Zimmer Biomet Holdings Inc (ZBH) 2011 Q4 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.

Good morning and welcome to Zimmer's fourth quarter 2011 earnings conference call.

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

Before we start I'd like to remind you that our discussions during this call will include 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 SEC filings for a detailed discussion of these risks and uncertainties.

Also, the discussions 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 which is available on our website at investor.zimmer.com.

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

David?

Thank you, Bob.

Good morning, everyone.

We're glad you've joined us on the call today.

This morning, I'll review our fourth quarter and full year financial results providing commentary on Zimmer's performance in 2011 and highlights from the quarter and the year.

Jim will then provide additional financial details as well as our 2012 guidance.

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

Zimmer achieved a solid finish to 2011 driven by above market performance in our Europe, Middle East and Africa and Asia Pacific businesses as well as in certain product categories.

Once again, new product introductions contributed substantial growth in the quarter reinforcing our confidence that the market will continue to reward clinically relevant innovation.

Consolidated net sales for the quarter were $1.17 billion, an increase of 2.4% and our earnings per share were $1.36, an increase of 7.1% over the prior year period.

Full year 2011 sales were $4.45 billion, an increase of 2.6%, and our full year 2011 earnings per share were $4.80, an increase of 10.9% over the prior year.

In line with our third quarter performance, we believe we continue to gain share in a number of established markets in our Europe, Middle East and Africa and Asia Pacific segments through the end of 2011.

Our Americas business performed in line with the overall Americas market with a decline of 0.4% in the fourth quarter.

Europe, Middle East and Africa delivered sales growth of 6.1% and Asia Pacific grew at 5.5%.

New product introductions and targeted investments in these regions are contributing to strong performance.

In addition, a core component of our strategic agenda is expanding Zimmer's global footprint with a focus on fast growing emerging markets.

In the fourth quarter these markets continued to generate impressive growth.

Turning now to the results of our product categories.

Knee sales for the fourth quarter increased year-over-year 0.2% reflecting positive volume and mix of 2.2% and negative price of 2.0%.

In the quarter, our Americas segment reported a decrease of 3.8% while our international operating segments delivered growth of 6.3% in Europe, Middle East and Africa and 5.6% in the Asia Pacific region compared with the prior year.

Sales of our Patient Specific Instruments continued to increase globally while our Mobile Bearing Knee system and our Revision products including Trabecular Metal Revision Shapes and Augments generated strong sales in the quarter.

A key focus of our innovation strategy for the knee business and across the Company is to provide differentiated technologies that enable clinicians to deliver more personalized therapies to their patients while also improving clinical outcomes.

We believe Zimmer's pipeline positions the Company as the leading innovator in personalized solutions and intelligent instruments.

The Company recently introduced patient specific instruments for partial knee replacement procedures, having received 510k clearance in the United States.

This system represents the first of a number of exciting technologies to be introduced in 2012 and beyond that deliver on the promise of personalization.

We introduced another addition to this differentiated portfolio by way of a strategic transaction announced several weeks ago.

The acquisition of Synvasive Technology.

Synvasive is the leading developer of surgical cutting technologies as well as advanced instrumentation systems.

Synvasive's eLIBRA Knee Balancing System is the industry's premier offering for flexion gap and soft tissue balancing.

This acquisition further strengthens Zimmer's position as a leading provider of intelligent instrumentation systems.

Hip sales in the fourth quarter increased 3.6% reflecting positive volume and mix of 5.8% and negative price of 2.2%.

These results included at or above market performances in all global segments with the Americas generating 0.2% growth, Europe, Middle East and Africa recording 5.9% growth, and Asia Pacific delivering 7.3% growth compared with the prior year.

The performance of the hip business continues to reflect the positive impact of our customizable product lines, including the Continuum and Trilogy IT Acetabular Systems and the ML Taper Stem with connective technology as well as the Maxera Cup, Zimmer's first to market large-head ceramic-on-ceramic option for younger and more active patients, which is currently available in European markets.

In the fourth quarter we introduced the CLS Brevius stem with connective technology to the United States market, another product which offers surgeons options to customize a personalized fit for their patients.

Extremity sales improved 9.3% in the fourth quarter.

Sales of our Trabecular Metal Shoulder System continue to be strong globally and we're receiving positive clinical feedback about the new Anatomical Combined Shoulder Adapter.

As part of our growth acceleration strategy for the extremities business, further product introductions planned for 2012 will include implants for new anatomical sites as well as additional offerings in the upper extremities.

In the fourth quarter, our dental business recorded sales growth of 2.3%.

The Americas business generated organic growth of 10%.

In some international markets, we continued to experience slower growth resulting from temporary distributer inventory reductions and broader market conditions.

In Europe, we continued the introduction of our new Trabecular Metal Dental Implant.

In 2012, we anticipate introducing this exciting new product globally, furthering the applications of our proprietary and clinically differentiated Trabecular Metal technology.

Trauma sales in the fourth quarter were up 10.6% over the prior year period, with all three geographic segments again contributing above market sales growth.

These results were supported by strong sales of our anatomically designed Zimmer Natural Nail family and the NCB Periprosthetic Plating System.

In the fourth quarter, we also announced a strategic acquisition for the trauma business, ExtraOrtho and the Company's ExtraFix External Fixation System.

