Zimmer Biomet Holdings Inc (ZBH) 2012 Q3 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, Regina.

Good morning, and welcome to Zimmer's third quarter 2012 earnings conference call.

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

Before we start, I would 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 at our website at investor.zimmer.com.

With that I will turn the call over to David Dvorak.

David?

Thank you, Bob.

Good morning everyone, and welcome to Zimmer's earnings call for the third quarter of 2012.

This morning will review our third 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 will state all sales in constant currency terms, and I will discuss all earnings results on an adjusted basis.

At the beginning of the year, we articulated a goal of generating 8% to 12% growth in earnings per share in an environment of low to mid-single digit top line growth.

We indicated that this goal would be achieved through the successful execution of strategic initiatives, including significant product introductions across the portfolio, the continued execution of our transformation agenda, and rigorous management of capital.

I am glad to report that we remain on track to deliver against this commitment in 2012.

Further, we believe progress across each of our strategic priorities will position Zimmer to achieve our value creation objectives through the remainder of the year and into 2013.

Consolidated net sales for the third quarter were $1.03 billion, an increase of 2.5%, and our earnings per share were $1.15, an increase of 10.6% over the prior year period.

Compared to prior year, America sales grew 0.5%, while Europe, Middle East and Africa delivered growth of 7.9%, and Asia Pacific recorded sales growth of 1.6%.

For the third quarter, our America sales were negatively affected by one fewer billing day, while our Europe, Middle East, Africa and Asia Pacific sales benefited from an additional billing day.

In the quarter, we recorded strong performances in Europe, Middle East, and Africa, and in certain emerging markets in Asia Pacific.

These results reflect the benefit of operational and sales force investments in these regions.

We continue to pursue similar commercial excellence efforts in the United States to ensure at or above market performance across our sales territories, both here and abroad.

Progress in these efforts, combined with ongoing and upcoming new product introductions across the portfolio, will contribute to improved performance in the future.

Turning now to the results of our product categories, knee sales for the third quarter increased year-over-year 0.5%, reflecting positive volume and mix of 3.3%, and negative price of 2.8%.

Our international operating segments delivered strong knee sales growth of 8.7% in Europe, Middle East, and Africa, and 4.3% in the Asia Pacific region compared with the prior year.

During the quarter, we generated increased sales of our intelligent instrument offerings, including Zimmer patient-specific instruments for our NexGen and Natural Total Knee Systems, and the Zimmer Unicompartmental High-Flex Knee System, as well as the eLibra Dynamic Knee Balancing System.

In many markets, we are beginning to see accelerated adoption rates of these intelligent instrument systems, which offer hospitals the potential to drive more consistent clinical outcomes and procedural and logistical efficiencies.

Also, in the quarter we continued the limited developer release of our next generation knee system, Persona, the Personalized Knee System.

This exciting new system builds upon the tremendous clinical legacy of our NexGen and Natural Knee Systems, leveraging fundamental aspects of these designs, while adding new technologies and innovations that allow for much greater personalization and improved performance.

Coupled with our intelligent instrument offerings, the Persona Knee System will allow surgeons to personalize the best possible fit for each patient, which we believe will lead to a more natural feeling knee.

We look forward greatly to the benefits of the broader release of Persona in 2013.

Hip sales in the third quarter increased 1.6%, reflecting positive volume and mix of 4.4%, and negative price of 2.8%.

In the quarter, our Americas and Europe, Middle East and Africa operating segments delivered an improved performance, while in Asia Pacific sales declined slightly compared with prior year, due primarily to the previously discussed pricing pressure in Japan.

Across our hip portfolio, we continue to derive benefit from our proprietary technology platforms, including Trabecular Metal technology, which offers a differentiated advantage in the revision market, as well as its applications in primary Acetabular cups and stems.

In the quarter we also continued the introduction of our VIVACIT-E Highly Crosslinked Polyethylene in the United States, and will soon make this advanced material available to certain European markets.

Extremities recorded above market sales growth of 12.3% in the third quarter.

Recently introduced products supported by improved sales execution contributed to this performance.

Globally, our Anatomical Combined Shoulder System and Trabecular Metal Reverse Shoulder System recorded impressive growth.

In Europe, Middle East and Africa, the Sidus Stem-Free Shoulder System is providing opportunities for new account conversions in a growing category of the shoulder replacement market.

In the quarter we also received FDA clearance for our new Trabecular Metal Total Ankle Replacement System, which provides us with an entry point for the lower extremities market.

This exciting new system that incorporates our Trabecular Metal technology is designed to support a novel innovative lateral surgical approach.

First surgeries have taken place for this product over the past several weeks, and we are excited for its broader commercial introduction in 2013.

Our dental business delivered sales growth of 3.5% in the third quarter amid a challenging market, which continues to be impacted by suppressed procedure volume in key European and Asia Pacific markets in particular.

In the quarter, our Americas growth was attributable to the revenues associated with the Exopro acquisition, the Brazilian manufacturer of differentiated dental implant products in the P-I Branemark philosophy.

