolaus.

Great.

Thank you very much.

Just wanted to transition, focus to some of the non-large joint recomp businesses like trauma and extremities.

So these accelerating trends that we're seeing here, as we think about these businesses going forward, are there product gaps that Zimmer needs to fill?

Or is it a matter of just building out better distribution in terms of gaining better visibility in terms of growth profile for these businesses?

Charlie, in the case of trauma we feel like we have, at this point, most of the major pieces that we need.

Of course there are always going to be other anatomical sites that we can better address or provide innovative solutions with respect to.

But the big leg of the stool that we needed to address historically had been, say, over the last 5 years, had been the intramedullary nail line.

And Zimmer Natural Nail, with all the different anatomical sites, antegrade, retrograde, cephalomedullary nail, tibial nail is fully launched at this point in time.

And then, as well, the differentiated NCB Periprosthetic Plating System, those are products that are making a big difference for us.

We're doing a nice job of taking advantage of the unique anatomical features of the nail.

But more broadly, it allows us to penetrate accounts that were difficult for us to penetrate, particularly the level 1 and level 2 trauma centers.

So we're going to continue on.

We're concurrently investing more in research and development at the same time that we're investing to strengthen our distribution channel.

And we think that we're going to be able to create a lot of value by doing so at this point in time.

Now, going forward, we'll continue to innovate internally.

And to the extent that there are external opportunities that would augment what we already have and be complementary or fill in some spots that we aren't as competitive currently, we would go ahead and pursue those transactions at the same time.

So we're really optimistic about what we have s going on with our trauma business and are very positive about what kind of growth we can generate in the future and our ability to take some market share and gain more and more critical mass through that process.

Right.

So in terms of that transaction related growth, can you do that without disrupting your leverage goals here?

Yes, and I think in the case of a business like trauma, it's most apt to be product line acquisition, technology acquisition, innovation.

And the answer is absolutely we can do that without disrupting anything else that we need to achieve in the way of value creation.

That brings me to my second question, which is, the Company's done a great job achieving relative outperformance throughout 2011 so far.

As we look beyond the second half of 2011, into 2012, we annualize the benefit from the transition away from metal-on-metal in hips or the benefit of new instrumentation in knees.

Without pinning you to specific targets for 2012, can you provide a little more granularity on the specific growth drivers that we can point to that would help the Company maintain the momentum that it's been able to achieve here in 2011?

Sure, Charlie.

We're excited about the future beyond 2011 in the back half.

I think that we're positioning the Company very well for that future.

At some point in time these procedure deferral rates are going to wash out and these patients that have been putting off the procedures are going to come back into the fold.

There's going to be a boost in the procedure rate and it's going to very positively affect big markets like the United States market.

We're preparing for that day, let alone the demographic drivers with the aging population in all jurisdictions around the world.

And we believe are providing the most innovative portfolio with respect to personalization of these implants on the large joint reconstruction side.

So acetabular cups such as the Continuum, our stems on the hip side with the ML paper and connective technology being incorporated into other stems, as well.

Our patient-specific instruments are all examples of the personalized approach that we're taking to these implants and differentiated solutions with great clinical benefits.

And then beyond that core aspect of our business, we're very optimistic about our ability to continue to grow in areas like the one we were just talking about, trauma, in our emerging businesses.

You can see what we're doing in trauma.

You can see what we're doing in dental.

You can see what we've been doing in surgical for the last many quarters, as well.

The third prong of growth is really going to come from the emerging markets.

And our O-US performance in this quarter is indicative of the kind of growth we think we can generate with intelligent investments to exploit those emerging market opportunities, coupled with good, solid execution of our sales and marketing efforts in the developed markets O-US.

So again, large joint reconstruction with personalized solutions, leveraging our market share position and our brand in that space, and then getting after the emerging businesses as well as the emerging markets.

Kristen Stewart from Deutsche Bank.

Hi.

Good morning.

Thanks for taking the question.

I was wondering if we could just touch back around on pricing trends.

You had mentioned that price was down, I think it was 90 basis points in this quarter., which was similar to last quarter.

But then you also commented, obviously, that Asia-Pacific was a lot better due to the anniversarying of Japan.

I think was down 3% versus 1% this quarter.

So clearly it looks like the pricing trends got worse either in the Americas or Europe.