This acquisition provides Zimmer with a strong position and a growing External Fixation market.

We're well positioned to compete aggressively in all three major segments of the trauma market.

Plates and screws, Intramedullary Nails and now, External Fixation.

With these offerings we expect to make significant headway in level one and two traumatology centers globally.

Zimmer's spine business reported a sales decrease of 5.9% in the fourth quarter.

Recently introduced products including the PathFinder NXT percutaneous MIS pedical screw system and a TMS Trabecular Metal Cervical Interbody Fusion device continued to grow at attractive rates.

The Company also introduced the inVIZia Anterior Cervical Plate System during the quarter expanding the Company's cervical plating technologies.

In the fourth quarter, Zimmer's surgical and other business category delivered 5.4% sales growth over the prior year period.

This business continues to gain share in a number of categories including bone cement, wound debridement and tourniquets.

The continued rollout of our new Zimmer surgical power equipment offerings in 2012 will contribute to further growth in this business.

As I mentioned earlier, our surgical resection portfolio will be strengthened by the addition of Synvasive's leading surgical cutting technologies including the STABLECUT blade line.

In 2011, products in our biologics portfolio delivered attractive growth rates.

Zimmer became the market leader in cartilage graft treatment with more than 1600 procedures involving our DeNovo NT Natural Tissue Graft completed during the year.

In the fourth quarter, we continued training for the new Chondrofix Osteochondral Allograft which will be introduced broadly at the upcoming American Academy of Orthopaedic Surgeons Annual Meeting.

Chondrofix is an osteochondral plug comprised of articular cartilage and subchondral bone.

The product is designed to address osteochondral lesions in a single stage procedure.

These biological joint preservation and restoration offerings are consistent with our objective of providing personalized solutions across the continuum of care.

Turning now from our product category results, I'd like to highlight a few other matters.

We continue to believe the procedure deferrals will diminish slowly over time and that growth rates will trend higher as they track more in line with historical usage rates among the aging population.

Moving into 2012 and beyond, the Company is uniquely positioned to take advantage of future normalized procedure growth rates with the steady cadence of new product introductions and a robust pipeline.

As demonstrated by the positive contributions of a number of recently introduced innovative products, we continue to see productive returns from our R&D investments.

We completed a key element of our organizational transformation activities in 2011 by improving the alignment of our R&D functions.

The success of these changes and our investments is reflected in our exciting pipeline of new products to be introduced in 2012 and the coming years.

Looking forward, the Company is establishing a Research and Development center in Beijing, China, focused on innovations designed to address the unique needs of Asian clinicians and their patients.

We have also recently completed several strategic bolt on acquisitions including ExtraOrtho and Synvasive Technology.

We'll continue to pursue similar opportunistic investments while returning excess cash to stockholders through our new quarterly dividend and share repurchase programs.

While a number of our businesses continue to face some headwinds in 2011 as a result of global economic conditions, the Company is well positioned to take advantage of the extraordinary long term potential of our industry.

Future growth will be achieved through continued momentum in established and emerging international markets, product innovation, and incremental contributions from recently completed and future strategic acquisitions.

I'll now turn the call over to Jim who will provide further details on the quarter and our guidance.

Jim?

Thanks, David.

I will review our fourth quarter financial performance in more detail and then provide additional information related to our 2012 full year sales and earnings guidance.

As David discussed, our total revenues for the quarter were $1.167 billion, a 2.4% constant currency increase compared to the fourth quarter of last year.

Net currency impact for the quarter was slightly positive increasing revenues by an additional 0.5% or $5.5 million.

The favorable currency impact for the quarter related principally to our Japanese Yen denominated revenues.

We experienced price pressure of negative 1.6% in the fourth quarter.

Pricing for the quarter was impacted by anniversarying out of benefits associated with the prior change in our distribution arrangement for Puros, our Dental Allograph solution and international distributor acquisitions.

Our adjusted gross profit margin was 74.2% for the quarter, the margin ratio declined 160 basis points compared to fourth quarter 2010.

In the quarter, we faced higher unit costs associated with lower manufacturing volumes.

Our continued efforts to streamline inventory during a period of suppressed surgical procedures contributed to lower than planned utilization of our manufacturing operations.

Gross margin was also impacted by lower average selling prices and higher obsolescence charges.

Additionally, higher currency hedge losses contributed to the decreased margins compared to prior year.

In connection with our transformation programs, we have initiated steps to implement leaner and more standardized processes of manufacturing, which we believe will drive greater efficiency and lower unit costs when fully adopted.

R&D expense increased 15.1% on a reported basis when compared to the prior year.

The step up in R&D expense for the quarter reflects an increased level of activity on new platform development projects across a number of product categories including our largest franchise, knees.

A sizeable number of clinically relevant product and technology development projects are currently underway and are expected to drive new product sales going forward.

Selling, general and administrative expenses were $462 million in the fourth quarter, and at 39.6% of sales were 110 basis points below prior year.

Changes stemming from our restructuring and transformation initiatives drove improvement in SG&A while advertising and marketing efficiencies also contributed.

Special items amounted to $28.2 million in the quarter.

These expenses include costs associated with global restructuring and transformation initiatives as well as integration costs from our acquisitions of Beijing Montagne, Sodem Diffusion, ExtraOrtho and Zfx.