Globally sales growth in the third quarter was supported by a number of recently introduced products, including the Trabecular Metal dental implant, the IngeniOs value line of synthetic bone graft, and Zfx digital dentistry solutions.

In the third quarter we again delivered above market sales growth in all geographic segments in our trauma business.

Sales increased 10.8% over the prior year period, including stand out 24% growth in Europe, Middle East and Africa.

Globally, new products in the trauma portfolio are driving significant growth in this business.

The Zimmer Natural Nail family once again delivered strong sales, while the XtraFix External Fixation System continues to provide entry opportunities for new accounts.

Complementing our hip revision products, the NCB Periprosthetic Plating System is driving growth in existing reconstructive accounts as part of a revision total continuum of care solution.

Zimmer's Spine business reported a sales decrease of 7.4% in the third quarter.

We continue to face significant challenges in this business related to pricing and utilization.

In the cervical inner body and outer body segment and in Minimally Invasive Solutions we are developing a competitive portfolio.

Recently introduced products in these categories continue to deliver solid sales results.

This week at the North American Spine Society meeting, we are highlighting our differentiated inViZia Cervical Plating System and the Trabecular Metal Ardis Interbody system.

In the third quarter, Zimmer's Surgical and other business category again delivered above market sales growth of 10.7% over the prior year period.

Recently introduced products contributed meaningful growth in this business.

Specifically, the Zimmer Surgical power equipment line and Synvasive line of surgical blades continue to present significant opportunities.

At the end of the third quarter, Zimmer further expanded our surgical products portfolio through the acquisition of Dornoch Medical Systems, a medical waste management technology company.

Dornoch offers a comprehensive range of medical waste fluid disposal equipment and accessories, including its patented Transposal integrated infectious fluid collection and disposal system.

We continue to generate encouraging growth rates from our early intervention technologies, which include a broad range of products across the continuum of care.

In particular, we are seeing increased utilization of our DeNovo and counter-fix cartilage repair products.

Another early intervention technology for patients with knee arthritis is our Gel-One injectable hyaluronic acid product.

In an important development in the quarter, we successfully defended Gel-One in patent litigation.

We are pleased that the jury returned a verdict in our favor.

Gel-One offers further opportunities for us to expand our reach earlier in the continuum of care for knee arthritis, which is a strategically important area for the Company.

Turning now from our product category results, I would like to discuss several broad market factors.

Reconstructive procedures in the third quarter were slightly lower than expected in certain key markets around the world, due to uncertainty in the macroenvironment.

As Jim will discuss, we have adjusted our outlook for the fourth quarter and full year accordingly.

Yet we remain confident that a robust product pipeline will enhance our revenue growth as we look beyond 2012.

Specifically, revenue growth is expected to improve as we make necessary investments in our sales channel and other areas concurrent with the launch of many new products, including the Persona Knee System, VIVACIT-E Highly Crosslinked Polyethylene for hips, the Sidus Stem-Free Shoulder, the Trabecular Metal Total Ankle replacement, the Gel-One single injection hyaluronic acid product, and Zimmer's surgical power equipment, as well as the recently acquired Transposal waste management devices.

We experienced price pressure of negative 2.1% in the third quarter, in line with our expectations.

We are confident full-year pricing for 2012 will remain at or near negative 2%, consistent with our guidance.

The mix benefit of new product sales contributions across the portfolio, many of which incorporate premium price technologies, enabled Zimmer to partially offset price pressure in several of our franchises.

In the third quarter, we made further progress in the transformation agenda we are pursuing across our commercial and corporate operations.

Notable steps taken included progress in strategic sourcing, distribution and advanced manufacturing activities.

As well as making Zimmer a more effective and efficient organization, our transformation programs generate substantial cash flows.

We are deploying this cash and capital in a disciplined fashion, returning excess value to our stockholders through our dividend and share repurchase programs, and pursuing prudent acquisition opportunities.

Finally, this quarter we celebrated 15 years of clinical success for Trabecular Metal technology, and we are truly only just beginning to scratch the surface of its potential.

This technology has now been used in more than 0.75 million procedures, helping literally hundreds of thousands of patients return to active lifestyles.

In many applications, Trabecular Metal technology offers a unique solution for patients who might otherwise lose their mobility.

With that, I will now ask Jim to provide further details on the third quarter and our guidance.

Thanks, David.

I will review our third quarter performance in greater detail, and will then provide an update regarding our full year 2012 guidance.

Zimmer's total revenues for the third quarter were $1.026 billion, a 2.5% constant currency increased compared with the third quarter of 2011.

Net currency impact for the quarter was negative, decreasing revenues by 3.1%, or $31.8 million.

Our euro denominated revenues were the primary driver of the negative impact.

Adjusted gross profit margin in the third quarter was 75.1%, consistent with the first and second quarters but down by 70 basis points compared to the third quarter of 2011.

The positive effect of lower foreign currency hedge losses was offset primarily by negative price, and excess in obsolescence costs in the quarter.

The Company's R&D expense constituted 5.2% of sales in the quarter.

This is lower than the prior year third quarter but still within our target range of 5% to 6% of revenue.