So could you maybe just review with us just the sequential pricing for the markets geographically?

Sure, Kristen.

This is David.

I think you're correct that it did improve in Asia-Pacific due to the anniversarying out of the Japan price cuts.

And it did get marginally worse in the Americas going from negative 1.3% in Q1 to negative 1.6% in Q2.

But that negative 1.6% is something that we've seen over the course of the last year and-a-half.

We had a negative 1.6% in Q3 of 2010.

I think that the context that one really has to look at this pricing is, again, on a global basis, we've been in a pretty tight band as a Company.

Ranging, I don't know, maybe 700 basis points from negative 0.7% to negative 1.4% over the last year and-a-half or more.

And for the last 4 quarters now, our global pricing has been either negative 1% or negative 0.9%.

So again, it's a tight band.

And relative to conversations that we had around this topic, going back some time when people were fearful that that negative 1% was going to become negative 5% or 10%, we're just not seeing that.

We haven't seen it for the couple years that we've been talking about it.

So I think we're doing a nice job of managing these conditions.

As Jim said, we don't think that the pressure in the US is a forever thing.

And we do think it will moderate as the price compression plays out and we work our way back to a less distributed curve with respect to pricing and a regression back to the mean.

But over the last many quarters now we've been in a pretty tight band on a global basis with respect to pricing.

And do you have just the European number?

Sure.

The European number was positive 1.2% in the first quarter and positive 0.6% in the second quarter.

Okay.

And then just with respect to the SG&A line, do you guys have or are you thinking about just changing the distribution model?

I know you use independent distribution.

I'm just wondering if you're reconsidering perhaps moving more to a direct sales model and/or perhaps cutting some of the rates that you pay to these independent distributors in the US to help offset some of these pricing and perhaps mix trends.

We've done some forward acquisitions of distributors outside the United States markets and that's been consistent with our strategic plan.

We've executed those transactions well.

And the transitions have gone well from an integration standpoint also.

So it is very much market-dependent.

There are instances where we use independent distributors and we're moving towards, such as those O-US markets, going direct through the acquisitions.

There's other instances where we have hybrid models.

And it's very situation-dependent, in our case.

With respect to the compensation, I think that the adjustments that we've made over the last couple of operating periods is to drive those commission rates to be more performance-based.

And I think that that's a path that we'll continue to go down or sustain.

And then just the total sales number or growth number, if you were to X out some of these acquisitions from distributors and what-not, what would be, on acquisitions, a more normalized organic growth rate, if you will, for the Company?

Those acquisitions aren't material relative to our overall sales, Kristen.

Larry Biegelsen from Wells Fargo Securities.

Good morning.

Thanks for fitting me in.

Starting with the gross margin, do you still expect a 90 basis point headwind from FX in 2011?

And should we expect to see that reverse in 2012?

Larry, this is Jim.

We do, actually.

I think the headwind related to hedge loss is probably a little bit higher even than the 90 basis points, just given what we saw over the course of the last quarter and relative weakness in the US dollar going now into the second half of the year.

And, again, we're only talking about hedges.

We're not providing guidance on gross margin for 2012.

There's a lot of other things that can factor on gross margins.

But we would expect those hedge losses to moderate as we get into 2012.

And then on knees, do you still expect the knee market to grow in the second half of 2011.

I think that was what you said on the last call.

Thanks.

Sure.

I think if you look at where we are at this stage in the first half of the year, estimates are coming in at around minus 1% for the knee market globally.

Down a little more in the US than outside the US.

As we indicated, if nothing else as a result of easing comps would expect to see the market growth rates improve anywhere from 100 to 200 basis points in the second half of the year.

Lastly, on Gel-One, do you think it's possible that that could have a positive halo effect on your knee implant business?

And then I'll drop.

Thanks.

I think we've talked about this a little bit in the past.

Before entering into the transaction with Seikagaku, we canvassed our surgeons to get an understanding of whether or not they prescribe HA.

And found that, in fact, most, if not many of them do.

And their partners who are more focused on sports medicine do, as well.

So, this represents a really exciting opportunity for us and it's going to impact our results and the opportunities we have to further build out our relationship with our current customer base and hopefully some new customers, as well, in a very meaningful way.

Raj Denhoy from Jefferies.