In the quarter we increased our provision for certain claims by approximately $108 million following a number of recent developments.

This reflects an increase in the total number of Durom Acetabular component related claims we expect to receive for revision surgeries.

For the full year 2011, the Durom related claims liability was increased by approximately $158 million.

Adjusted operating profit in the quarter amounted to $339 million, at 29% our adjusted operating profit ratio to sales is 120 basis points lower than the prior year fourth quarter primarily driven by lower gross margins.

Net interest expense for the quarter amounted to $12.7 million compared to $13.4 million in the prior year quarter.

Adjusted net earnings were $245 million for the fourth quarter, a decrease of 2.2% compared to the prior year.

Adjusted diluted earnings per share increased 7.1% to $1.36 on 179.6 million average outstanding diluted shares.

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

At $0.87, reported diluted earnings per share increased 383% over the prior year fourth quarter reported EPS of $0.18.

Our adjusted effective tax rate for the quarter was 25.1% and our full year 2011 adjusted tax rate was 26%.

The lower tax rate reflects a more favorable mix of earnings and profits between low tax and higher tax jurisdictions.

During the quarter, we repurchased 2.7 million shares at a total purchase price of $143 million.

For the full year 2011, we utilized our repurchase program to reclaim almost 10% of the Company's issued and outstanding common stock enabling us to return increased value to stockholders.

In the fourth quarter, our Board of Directors authorized a new $1.5 billion repurchase program to run through December 31, 2014.

The Company had approximately 178 million shares of common stock outstanding as of December 31, 2011, down from 196 million as of December 31, 2010.

Operating cash flow for the quarter amounted to $393 million, an increase of 15.3% from $341 million in the fourth quarter of 2010.

Net inventories were $930 million at the end of the fourth quarter, a decrease of $7 million from the fourth quarter of the prior year.

Adjusted inventory days on hand finished the quarter at 277 days, a decrease of 30 days compared to the fourth quarter of 2010.

As of year-end 2011, net receivables increased to $839 million from $776 million in 2010 or 8% over prior year.

Our adjusted trade accounts receivable days sales outstanding finished the quarter at 64 days, an increase of six days over the fourth quarter of 2010.

Depreciation and amortization expense for the quarter amounted to $94.3 million.

Free cash flow in the fourth quarter was $321 million, $78 million higher than the fourth quarter of 2010.

We defined free cash flow as operating cash flow less cash outlays for instruments and property, plants and equipment.

The substantial improvement in free cash flow compared with the prior year fourth quarter reflects meaningful progress in our efforts to streamline inventory as well as lower spending on instruments as we also continue to drive greater focus on instrument productivity.

Capital expenditures for the quarter totaled $72.5 million, including $26.5 million for instruments and $46 million for property, plant, and equipment.

Cash outlays associated with investing activities during the quarter include $40.4 million for acquisitions and approximately $12 million for other investments.

I'd like to turn now to our guidance for 2012.

In our earnings release this morning, we announced that the Company expects full year revenues to increase between 2% and 4% in constant currency when compared to 2011.

At this time, assuming currency rates remain at year-end 2011 levels, we anticipate foreign currency translation will decrease our reported 2012 revenues by an estimated 1%.

Therefore, on a reported basis our revenues are projected to be between 1% and 3% above 2011 results.

Among our market assumptions for 2012, we believe that full year knee and hip procedures will grow in the low single digits.

We expect market conditions will remain challenging but relatively stable in 2012.

We anticipate growth in the first half of 2012 at or near the low end of our full year range for revenue guidance and the second half to be at or near the high end.

With regard to pricing for 2012, we assume that price compression within our reconstructive business will continue.

New reimbursement prices will also go into effect in Japan beginning in April 2012 after biannual price adjustments are issued.

In the aggregate this leads us to expect pricing for 2012 to be at or near minus 2% compared with 2011.

Moving down the income statement, assuming currency rates remain at recent levels we expect our gross margin ratio to be between 74% and 75%.

This takes into account the cost pressures we have experienced from lower than planned manufacturing volumes as well as anticipated losses on foreign currency hedges resulting from relative weakness in the US dollar.

We expect R&D expense for the year to average between 5% and 6% of sales as we advance development of a number of new platforms and technologies.

SG&A is expected to be between 39.5% and 40.5% of sales for the year as we realize operational efficiencies from the global restructuring and transformation initiatives and further leverage revenue growth.

We expect to incur higher net interest expense in 2012 as we recently concluded a $550 million senior unsecured notes offering, assuming variable rates remain near recent levels we expect interest and other expense of around $65 million in 2012.

We anticipate a 2012 full year tax rate of approximately 27%, 80 basis points above our final rate for 2011.

This projected increase is primarily due to a larger proportion of our earnings and profits anticipated from higher tax jurisdictions in 2012.

We anticipate the diluted weighted average shares outstanding for 2012 to be between 177 million and 178 million shares.

Therefore, 2012 full year adjusted diluted earnings per share are projected to be in a range of $5.20 to $5.40.

As indicated in our release, we expect to record pre-tax charges of approximately $100 million within the 2012 operating period related to restructuring and transformation initiatives.