R&D spending benefited from operational efficiencies, as well as a natural decline relate to certain large projects that are approaching full commercialization, including Persona, the Personalized Knee System, and the Trabecular Metal Total Ankle.

Selling, general and administrative expenses were $430 million in the third quarter, a decrease of 3.2%.

At 41.9% of sales, SG&A expenses were 110 basis points below prior year, reflecting significant savings from our transformation and operational excellence programs.

In line with the prior quarter's guidance, SG&A as a percentage of sales is expected to be approximately 40% for the full year.

Special items accounted for $37 million of expense in the quarter.

This included costs associated with our distribution and advanced manufacturing transformation initiatives, quality system enhancements, and integration costs associated with recent acquisitions.

Adjusted operating profit in quarter increased to $286.8 million, amounting to an operating margin ratio of 28%.

This ratio reflects 120 basis points of improvement relative to the prior year third quarter.

This improvement was driven by operational efficiencies in SG&A and R&D.

Net interest expense for the quarter totaled $14.5 million, an increase of $2.8 million over the prior year period.

This change results from our $550 million senior notes offering in November of 2011.

Adjusted net earnings were $202 million for the third quarter, an increase of 2.5% compared to the prior year.

Adjusted diluted earnings per share increased 10.6% to $1.15 on 175.3 million average outstanding diluted shares.

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

At $1.02, reported diluted earnings share increased 1% from the prior year third quarter reported EPS of $1.01.

Reported diluted earnings per share for the third quarter includes special items net of tax.

Our adjusted effective tax rate for the quarter was 25.9%, which represents an increase of 30 basis points from the third quarter of 2011.

Based on the year-to-date geographic mix of earnings and profits, we now anticipate our full year effective tax rate to be between 26% and 27%.

Our reported effective tax rate for the quarter was 24.3%.

As indicated in our earnings release, in the quarter we acquired 1.6 million shares of Company stock, at a total purchase price of $98 million.

Year-to-date we have repurchased 5.5 million shares at a total spend of $345.7 million.

As of September 30, 2012, approximately $1.15 billion remained authorized under a $1.5 billion repurchase program which expires at the end of 2014.

The Company had approximately 173.5 million shares of common stock outstanding as of September 30, 2012, down from 180.4 million shares as of September 30, 2011.

Operating cash flow for the quarter amounted to $345 million, a decrease of 1.6% from $350.6 million in the third quarter of 2011.

Day sales outstanding finished the quarter at 72 days, an increase of one day over the prior year period.

Adjusted inventory days on hand finished the quarter at 350 days, an increase of two days over the third quarter of 2011.

The increased investment in inventories reflects the pipeline buildout of Persona, the Personalized Knee System, the Trabecular Metal Total Ankle, the second generation XtraFix External Fixation System, Zimmer surgical power equipment, and Gel-One hyaluronic acid, offset by inventory reductions in our international operating segments.

Depreciation and amortization expense for the third quarter amounted to $82.7 million.

Free cash flow in the third quarter was $281.5 million, $8.4 million higher than the third quarter of 2011.

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

Capital expenditures for the quarter totaled $64 million, including $36.4 million for instruments, and $27.1 million for property, plant, and equipments.

I will now provide an update to our guidance for the fourth quarter and full year 2012.

In our earnings release this morning we announced that the Company is updating its full year sales and EPS guidance.

We now expect full year revenues to increase approximately 2% constant currency when compared to 2011.

We have adjusted our outlook for the balance of this year in response to our refined expectations for the ramp up of revenues associated with new product launches, as well as the apparent modest deceleration of musculoskeletal market growth.

The Company now estimates that foreign currency translation will decrease revenues by approximately 2% for the full year 2012, resulting in flat revenue growth on a reported basis.

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

Taking into consideration our current revenue expectations and line item guidance we have previously provided, full year 2012 adjusted diluted earnings per share are now projected to be in a range of $5.25 to $5.30.

This guidance is consistent with the value creation framework we outlined earlier in the year, and that David referenced in his remarks.

To arrive at GAAP earnings per share, you should subtract total charges for special items of approximately $135 million pre-tax, or approximately $0.50 per share.

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

Finally, would I like to make a brief comment regarding the medical device excise tax, which is set to go into effect in 2013.

Pursuant to the statue, the excise tax is imposed on the first sale in the United States by the manufacturer, producer or importer of a medical device to either a third party or an affiliated distribution entity.

Since we distribute the majority of our musculoskeletal products through a distribution entity, the tax generally represents an inventoriable cost for us.

As such, we expect the excise tax expense recognized in 2013 to be lower than prior estimates and we will report the expense in cost of goods sold on the face of our consolidated income statement.

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

Thank you, Jim.

Continued above market performances in a number of international markets and emerging businesses supported year-over-year sales growth in the third quarter.

A substantial amount of this growth was attributable to the new product introductions in existing and adjacent categories across the portfolio.

Going forward, we remain on track to increase value for stockholders through the ongoing commercialization of innovative new products, continued progress in our operational excellence programs, and disciplined capital deployment.

