Zimmer Biomet Holdings Inc (ZBH) 2013 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.

Good morning.

And welcome to Zimmer's third quarter, 2013 earnings conference call.

I'm 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 on our website at investor.

Zimmer.com.

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

Thank you, Bob.

Good morning everyone and welcome to our earnings call for the third quarter of 2013.

This morning I'll 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.

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

Zimmer accelerated top line growth in the third quarter, with notable contributions across our core franchises.

This growth was also driven by our innovative new product offerings, contributions from recently entered new product categories, and the focused execution of our global sales teams.

Consolidated net sales for the quarter were $1.07 billion, an increase of 6.7%, and our earnings per share were $1.25, an increase of 8.7% over the prior year period.

We again delivered margin expansion through disciplined operating expense management, and generated leveraged earnings per share aided by our capital deployment strategy.

Also in the quarter, Zimmer made additional investments to enhance all aspects of our quality management system.

This focused work will continue into future quarters as part of our quality and operational excellence agenda.

Additionally, the Company remains committed to continuing to build stockholder value in the future by executing on our established growth initiatives, and capital allocation programs.

Our performance in the third quarter represents a validation of our ongoing business strategy, which will continue to serve as the Company's guiding compass as we get capitalized on future growth opportunities.

Turning to global market conditions.

In the third quarter, musculoskeletal markets demonstrated stability with some improvements over recent quarters in certain geographies.

With respect to pricing, we experienced pressure of negative 1.5% in the quarter, consistent with our expectations coming into the year.

I'd now like to comment on our sales performance in each of our geographic segments.

In the third quarter, Americas' sales grew by 8.7% year-over-year while Europe, Middle East and Africa increased by 0.9%, and the Asia-Pacific region grew 8.0%.

In the quarter, the Company continued to benefit from strategic investments in broadening our industry-leading product portfolio as well as strengthening our sales channel.

These investments demonstrate our ongoing commitment to delivering a compelling value proposition to surgeons, their patients, and healthcare institutions.

Turning now to the results of our product categories, I'm extremely pleased to report that sales from our market-leading knee business increased in the third quarter by 7.4%, reflecting positive volume and mix of 9.1%, and negative price of 1.7%.

Our Americas' segment reported an impressive sales increase of 9.1%, while Europe, Middle East and Africa grew sales by 1.3%, and the Asia-Pacific region delivered strong 9.0% growth compared with the previous year.

In the third quarter we were very encouraged by steady sales growth for Persona, the personalized knee system.

As we continue to roll out this premium offering, we're receiving excellent feedback from both new and legacy clinician customers.

Their testimonials powerfully illustrate why we believe the Persona system and its accompanying intelligent instrumentation represent the next generation of advancement in total knee replacement technology.

The Persona system gives surgeons a new level of inter operative precision to personalize the best fit for their patients.

These high fidelity implants, along with intelligent instrumentation designed to support the precision and intra operative efficiency of the total knee replacement, have earned the enthusiastic endorsement of customers around the world.

Ultimately, of course, we designed the Persona system with the needs of patients in mind.

Promising early feedback from clinician customers continues to validate the design rational behind Persona, to allow patients to achieve unprecedented postoperative fit, feel and return to normal function.

Our outlook, therefore, remains bullish for the future of this revolutionary knee system.

The performance of our knee franchise in the third quarter was also supported by growing sales of Gel-One.

Zimmer's single injection treatment for early knee osteoarthritis and a major component of our exciting and growing early intervention in joint preservation offerings, which also include DeNovo NT, Chondrofix and Subchondroplasty.

Turning to our hips business, in the third quarter we achieved sales growth of 2.2%, reflecting positive volume and mix of 4.3% and negative price of 2.1%.

Sales increased by 3.7% in the Americas, decreased by 2.1% in Europe, Middle East and Africa and increased by 5.0% in the Asia-Pacific region.

A positive shift towards premium solutions in the United States, such as our continuum acetabular system, Vivacit-E liners, and Biolex ceramic head offerings, help support our increased revenues.

In addition, the Avenir and Fitmore hip systems each delivered impressive global sales growth in the quarter.

These competitively differentiated offerings are just a few of the many examples of how our portfolio closely matches patient anatomy, and helps surgeons achieve the best outcomes for their patients.

Our extremities business delivered strong 15% growth in the third quarter with all geographic regions reporting what we believe to be above market performances.

Our sales continue to be driven by our highly successful shoulder replacement portfolio, led by the Trabecular Metal reverse shoulder.

To complement this system, in the quarter we received 510K clearance to market the Zimmer patient specific instrument shoulder.