The programs to be completed in 2012 are expected to generate annualized pre-tax savings of $80 million, including $30 million to $40 million to be realized in 2012.

Our business transformation efforts began in early 2011 and involve a number of programs targeted at streamlining the organization and business processes.

These initiatives, which include a management restructuring completed in 2011, ongoing centralization of certain functions such as strategic sourcing, implementation of lean Six Sigma principles in our manufacturing operations and other changes are expected to drive $400 million in savings by 2016.

Returning to 2012 guidance.

We also expect to incur an additional $10 million for certain acquisition and integration costs connected with the acquisition of third party distributors and the recently completed acquisitions of ExtraOrtho and Synvasive Technology.

Therefore, to arrive at our anticipated reported GAAP earnings per share, you should subtract total charges for special items of $110 million pre-tax or approximately $0.45 per share.

Turning to cash flow, we anticipate total capital expenditures for the year to be in a range of $240 million to $280 million, instrument capital is expected to be in a range of $120 million to $140 million, traditional PP&E is also expected to be in a range of $120 million to $140 million reflecting the cash outlays necessary to drive new product development activity as well as the replacement of older machinery and equipment in the normal course of operations in 2012.

Our guidance assumes that we will utilize approximately $100 million for dividend payments to be made in 2012 and another $500 million of cash flow for share repurchases during the year.

Free cash flow in excess of this $600 million is assumed to be held in cash and cash equivalents.

Estimated depreciation and amortization expense for the year is in a range of $360 million to $370 million.

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

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

Thank you, Jim.

The full year 2011 for Zimmer was characterized by the successful commercialization of new products and expansion of our global footprint in both established and emerging markets.

Sustained growth in 2012 will be supported by a continued focus on our strategic priorities.

Specifically, progress in our business transformation programs coupled with disciplined financial management have enabled us to build a balanced and conservative capital structure with high levels of operating cash flow.

This structure provides the Company with the flexibility to continue to make investments in strategic growth drivers.

Zimmer is building a business that is well positioned to deliver increased value to our stockholders in any market environment.

As a result, the Company expects to deliver high single to low double digit earnings per share growth off of low to mid single digit growth and net revenues in the near term.

With economic recovery, there will be an opportunity for mid teens earnings per share growth from mid to upper single digit revenue growth in the medium to long term.

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

(Operator Instructions)

Mike Weinstein, JP Morgan.

Good morning.

It's Kim here for Mike.

So a couple questions, I guess the first one on pricing.

Pricing was down 160 basis points for you guys in the quarter and that's off of the first nine months of the year, we saw it down about 90 basis points, is all of that delta this anniversary of the distributor buy-ins and as you look to 2012, can you sort of talk about, that you called for pricing down 200 basis points in 2012.

Can you talk about the year-over-year impact from pricing from both Japan and then secondly, this anniversary of the distributor buy-ins.

Sure, Kim, this is Jim.

It's not the case that all of the step down from where we were in the first three quarters of the year to the minus 1.6% in the fourth quarter that -- not the case that all of that is attributed to anniversarying out of the couple of things that I mentioned, both the dental distribution agreement and the international distributer acquisition.

So there was a bit of additional pressure in a number of product franchises that we saw in the fourth quarter and of course we've taken that into account in our guidance for 2012.

We saw some additional pressure in, specifically in hips and in spine in the fourth quarter and again, that's taken into account in our expectations for 2012 as well as an expectation that we'll see price adjustments or price decline in Japan that will take effect in April.

That will be very much in line with what we've experienced in the past, and I believe we would expect to see prices in Japan come down somewhere in the order of 4% to 5%.

And again, Japan represents about 10% of our total revenue, so that shows up in our consolidated pricing at a level of around minus 30 basis points in our consolidated price.

That's very helpful, and maybe following up on the distributor buy-ins.

What impact would you say that that's had on your top line here in the fourth quarter and maybe what are you thinking that the impact of those moves will be as we look to 2012?

Thanks.

In the fourth quarter, I would say that the impact of the forward acquisitions was not material.

That's a business that's growing organically.

They clearly are taking market share and they're doing it in almost every product category.

Matt Miksic, Piper Jaffrey.

Sorry about that.

I had you on mute.

Good morning, Matt.

Thanks for taking my questions.

Good morning.

So we looked, I guess we were looking for a slight improvement in knees and that seemed to come in in the fourth quarter but maybe not where we were looking for the improvement.

Can you talk a little bit about, David, you had mentioned during your prepared remarks sort of getting back to normalized volume growth.

What did you see in the fourth quarter that gives you that view and what are you expecting to happen here throughout 2012?

Matt, I think that the fourth quarter showed no further deterioration in those procedure rates.

I don't think that you want to read into that that it's a step up in procedure rates.

I don't think that the numbers really bear that out at this point in time.

We just continue to believe that you're seeing procedure deferrals and that this is anything but a normalized usage rate relative to the population base, so those patients are out there, the ones that are in the advanced stages of osteoarthritis aren't finding other solutions and they are going to come back into the fold.

It's going to take broader macroeconomic conditions to improve to bring more of them back into the fold.

I'd say for us on the knee side, we continued to perform quite well outside the United States in that product category and showed some modest improvement within the United States.