And now I would like to ask Regina to begin the Q&A portion of our call.

(Operator Instructions).

Our first question comes from the line of Matt Taylor with Barclays.

Hi, and thanks for taking the questions.

I guess the first question is on guidance.

You had a nice quarter here, coming in at 3%, and we are calculating I guess 2.6% for the first nine months.

So I wanted to do understand, the 2% for the year, does that imply roughly flat to 1% growth in the fourth quarter, and if that is right, can you just talk about what your expectations are for the quarter, and if you have seen a slow down since the third quarter?

Sure, Matt.

Good morning.

What we are doing is revising the guidance for the year in accordance with what we have seen in the market, really, through the third quarter, which there is some slow down within the market that is apparent in the large joint side, probably at least 0.5 point, maybe a bit more than that on a global basis.

And then in addition to that, just refining our view as we get further along with these product launches as to what the uptick is going to be.

So it is a broad range understandably, when you frame out the math the way that you do on the downside.

But we are being conservative, and we think appropriately conservative relative to the timing of the ramp up of those products that are being introduced.

And the largest of those is the Persona Knee System.

We are about to move forward with a broader release of that system, but we want to get that broad introduction just right at the point of launch.

And as a consequence of that timing, any instance that we have to take competitive business, those customers are going to be more interested in moving directly to the Persona System than the likelihood of them moving through two transitions of knee systems.

So there is a bit of a lull until we move forward.

But again, we are absolutely confident that all of these product launches are going to lead to accelerated revenue, and we are being conservative as to our views on the Q4 guidance.

Okay.

So is it fair to say that it is more after timing issue?

On a prior call you had talked about a little bit about a step up in the fourth quarter leading to some higher growth next year.

I guess, do you still view these products leading to you higher growth, but you may have just an air pocket here?

That is exactly right.

We absolutely are confident that we are going to see accelerated top line growth.

And that may begin in Q4, but we want to be conservative in managing expectations as to when we are going to find that traction point.

But it is going to happen, if not in Q4, as we get into 2013.

Okay.

Thank you very much.

You are welcome.

Your next question will come from the line of Bruce Nudell with Credit Suisse.

Good afternoon, or good morning.

I am sorry.

Good morning, Bruce.

Good morning.

You guys did very well in US hips.

There was sluggishness in US knees.

What is that telling us, if anything, about the status of your kind of sales force adjustments in the United States?

Well, I think, Bruce, you are right.

We had categories that performed very well within the Americas.

We had super performance in surgical.

We had a good performance in hips, as you point out, within the Americas.

More work to do in knees.

But again, as I was just explaining to Matt, Bruce, some of this is a bit of a lull before we move forward with what will be the biggest system launch in the Company's history.

And we are trying to get those details buttoned down just right, and launch that system with absolute precision.

So that is going to create that kind of a lull.

I think we are weeks or maybe a couple of months away from seeing the traction of that new knee system, and that combined with the effort that we have undergoing to improve our commercial execution in the United States is going to put us in a really good place in the coming quarters.

I guess just to follow up on that point, what I was trying to say I guess, should we look at the good performance in hips, which may have been influenced by vitamin E, as an indication that you have really made some progress in the US sales force situation?

And then my follow-up question really has to do with Persona.

Because, could you just shed any light on how the more natural feel is accomplished?

And is it something that can be kind of empirically demonstrated as opposed to kind of a word of mouth, yes, it does feel better, patient by patient?

Thanks very much.

Sure, Bruce.

I think the first question or the first subject, I think we are making progress on the sales force side, but I would tell you that with the portfolio that we have, and the products that we are rolling out, there is a lot more opportunity.

I think if within our own world you want to score out a performance at a level that is consistent with our expectations, the Europe, Middle East and Africa performance is the one to highlight.

They are in almost every product category in almost every country, we are in a share take position.

And that is what we are going to strive to in all of our geographic segments.

So while we are seeing some improvement in certain areas within the Americas in certain product categories, that needs to be consistent and across the board, and we are going to keep striving until you start to see some of the numbers in the Americas that you are seeing in EMEA relative to market growth rates.

The second question on Persona, I would tell you that in due time, Bruce, we are going to come back to you, and get much, much more granular about the benefits of that system.

We are excited about it.

But we are going to be disciplined about how we roll that out, and how we make the disclosures around the benefits of the system.

So bear with us a bit longer.

Thanks so much.

You are welcome.

Your next question will come from the line of Bob Hopkins with Bank of America Merrill Lynch.

Hi, this is Robby in for Bob.

Can you hear me okay?

We can.

Good morning.

Hi.

Good morning.

I just wanted to know if you could give us a sense of how the Gel-One or power tool launches are going?

I know you referenced it in your prepared comments, but how are those launches progressing?

And if you could give us a sense of what you think the potential contribution from those products could be over the next six to twelve months, that would be great.

Sure.

We know Bob gave you this question, so early stages on both of those launches, and there are some staging items until we get to a point where we are fully exploiting those opportunities.

I will tell you on the power tools side the evaluation response that we are getting from potential customers is good.