Hi, good morning.

Wonder if I could ask a little about the US pricing dynamic.

I appreciate your comments about the heterogeneity you're seeing in that market with the larger accounts maybe extracting a little bit more price.

Could you maybe talk about how you could cut that in other ways?

Are you seeing more pricing out of accounts that maybe have a higher proportion of surgeon employees as opposed to ones that are in the more traditional model?

We really haven't seen that dynamic.

It's been an assortment of circumstances.

The volume of the account, the service levels within those accounts.

It's varied from private practice groups to surgeons that are employed by the hospital systems, the larger networks.

So it's been business as usual, and just a lot of focus on that topic, obviously, on both sides of the table.

Okay.

Maybe I could ask again just a little about the US recon market, as well.

First on the knee side.

A bit surprising that the market remains fairly weak, particularly in light of the launch of custom cutting blocks from you and pretty much every large joint company out there.

Why have we not seen an impact of those in numbers yet?

Is it still early?

Does it speak to surgeon receptivity of those products?

I think the point that you make, Raj, is the right one.

There is productivity on those launches but it's in the headwind of a more significant procedural slowdown on a year-over-year basis.

So that's the challenge and it's not going to be a forever thing.

We really believe that even in the second half of the year we're going to start anniversarying out of the slowdown.

That doesn't mean that the procedure rates will become normalized.

But I think that the growth opportunity of the customized solutions, or customizeable solutions, is just a bit masked by the overarching economic conditions that are driving the procedure rates.

Okay.

Then just lastly, on that comment about easing comps in the back half.

I appreciate that the knee comp for your guys does ease, but the hip comp actually gets harder into the fourth quarter.

You posted a 7% number in the fourth quarter.

So maybe you could explain more why you're expecting a resumption in growth in that business against harder comps in the back half.

Yes, I think that the analysis that we've done is you had the extension of COBRA that ran out in the May 2010 time period.

And at that point in time, due the unemployment rates, you can do the math and end up extracting some 5 million patients from the potential pool.

The enrollment rates within the private insurance world declined, and you can track those statistics as well.

And so we see that biting in a more significant way in the second half of last year.

So you're going to get some dynamics in the fourth quarter always, because of the end of the year and the decision to move forward with procedures, the extent people have met their deductibles for the year, et cetera.

But we do think that there's going to be a positive impact.

And it may be more profound in Q3 than Q4, but we think that the second half will show improvement.

And a comment, Raj, it's really directed at our expectations with respect to market growth for the second half.

And if the market's up, we would expect to benefit from that.

Sarah, we have time for one more call.

Rick Wise from Leerink Swann.

Good afternoon.

Hi, David, hi, Jim, thanks for taking the question.

Let me touch on just a couple of smaller points on the P&L.

R&D, can you help us think through R&D directionally?

You talked, I think, last quarter about it moving up to a 5% to 6% range and you've been at the low end for the first couple of quarters.

And when I look back at just the dollars spent, you've been at the $56 million, $57 million level for the last 4 quarters now sequentially.

How do we think about the range?

How do we think about the dollars, particularly in the second half?

Maybe just give us some of your thoughts about where spending's going up or down and where.

Sure.

Rick, this is Jim.

As you rightly pointed out, we were coming into the year talking about an expectation that it could work its way up towards the higher end of the range over the course of the year.

I would tell you at this point, particularly given the pressure we've talked about that we're seeing on SG&A, in part a function of a different mix of revenues, that spending is certainly going to keep pace.

The increase in spending in R&D is certainly going to keep pace with growth in revenue.

But at this stage I would tell you, likely now for the full year to be a range of 5% to 5.5% as opposed to 5% to 6% for the full year.

So the dollars will go up in the second half, is what you're saying?

That is the expectation, yes, yes.

And just one last quick one.

Tax rate for the year, I think you had said around 27%.

You were a shade below that in the first quarter, maybe first half a shade below that if I look at the first and second quarter.

Are we still at 27% for the year?

We are.

I'd like to thank everyone for joining the call today and for your continued support for Zimmer.

We look forward to speaking to you on our third quarter conference call at 8 AM on October 27, 2011.

With that, I'll turn the call back to you, Sarah.

Thank you, again, for participating in today's conference call.

You may now disconnect.