We're anxious to get after some of the opportunities that we have in all the categories within knees as we get into 2012 including the PSI instruments for our Uni, the ZUK, the LIBRA Dynamic Knee Balancing System within the primary category and then on the revisions, continued progress with TM Cones and Augments, so we're really enthusiastic about our future and our largest product franchise, knees.

And just to be clear, the guidance you've laid out for this year assumes sort of a stability in volumes or similarity in volumes in '12 versus '11, how would you characterize that?

I think that's exactly right.

I think we're looking for 2012 or providing guidance relative to 2012 to be quite similar to 2011.

Okay, and then just one if I could on some of your longer cycle investments that are coming through in terms of biologics and cartilage product that you mentioned.

In terms of your R&D strategy given the markets that you're in and the regulatory environment that's involved, the challenges related to getting mix and price in this sort of 510k channel of products, are you rethinking or are you evolving your R&D strategy to start trying to deliver more products like this over time or is that sort of too much to bear in a sort of orthopaedic model?

Any color would be helpful.

Sure.

I think our portfolio decisions in that respect, Matt, have been pretty consistent over time and as you said, we've had some long term investments.

We've been making investments in the biological solutions area for over a decade now and some of those investments are bearing fruit.

I think that we've done it in a very cost effective way but we have the benefit of scale within the musculoskeletal space and that allows us to make investments in both products that are going to come to market sooner and those that are going to take longer and may involve PMAs.

And oftentimes, we can justify doing that and still create value for the business because those technologies can be leveraged across several of our franchises, so I would say that we're going to continue to strike an appropriate balance.

It will be a mix of those products and you won't see us skewing those investments increasingly towards PMA type products but there will be a steady diet of those as well.

Terrific, thanks.

You're welcome.

Bob Hopkins, Bank of America.

Thanks.

Can you hear me okay?

We can, Bob.

Good morning.

Great.

Good morning.

Thanks for taking the questions.

Just a couple of quick ones.

First, on the revenue guidance for 2012, could you just talk a little bit as to why you think it will be towards the lower end in the first half and towards the higher end in the second half?

Sure, Bob.

It's really driven by new product introductions, both those products that have already been launched and those that we anticipate launching in this year as well as projects that have come to us through external development and being able to ramp up and take advantage of those opportunities, so we split the year in half, characterized it the way that we did because of where we're going to be in that launch cycle across our various portfolio.

Great, thank you and then a question on margins also.

First on Q4, you guys said last quarter that you felt there would be some pressure on gross margins this quarter, but I was wondering, is the down 160 basis points what you expected or is that a little worse?

And if it was a little worse what surprised you?

And then just a follow-up on margins for the operating margin guidance for 2012, I think that -- is the net impact of all the things you said a slight operating margin uptick year-over-year or is it more flat?

Thank you.

Yes, Bob.

This is Jim.

We are not surprised by what we saw in the fourth quarter.

Obviously, given the fact that the results are in line on -- the bottom line results were in line with the expectation we laid out, even a little bit ahead of that expectation, clearly we had recognized coming into the quarter we had some opportunity in SG&A that would offset some of that pressure on the gross margin, and in fact that's kind of how things played out for the quarter.

So when you consider -- I'll tell you when you consider the opportunity we have going forward with leverage, we're obviously very focused on these restructuring and transformation initiatives.

In fact, we're pretty excited about the opportunities we have to enhance the profitability of the business through those initiatives.

There's a lot to them and a lot of work ahead of us, but as we look at those initiatives, we feel we're going to have the opportunity to sustain year-over-year improvements and beyond 2012, both on the gross margin line and on the operating profit margin and the P&L.

Okay, and then just one quick follow-up on pricing.

Could you break out in terms of the earlier question on pricing specifically the negative impact in the fourth quarter that you saw relative to the earlier part of the year, how much of that was due to distributors in Japan versus the pricing declines you talked about in hips and spine?

I'd say it's probably somewhat evenly distributed between the two.

Great.

Thanks for the color.

Okay.

Adam Feinstein, Barclays Capital.

Good morning, everyone.

Thank you.

Good morning.

I guess maybe just as a starting point, in your prepared comments before you talked about business transformation and financial management and just that driving your strategy.

Maybe just talk about your thoughts in terms of acquisitions playing into that also, just any updated thoughts in terms of how you're viewing that opportunity and in terms of what you would anticipate.

Sure.

I think that you should assume that you're going to continue to see a steady flow of the types of deals that we've been doing in the last year, year and a half, with Beijing Montagne, with the External Fixation System pick up on the product line, Synvasive, on the cutting blade technologies and the knee balancing systems.

All of those types of acquisitions are going to continue to flow.

And from our perspective, those bolt on or tuck in deals are just another prong of our product development efforts essentially, whether it's internally developed or we gather it through external development is no matter to us as long as we can do it in a manner that creates value and continues to provide broader solutions within the musculoskeletal space.

We're just as interested in doing transactions that you've characterized as being bigger but again, we're going to be very financially disciplined about how we evaluate those opportunities and insure that they model out in a manner where they're going to create value for our stockholders.

And we're comfortable with our capability to integrate those transactions in a manner that would allow us to realize that potential and create value for our stockholders and those bars are pretty high.