There is time between converting those positive evaluations into POs.

And so that is progressing.

We are very confident that on a global basis we have a terrific opportunity to penetrate that market.

And I think that you probably point out those two launches in particular, because they are among the examples of new product categories.

For us, there is no cannibalization in those categories.

And so that is one of the reasons that we are going to see top line acceleration as we find more traction with those launches.

So well received on the power tools.

Gel-One, we are just getting going on that in earnest.

Obviously, we were in a bit of a holding pattern prior to the completion of the successful patent litigation just a couple, three months ago.

So it is ramping up.

But we are very confident as we get into 2013 with both of those products that we are going to see good results.

I don't want to get into characterizing and scoring out the opportunity there yet, but we will take that comment in mind as we get back on the next quarterly call, and we are trying to provide you with some color on the guidance front.

Okay?

Great.

Thanks a lot.

And just one more quick follow-up.

I understand the delay and the timing with Persona is kind of impacting the US knee performance.

But I was wondering if you could just talk in a little bit more detail about what changes you are making to the business on the sales that are operation side to turn around the whole US recon business and get it growing at market rates again?

And also how long you think that will actually take?

Yes, I don't think it is going to take us long.

It is a territory by territory management matter, and that is no different than anywhere else in the world for us.

And so we have many territories that are performing very well, and obviously when you look at that with the same bag of products competing against the same companies, you are looking for that performance to be brought up in areas that are underperforming relatively speaking.

And so that is the work that we are doing.

In instances it requires more investment.

In instances it requires leadership changes within those territories.

But I think our effort is well underway, and you can see that positive result with some of the product category results that we are delivering at this point in time.

More work to do, but that effort that is ongoing, along with these product launches, are going to come together nicely as we get into 2013.

So I think from a timing perspective, you should expect us to put together sequential improvement as we get into 2013, and we are going to keep striving away to try to put numbers on the board, again, that look like the EMEA performance in this quarter within the Americas.

Those are our expectations.

Great.

Thanks very much.

You are welcome.

Your next question will come from the line of Mike Weinstein with JPMorgan.

Good morning, guys.

It is Kim in for Mike.

Hello.

Hi there.

So a question on the sales outlook, and I appreciate your comments on the fourth quarter.

But you indicated a couple times on the call that sales growth is expected to improve going forward.

Is that something, in light of the new product launches, that you could frame for us at all going forward?

So kind of from flat to 2%, what kind of growth outlook should we be looking for in 2013 and beyond?

Yes, please let us do that in the next quarterly call as we give you guidance.

I would tell you that the baseline would be the kind of numbers that we are putting on the board at this point in time, and we ought to be accelerating up.

And if you take what we were providing in the prior quarter's guidance as far as the second half and the ramp up, I think it is fair to push that out a quarter or two, and expect us to step up 100-plus basis points from that level, but we will frame that out for you much more specifically as we provide you with 2013 guidance.

Okay.

Just a follow-up for Jim on the excise tax commentary.

Can you explain why you think that is going to be lower now versus the prior expectations, and maybe if you could kind of frame or quantify that piece, at least for 2013?

Thanks.

Sure, Kim.

We had prior to understanding how more precisely the tax would need to be accounted for, and we have done some research on this and have gotten technical literature out of the independent accounting firms that tells us that in our case, as I said, where our first sale of devices happens within our consolidated group between a manufacturing entity and a distribution entity.

The tax is assessed at that point.

And as a consequence, the tax initially will be capitalized.

We will be paying tax from the first of the year, but it initially will get capitalized as an inventoriable cost.

And if we assume at this stage, and we have more work to do admittedly, that our inventory turns two times a year, what we were estimating before, in the order of $40 million to $50 million of expense for the full year, half of that gets deferred.

It just gets pushed out six months.

So at this point and as I said, we have a bit more work to do, at this point we would be estimating an expense that would be roughly half of our prior estimate, and then building up to the $40 million to $50 million of expense when we get into 2014, and having it continue to run at that rate off of and growing in line with sales growth for our US business.

Okay.

Got it.

Thank you.

Your next question will come from the line of David Lewis with Morgan Stanley.

Good morning.

Good morning.

Jim, I was wondering if you could maybe go down the P&L here and talk about leverage.

It looks like even based on fourth quarter guidance you are still on pace to deliver perhaps 100 basis points of EBIT leverage, which is obviously a strong performance for the year.

If you just want to take David's comments about needing to reinvest in the US, you have a significant number of new products coming heading into 2013.

So how do we think about the ongoing cost initiatives relative to David's comments about the need to reinvest?

And you were talking about reacceleration of the top line.

Do we think about your strong EBIT performance in this particular year?

Can we expect similar levels of margin performance in 2013?

I would just reflect back on what we communicated earlier this year in the context of our value creation framework, David, where we indicated in an environment where we see an opportunity for top line growth in low to mid-single digits, we are committed to run the business in a way where we deliver somewhere in the order of 8% to 12% growth in earnings per share.

We have communicated that with respect to 2013 and EBIT leverage, it gets a bit more challenging to drive the kind of leverage you are seeing this year as we face into the medical device excise tax, which goes into effect in 2013.

Now having said that, we now understand that the tax is not going to be that expensive, it is not going to be quite as significant as the $40 million to $50 million that I referenced in 2013, so that perhaps is going to provide us with some opportunity to invest in 2013 a bit more aggressively, whether it is in the sales channel or product developments.

But as we develop our operating plans for 2013, we start with an objective that is aligned with those value creation objectives that I mentioned.

Okay.

That is helpful.

And then, David, just a quick follow-up on sales growth.

It sounds like obviously the Persona deliberate delay here in the fourth quarter, maybe delay is the wrong word, is the single biggest reason why maybe there is a slight depression in fourth quarter sales, and that should be done next year.

We have also seen the last couple of quarters strength outside the US, and obviously some sluggishness in the US.

Is it safe to assume that trend should reverse, perhaps in the first quarter of 2013 when Persona begins in earnest?

I absolutely believe that in the first quarter of 2013 you are going to see the Americas business improve its performance.

And I think that it will continue to improve its performance sequentially throughout 2013, both by virtue of the commercial improvement efforts that we have undergoing, that is to improve our execution within the Americas on the sales side, as well as the ramp up of the product launches that we have been talking about.

Great.

Very helpful.

Thank you very much.

You are welcome.

Your next question will come from the line of Derrick Sung with Sanford Bernstein.

Hi.

Good morning.

Thanks for taking my question.

Good morning.

Your pricing this quarter looked pretty stable, kind of similar to what we have seen, the declines that we have seen in the previous quarter.

We have heard from some other companies perhaps a little bit of an optimistic tone that maybe we are seeing a little bit of improvement in the pricing environment.

I was wondering if you were seeing any of that?

And kind of related to that, next year, now that you will be facing that medical device tax, do you think that you will be able to use that tax as any leverage to at least maybe stabilize pricing, or prevent further pricing declines next year?

Yes, I think from our perspective, it is a story of stabilization.

We have seen very consistent trends in this regard throughout the full year, as is evidenced by the fact that we have been within 10 basis points.

That is the range every quarter this year on a consolidated basis for pricing.

So I understand the tone is maybe a hint at a more positive environment coming from some of the other competitive calls as they reported out their third quarter results.

What we are seeing is stability rather than a reversal of those trends.

And I think that in light of that to carry that through into a belief that perhaps the med device tax is going to be capable of being passed on to customers, that probably is a bit of a leap forward in the pricing context for us at this point in time.

Okay, thanks.

And then as a follow-up, your Total Ankle launch, that is an exciting new launch.

It gets you kind of into that new category for the first time.

Can you talk a little bit about whether you have a dedicated sales force that will be selling that product, how you will be incorporating that into your sales infrastructure, and if you feel you have the infrastructure that you need to really launch that product full force?

That is a good question.

We are very excited about this new product launch obviously.

This is a space that, frankly, is an area that is in need of a better solution, the standard of care being fusion.

So the Total Ankle Replacement System that we developed, it incorporates Trabecular Metal technology.

We are very excited about it.

And furthermore the surgical approach with a novel lateral approach is something that we think can be a real difference maker as well.

So this will be one that we are very methodical at the launch at this system.

The training on the technique is crucial.

So it will be a slow walk, a methodical process to get it just right as well.

And as a consequence, any need to develop more focus or specialization within the sales force, Derrick, would be layered in as that product launches out.

But it really will be the center piece and anchor to the beginnings of our lower extremity offering, and that is a space that we look to expand as we broaden our extremities franchise as a whole.

Great.

Thank you very much.

You are welcome.

Your next question will come from the line of Matt Miksic with Piper Jaffray.

Hey, can you hear me okay?

We can, Matt.

Good morning.

Good morning.

I wanted to follow-up with the comments, [those] (inaudible) in the market (inaudible) --

Pardon me, Matt, you do sound like you are fading in and out?

Can you hear me a little better now?

Yes.

Okay.

So I did want to just follow-up on one of your earlier comments on the market.

[We've seen] a lot of results this quarter, and some good some bad, but I had not heard folks on the torso or spine side talk about sort of a market slowdown in the market per se, at least not in the US.

I wanted to get some color on what it is that you are seeing, where you are seeing it, what do you think your [timing-inaudible] mentioned].

I think I got the gist of your question, Matt, so let me give you a little bit of perspective.

Obviously, it is more difficult for us to give you better insights into the smaller product categories within our portfolio.

We, just by virtue of the size of the business and the market share, can probably offer a bit of color in the large joint side.

And that is a market that looks to us as though it slowed down sequentially from Q2 to Q3 by something like 0.5 point.

And we believe that it was more profound in the case of knees within the United States.

We believe that slowdown was probably more profound in the case of hips in the OUS market.

Okay.

I guess any sense of the top down observation, or have you picked up any color from your folks in the field about this?

No, you get all sorts of anecdotal explanations as to what is happening.

I think that there is no doubt that those summer months, people can speculate about the seasonality, and whether or not that is changing.