So I think it's easier for us to see our way into continuing to do these tuck in transactions but if the right larger transaction came along and we could create value for our shareholders and we evaluated that transaction relative to other uses of that cash and thought that it was superior, we would move ahead with those so long as they're strategically aligned with our musculoskeletal focus.

Great, and maybe a quick follow-up David.

Last quarter you guys provided an update on that Form 483.

Just want to see if you had any updates on that issue.

We continue to make progress on that, Adam.

We have been communicating regularly with the FDA providing them with updates as to the progress that we're making in our remediation efforts to address all of those concerns that the FDA provided in written form in the Form 483.

I would tell you that some of those areas we believe that we have fully addressed at this point in time by the nature of the observations.

In other areas, there's more work to do but we continue to make very good progress and communicate directly with the FDA to let them know of that progress.

Okay, great.

Thank you very much.

You're welcome.

Joanne Wuensch, BMO Capital Markets.

Good morning and thanks for taking my question.

Good morning.

Two things.

The first is in gross margins, you talked about several different pieces of it that drove that 160 basis point decline.

Any way to flush that out to give us more granularity on what the components were and what they contributed?

And then my second question is many management is starting to talk about 2013 and management of the med tech tax.

I was wondering if you wanted to throw your hat in the ring on how you're planning on approaching that.

Thank you.

Joanne, I'll start with the gross margin.

I would tell you somewhere in the order of 40 basis points of that step down is related to the higher hedge losses in the fourth quarter of this year compared to the fourth quarter of last year.

The balance of it is related to both higher unit costs and higher excess and obsolescence charges that we saw in the quarter.

The 75% gross margin for the full year is very much in line with what we guided to coming into the year.

As we look at 2012, we are anticipating another year of hedge losses, slightly lower in amount than the losses we recognized in 2011 and that has a lot to do with the fact that we hedge inner company sales of inventory out 30 months, so we wouldn't expect to see a significant change in hedge results in the near term.

Assuming currency rates remain consistent with the year-end 2011 levels we would expect losses to diminish once we get beyond 2012 beginning in 2013, and as I said in response to Bob's question a minute ago, maybe I'll just give you a little more color around the work that we're doing particularly as it relates to, this is the transformation restructuring work, particularly as it relates to manufacturing operations, I think we have a lot of opportunity there so those programs will take full advantage of those opportunities.

We look across the four major elements of our manufacturing costs, I'll tell you that material and other input costs are going to come down through our strategic sourcing initiatives.

Our indirect costs are expected to decline as we rationalize overheads and infrastructure around a leaner manufacturing model.

We anticipate driving process efficiencies as we reduce lead times and achieve higher labor productivity as well, and finally, some systemic improvements in our demand based planning systems are expected to result in lower excess and obsolescence charges.

And then 2013?

Yes, so well maybe 2013 and beyond, again I would, we're talking about a target of $400 million in savings, obviously by 2016, just to let you know more than 60% of that is anticipated to be in cost of goods and the balance of that in SG&A.

We do expect to be able to fully offset the medical device tax in 2013 through the savings that we'll be achieving both in cost of goods and SG&A.

Thank you very much.

Charles Chon, Stifel Nicolaus.

Thank you very much.

I found the growth outside the US to be a little better than what I was looking for, especially when you have to contemplate issues like austerity measures and healthcare programs running out of funding at year-end, like in Europe.

So first, from where we are in 2012, can you just give us a little bit more of a granular outlook on what these markets look like and how much of Zimmer's revenue outlook is predicated on what's going to happen in the markets outside of the US versus gaining share outside of the US?

I will tell you that those markets are varied, Charlie, across the Europe, Middle East and Africa segment for us as well as Asia Pacific, so there are some markets that continue to perform quite well among the developed markets in those two geographic segments and then others that are sluggish and are probably seeing the effects of the austerity measures more directly.

The key is to do well in all of them to produce the results that we're producing and I think that we're doing just that.

We're taking full advantage of the scale, the breadth of the portfolio and expanding our footprint and in places where those markets are growing more slowly, we're taking share to produce the growth rates that we've been producing.

So I will tell you that I'm quite confident going into 2012 that we're going to be able to continue to grow those OUS markets at attractive rates.

We have the right product portfolio.

We're expanding our footprint.

We have terrific leadership in those markets and those businesses just have a lot of momentum for us right now.

So not to understate the challenges that can be faced within certain of those developed markets in particular, but I think on balance we're in a position now where we just have momentum that's going to overcome that and continue in 2012.

And as that relates to the gross margin guidance that you've provided for 2012, you bracket that outlook to be less than where we are and we were in 2011 and I understand the granularity there, but how much of the gross margin guidance is reflecting faster growth from these lower margin revenues coming from these geographies?

Well Charlie, certainly taken into account, we saw the effect of that over the course of 2011.

We saw it in gross margin.

We saw it in SG&A as well.

We've talked about the fact that just given where we are with some of those markets, the operating expense and the fact that we're continuing to build out the sales channels, the operating expense ratios tend to be a bit higher than our consolidated average.

I will say that with respect to 2012, we are expecting more balanced growth across the geographic segments and that should provide a bit of a tail wind both with respect to the gross margin performance and the SG&A ratio for 2012.

Can I follow-up with just one housekeeping question?

The Company achieved some handsome leverage on SG&A during the quarter.