That is really difficult, and you get into a month or two of that, and you just need more time to examine whether or not there is a trend to be determined.

So I think you just have to get deeper into the fourth quarter to better understand whether or not that is a procedural slowdown that is blip or a bit longer in its duration.

It is part of the reason that we are being conservative about the top line guidance for Q4.

I don't think that there is anything fundamental about that in the sense that it is going to be a prolonged period, or that this is a sign that the market is changing.

I don't believe that at all.

And then you can see some specific slowdowns in particular countries within a jurisdiction, like our EMEA business.

But again, in EMEA we are outperforming the market in a significant enough way to where that isn't effecting our results.

Okay.

And then I just wanted to just follow-up with a product question.

You talked a fair amount about eLibra.

I guess we have an understanding of how custom cutting blocks, or the PSI system benefits the Company.

If you could maybe talk about what is the revenue model or the benefit stream of eLibra?

How does that work exactly, just because it is a relatively new product for us?

Sure.

So it is an incremental cost in the procedure, but the fundamental benefit of the eLibra System is it informs the surgeon when they are making their primary cuts, their initial bone cuts, both the femoral and tibia side, as to what that is going to get them by way of soft tissue balancing before they do their AP cuts.

So whereas other systems inform the surgeon after they have made all of their bone cuts as to what they need to do with regard to soft tissue releases, the eLibra system allows the surgeon to have the information while they are in the bone, the primary bone cut phase of the procedure.

It is integrated into their natural sequence and procedural algorithm, and the feedback information, because it is a sensor technology, allows them to get the bone cuts just right, and mitigate the chance that they are going to come to the end of the procedure and have to do soft tissue releases.

So when trained up and used properly, this cannot only be a system that provides a better answer for the patient, a more natural feeling knee because the soft tissue balancing is optimized, but it also can be integrated in a way where the surgeon is getting feedback at a point in time where they can become more efficient and avoid redos, avoid tweaking the soft tissue with releases at the end of the procedure.

And the economics of this?

I know you don't want to gets into pricing, should we think about it as something similar to maybe the premium you get from PSI per case, or something along those lines?

That is the right way to think about it.

That is right, Matt.

Thanks so much.

David Dvorak: You ire welcome.

Your next question will come from the line of Kristen Stewart with Deutsche Bank.

Hi, thanks for take the question.

I just wanted to go back again on this med tech tax and the rationale for why it is in cost of goods sold with the distributors.

Is that just simply a function of the network that you guys have set up just being these independently operated distributors?

Because you are the only company so far that has this kind of, at least talked about putting it into cost of goods sold versus SG&A, or even other expenses?

Sure, Kristen, it is not that we have independent distributors.

It is within our consolidated group of companies we sell from a manufacturing entity to a wholly-owned distribution entity.

It is a structure that we have had in place for many years, reinforced frankly by the transformation initiatives that we are executing on where we have, as you may know, established a distribution hub for the US market near Memphis.

So it really is that the inventory that leaves the manufacturing entity and is sold admittedly to an affiliated company, to the distribution entity, is the point at which the tax is getting assessed under the statute.

And that is the fact that we, our supply chain is set up that way, that leads us to account for the tax expense as a cost of goods.

And this is very consistent with the way in which the excise tax that was imposed in Puerto Rico a couple of years ago was accounted for as well.

It is a manufacturer's tax, which is why it ends up being accounted for as an inventory cost.

And I assume that it is still tax deductible at the end of the day too?

Yes.

Okay.

So the way to think about it is, even though everyone else will start to be accounting for it through their P&L in the first quarter of 2013, you guys won't actually see the impact of the med tech tax running through your P&L until probably more mid-year, as some of the kind of older inventory works through, and until you get some of the newer inventory with the tax built-in?

Right.

And I would be surprised if we were the only company that has the supply chain set up in that way.

Okay.

And then just on project transformation, can you just remind us kind of what the net savings have been this year, and kind of what is left in that program to give you confidence to maybe grow double-digits, as I think you said in the past, despite I guess the device tax coming in next year, which now is obviously half as much of a headwind?

Sure.

So coming into the year, we had talked about the actions that we would be able to get completed this year would generate $80 million of savings on an annualized pre-tax basis, with an expectation that we would realize $30 million to $40 million of that in 2012.

We communicated on last quarter's call that the programs are on track.

I would tell you that they are still, they remain on track.

And when you take that $80 million that is generated out of this year's actions and add that on top of the savings that were derived or realized from the actions we took in 2011, we come out of 2012 at a run rate of $130 million to $140 million in total.

Now admittedly some of those savings are being reinvested in the business in the short term, as you know, to accelerate our certain technology and product development programs, a number of which we have touched on in this call.

Also to cover some of the short term dilution that comes with acquisitions, we have done a number of admittedly small acquisitions, but typically there is some dilution that comes with those acquisitions in the short term.

And also, to continue to build out the channels in our emerging markets and support some of the other investments that we are making in those emerging markets.

So that the extent to which we need to reinvest those savings is something that we look at in some detail as we go through the development of our operating plans.

We haven't completed that yet for 2013, but we will have decisions to make around how much of the $130 million to $140 million we can reinvest, and how much needs to be dropped through to the bottom line to deliver on the goals that we have with respect to earnings growth.

And we are still targeting $400 million in total by 2016, and we are on track to hit that target.

Perfect.

And then just a quick last one, I guess, since you brought up emerging markets, I was wondering if you could give perspective on how you look at China?

I know Medtronic just announced that they were buying a company, an orthopedic company there.

How do you kind of see your China business shaking out?

We are executing a plan that was developed several years ago in China, Kristen.

It is a market that we are very focused on.

We have had a terrific distribution channel team over there for years and years, and then augmented that with the acquisition of Beijing Montagne almost three years ago now.

And so I think that we have the building blocks of what we want to do, at least on the large joint side within China, but it is a market that we are going to continue to make investments in, both on the distribution channel and product side and likely as well on the operations side going forward.

We are growing that business at a very attractive rate at this point.

Okay.

Thank you.

You are welcome.

Your next question will come from the line of Larry Biegelsen with Wells Fargo.

Good morning.

Thanks for taking the question.

Good morning.

David, I just want to do clarify.

It has been asked on this call a few times, the value creation goal of 8% to 12% EPS growth.

Do you still think you can get there in 2013, in light of the lower expense for the medical device tax as you articulated on this call in 2013?

And would you be disappointed if the top line growth in 2013 was not higher on a constant currency basis than in 2012?

The answer to your first question is absolutely, and the answer to your second question is absolutely.

Okay.

Great.

Thank you for the clarification.

And then in Europe your results this quarter were very strong, even adjusting for the extra day.

Can you talk about the sustainability of that, please?

Thank you.

Yes, they were very strong, and that team deserves all of the credit for generating those results.

If you look at the last many quarters, they put terrific numbers on the board.

And if you go back a couple of years, all of us were having discussions about what a drag the European business might be to our overall results.

Anyone within this industry.

And that is a commercial team that is finding a way to get to the growth, and where there aren't natural opportunities because of the market growth rates, they are finding it through share gains.

So they are doing a terrific job.

I would tell you I have absolute confidence that they will be able to continue to grow above market rates.

I think that this quarter is a pretty extraordinary accomplishment.

I am not sure that level of above market growth rate is reasonable to expect every quarter.

But with the momentum that they have, they are going to continue to do well relative to the market.

Some of the ramifications or practicalities of that extraordinary result that they produced in third quarter is a reason that we are a little bit cautious about our guidance in Q4, in the sense that you are asking them a lot to keep stringing those kinds of quarters together.

But we are going to do very well in that European business for the coming quarters and years, in my view.

Thank you.

You are welcome.

Regina, we have time for one additional question.

Your final question will come from the line of Michael Matson with Mizuho Securities USA.

Thanks for taking my question.

I guess just with regard to the selling days.

With one less selling day in the US, and I guess one additional selling day in some of the OUS regions, I assume there was still a net negative impact to your revenue growth, just given that the US is so much larger.

Is that a fair assessment?

It is pretty close to a wash, Michael, on billing days in Q3.

I mean you are right.

You lose a day in the Americas, pick up a day in Europe, pick up a bit more than a day in Asia Pacific, and so the math works out to be essentially a wash within the quarter.

And then looking at Q4, Americas is even year-over-year.

We pick up part of a day when you average it all out in Asia Pacific.

But we lose two days in Europe in Q4, which impacts the growth rates sequentially there.

Okay.

And then can you give us an update on your PSI instrument for your Uni Knee?

Are you seeing any traction there?

What does the initial uptake and demand for that system look like?

That is a good question.

We have been pleased with the uptake of PSI for our Zuck product, and we are looking to further develop the application of our intelligent instruments within the Uni space, because we think it can be a difference maker.

That in our view is an underpenetrated market, and in some of the medical training and education as well as the intelligent instruments can be a difference maker, in allowing more surgeons to take advantage of that solution where the appropriate, or the patient presents in an appropriate way.

So would I tell that you that the uptake of PSI in the context of Zuck has been faster than it was in primaries as a percentage of total procedures that we are involved in, and I think that it will be a place where again the total package of technologies within intelligent instruments will be a difference maker going forward.

Okay.

Can I just squeeze one more in on the Dornoch acquisition?

What is the revenue contribution for that, or what was their run rate?

Can you quantified that?

Yes, in round numbers, it is a $10 million business at this point in time, and obviously that is not the point of the acquisition for us.

This rounds out our surgical portfolio, puts us in a very competitive position.

It is good technology.

That is another market that is underpenetrated in the sense that the standard operating procedure within the hospital systems is to red bag the fluid waste that is developed through these procedures, and so we think that there is a lot of upside within that space.

We have a much, much more comprehensive portfolio now than we did a couple of years ago.

So we are looking for big things from that division going forward.

Alright.

Thank you.

Thanks, Michael.

So I would 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 fourth quarter conference call at 8 AM on January 31, 2013.

I will turn the call back to you, Regina.

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

You may now disconnect.