Last quarter, this line came in slightly higher I think than what I was expecting because of reasons such as higher bad debt expense and I didn't get the impression that this expense was going to change substantially going forward, but perhaps can you give us an update on how to think about that specific expense?

Yes, well as we said we've given guidance for the full year 2012, 39.5% to 40.5%.

That takes into account all the things that we've been talking about.

I will say that you have to be really careful when you are looking at the quarterly ratios because there is very pronounced seasonality in our business which is often sort of understated frankly in some of the analyst models.

Our third quarter SG&A ratio is always going to be much higher relative to our full year ratio and our fourth quarter ratio.

You could look back over the last 10 years and you would see that we report an SG&A ratio in the third quarter that's typically at least 100 basis points higher than what we end up reporting in the fourth quarter and that just has everything to do with the seasonality of our business and the fact that there's significant slowdown in procedure volumes in the third quarter and we still carry obviously a lot of fair amount of fixed cost in SG&A.

Great, thank you.

Thank you.

David Lewis, Morgan Stanley.

Good morning, gentlemen.

This is Bill Carlyle on for David.

Good morning.

So considering the restructuring benefit, some of the emerging market initiatives and pricing headwinds that we've discussed so far on the call, can you help us understand maybe some of the organic EBIT trends in 2012 versus '11 with some of the various puts and takes there?

Sure.

I provided obviously some pretty granular guidance on every line of the P&L and if you work through that, I think what you'll find is there is an expectation going into 2012 that we're going to see some leverage in the P&L, so we are anticipating in spite of the headwind on gross margin, it's largely a function of again the opportunities we feel we have to drive the SG&A ratio down through these initiatives.

We are anticipating to see some positive operating leverage on the EBIT line in 2012.

Okay, and then as it relates to some of the pricing headwinds and their acceleration in 2012, and taking that into concert with the fact that you are going to be launching some new products in the back half of the year, how much of those headwinds could be possibly offset by positive mix going forward through 2012 or was that something that was already Incorporated in the price numbers that you gave.

Yes, well if you consider the gross margin guidance for 2012 relative to where we finished the year in the fourth quarter, there is an expectation that combination of something I referenced in response to a question a minute ago of more balanced geographic growth out of our geographic segments, because we do have higher, tend to have higher gross margins in our largest geographic segment, the Americas, but that's not the only issue or factor to contribute to some tail wind in gross margin.

The other thing would be more positive product mix and there is an expectation going into next year that we'll see that, particularly behind some of the recently launched products and some of the new products we will be launching in 2012.

So it is something that will have a positive impact both on the top line as well as on margin.

All right, thank you.

Derrick Sung, Sanford Bernstein.

Hi, good morning.

Thanks for taking my questions.

Good morning.

I just wanted to go back and clarify the comments that you'd made earlier with regard to your ability to offset the med tech tax in 2013 with your SG&A and COGS savings.

By that, do you still expect to be able to achieve the high single to low double digit EPS growth that you talked about over the long term off your low single digit revenue growth, and if so, does that come from even further operating leverage or are we talking about sort of maybe share buybacks or something getting you to that additional earnings leverage.

The answer to the question is yes.

These are businesses that in the environment that they were operating in for the last decade or more, frankly didn't have to run towards operational excellence, whether it was in the area of manufacturing or purchasing or logistics.

And we brought a lot of new talent on board over the last several years and developed plans and have begun to methodically execute those plans in various areas including strategic sourcing and enhancing the quality systems and employing lean and Six Sigma principles throughout our manufacturing operations that are going to produce significant benefits moving forward.

So we are quite confident that we're going to be able to achieve that kind of adjusted earnings per share growth number and absorb the tax at the same time.

And we also believe that we're going to be able to do as we have in 2011 continue to make all of the important strategic investments that are going to lead to sustained growth in the future for the business.

Okay, thank you.

That's helpful.

In your R&D guidance, you mentioned specifically some new R&D projects in knees that you'll be spending on and I was wondering when you would expect those to actually come to market and maybe related to that, what is your focus this year at AAOS in terms of new product introductions or what will you be focusing and highlighting to customers there?

Well, there are a lot of platform systems and broad offerings, Derrick, that are maturing through our system at this point in time and so, including within the knee franchise, we have some significant things that we're very excited about.

Not all of those will be broadly visible at the Academy meeting but the ones that you'll certainly see will be PSI for ZUK, our Uni system.

As I mentioned the LIBRA Dynamic Knee Balancing System.

This will be the first Academy meeting for our Trabecular Metal Cones and Augments on the revision side, so on knees, we have something new to talk about with surgeons and clinically relevant innovation whether it's pre-total knee arthroplasty all the way through revision.

On the hip side you'll see continued expansion of our personalization and customizable offerings with the CLS Brevius, with connective technology stem coming to the United States and then for the OUS surgeons, the Maxera large diameter head ceramic-on-ceramic cup.

Extremities, the Anatomical Shoulder Combined Adapter is something that we're receiving a lot of excitement about.

It's in the initial stages of launch and it will be featured at the Academy as we as some other interesting innovations within that franchise.

This will be the first Academy within the trauma segment for us to introduce the ExtraFix, External Fixation System, so we're excited about that one.

Spine, the inVIZia Cervical Plate offering.

Our dental pod will include the TM Dental Implant and Zfx digital dentistry solutions.

Surgical will include the SoPlus power tool line and then the Synvasive blade technologies which we're excited to add to the portfolio.

And then within biologics, exciting innovations, the ChondroFix product that I described earlier as well as the initial stages of our launch of Gel-One.

So we're going to have a busy booth we anticipate and there are, as I said, some other systems that either will not be broadly viewed but likely will make progress on pending clearances as 2012 progresses, so even after the Academy meeting we expect to be rolling out some very interesting innovations during the year.

Okay, thank you.

You're welcome.

David Roman, Goldman Sachs.

Hi, this is Nikhil for David.

Thank you for taking the question.

Thinking about longer term moving from where we are now in this low single digit environment on the top line to upper single digit, I was wondering if maybe you can talk through the dynamics from a volume share and then maybe pricing standpoint.

So in other words, does that assume we would have to see improvement in volumes, maybe the Company gaining share and then pricing staying where it is now?

How are you guys thinking about that?

Yes, I can kind of frame something out and come back if you have follow-up questions on this.

But I would think of the, as you said, low single digit volume in the operating environment that we're in currently and then as those procedure rates normalize, one would expect us to move back towards something that is more mid single digit.

And then on the price/mix component, I will tell you that if we're innovating the right way, we believe that even if price pressure were to continue in the form that we're seeing it currently and we don't expect it to accelerate, you'll recall that we've been guiding for one to two negative price for quite some time now, and that's the range that we've been operating in.

We think that with the right innovations, one can offset at least a portion, if not most all of that, within franchises, with mix opportunities.

And so you kind of reach back to a mid single digit growth rate and then you have to find ways to accelerate that growth.

Beyond that for us, I think if we're innovating the right way, we are going to be able to take share within their core recon markets so large joints within developed markets, we obviously are making significant investments to accelerate our growth rate and take advantage of emerging markets.

And then finally, the sort of our emerging businesses, spine, dental, trauma, surgical, provide us with opportunities to outperform the market if we're running those businesses the right way and you can see that we're achieving that objective in a couple, three of them right now.

So that really provides us with the opportunity to start moving up from mid single digit to something higher than that.

Okay, thank you for taking the question.

You're welcome.

Bill Plovanic, Canaccord.

Great.

Thanks.

Appreciate you taking my question.

It's really just, as you look at the business, I mean we've had a couple of years of slow growth in the knee and hip, especially in the US.

I'm just curious is, what's your thoughts on what we need to really turn this business around and get it growing again?

What needs to happen?

And then secondly, what do you think would be the normalized growth rates for knees and hips domestically and globally long term, like 5 to 10 years, thank you.

Good questions.

I think that the environment that we're operating in causes us to have to go out and find that growth.

These are slower growth markets.

The US for large joints is flattish in its growth patterns as of late so someone who wants to win has to figure out a way to take share in that environment.

I do think that market will stabilize, I think that it's going to take broader macroeconomic condition improvement for those procedure rates to come back into the fold and again, the way we view that market is kind of a 3% to 5% procedure growth rate depending upon the level of current penetration for those large joint procedures in various markets around the globe.

And we're placing all of the investments in the right strategic areas to be able to compete effectively in that market, so we're going to continue to innovate and position ourselves to win in any market environment that we find ourselves.

I think that again, you can see these markets normalizing in something between 3% and 5% procedure growth rate but we have opportunities within emerging markets and within our emerging businesses to grow at paces that are well beyond that as our current results even reflect.

The large joint globally 3% to 5% with international faster and maybe US a little slower and that's your longer term kind of thoughts?

Yes, I think that something procedure rate wise within developed markets that's probably closer to the low end of that range and something procedure growth rate wise within the emerging markets that's well above that so you'll probably blend those out to something that looks like mid single digits in a normalized environment, Bill.

Okay, and then a follow-up on the spine.

I think your comments were that pricing a little tougher in Q4.

Any comments on procedure volumes and then do you think that's Zimmer specific or do you think that's market specific and thank you very much for taking my questions.

You're welcome.

I don't know that we're seeing anything in the way of procedure rates that with our size business, Bill, gives us great insight as to what's happening.

I mean, it is sort of well publicized as to what seems to be occurring with respect to the approval of those procedures.

And so there clearly is pressure on that front.

And then from a pricing perspective, I don't know that we've experienced as much downward pressure as other companies but it exists within our business.

I would tell you that it's less than the negative mid single digits at this point for us which is what you hear from others is negative mid single digits, so it's a tough environment I think on the procedure rate wise, procedure growth rate side.

That's a business that we continue to be excited about primarily because we have about 2% market share in a $9 billion market, so I don't think that we're the price leader and I think that we're going to have good opportunities if we're innovating in the right way and strengthening our sales channel and those are the areas that we're focused on at this point so we're optimistic about seeing improvement in our spine business.

We are experiencing negative price but maybe not to the same extent as some of the larger players in that space currently and it's just tough, Bill, for us to give you any deeper insight into procedure rates beyond what you've heard from others that have a larger share of that market.

Great.

Thank you.

You're welcome.

So 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 first quarter conference call at 8.00 AM on April 26, 2012.

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

Thank you again for participating in today's call.

You may now disconnect.