Further strengthening our position in this rapidly growing segment of the shoulder arthroplasty market.

This intelligent instrumentation technology leverages 3D visualization software, to generate personalized surgical plans for each patient, utilizing patient-specific instrument guides to facilitate positioning of the implant, including precise reaming and screw placement.

This innovative application of Zimmer's intelligent instrumentation platform further demonstrates how these cost effective, efficient solutions are enhancing our portfolio of differentiated technologies for the achievement of personalized patient outcomes.

Dental sales experienced modest growth for the third quarter, as the Company continues to pursue opportunities in a mixed global market.

Solid sales growth of 6.8% in the Americas was offset by continuing market challenges in Europe.

We expect continued strong performance from our market-leading regenerative portfolio, premium Trabecular Metal Dental implants and custom milled Zfx CAD/CAM Digital Dentistry Solutions.

We also look forward to the ongoing introduction of value based offerings designed in the PI Branemark philosophy for certain international markets.

As markets stabilize, we're confident our differentiated portfolio offers both premium and value based offerings, which positions Zimmer Dental for improved growth.

Zimmer Trauma grew sales by 7.6% in the third quarter.

With our Americas' segment reporting a sales increase of 1.9%, Europe, Middle East and Africa growing sales by 15.9%, and the Asia-Pacific region delivering 12.0% growth.

In certain key geographies, we've benefited from investments into dedicated trauma sales teams to improve performance in top tier traumatology centers.

Product sales in the quarter were driven by steady results from our core plates and screws portfolio, as well as another strong quarter for the Zimmer Natural Nail family.

Further, the ongoing roll-out of the extra fix, external fixation system, continues to gain market acceptance.

In the quarter, we also garnered 510K clearance for the motion lock screw for periarticular locking plate system.

Which has been designed to promote faster and stronger healing.

Zimmer's Spine sales decreased by 3.4% in the quarter compared to the prior year.

We're generating encouraging growth internationally as we continue to add technologies and products that will increase our ability to compete in the US market.

Sales once again were led by our innovative core fusion portfolio including the TM Artis and TMS Interbody fusion devices and the inViZia interior cervical plate system.

Additionally, our minimally invasive solutions continue to show promising growth, led by the Pathfinder NXT pedicle screw system.

We're also making progress with our ongoing commercialization of the APEX Spine System, for degenerative deformity and complex spinal conditions.

Additionally, Zimmer Spine recently signed an exclusive global distribution agreement for the lateral locking cage, a first of its kind minimally invasive lateral interbody cage.

This deal marks Zimmer Spine's entry into lateral access surgeries, one of the fastest growing segments of the global spine market.

In the third quarter, Zimmer's Surgical and other category continued to deliver outstanding performance, with a 24.7% sales increase over the previous year.

Our Americas' Surgical business delivered exceptional 35.9% growth, in addition to above market performances internationally.

The Transposal Fluid Waste Management System again led our strong performance in the third quarter.

Patient care solutions and capital sales for our power tools remain drivers of growth in Europe, while our legacy surgical portfolio continues to deliver solid performance in the Asia-Pacific region.

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

Jim?

Thank you David.

I will review our third quarter performance in more detail, and then provide additional information related to our 2013 sales and earnings guidance.

Our total revenues for the third quarter were $1.074 billion, 6.7% constant currency increase compared to the third quarter of 2012.

Net currency impact for the quarter decreased revenues by 1.9% or $20 million.

The negative currency impact for the quarter related principally to our Japanese yen and Australian dollar denominated revenues, partially offset by positive currency translation associated with our Euro based revenues.

Our adjusted gross profit margin was 73.5% for the quarter, the margin ratio declined 160 basis points compared to the third quarter of 2012.

This quarter's adjusted gross margin ratio is slightly improved compared with our second quarter results.

In the third quarter, we continued to experience a higher mix of lower margin product and geographic revenues as well as manufacturing related charges.

Together with the slight year-over-year decline in price, these headwinds outweighed foreign currency hedge gains and cost savings from our operational excellence initiatives.

In the quarter, while we again realized significant growth in sales of the capital component of the Transposal Fluid Waste Management System, we are beginning to see a more balanced contribution coming from the higher margin, single use disposable components utilized with the capital.

We would expect this trend to continue to evolve in coming quarters.

The Company's R&D expense decreased 7.8% or $4 million on a reported basis to 4.6% of net sales, when compared to the prior year.

As noted in prior quarters, the decrease in R&D expense continues to reflect a natural decline related to the completion of a number of large projects, as well as the dedication of resources to our quality and operational excellence initiatives.

Our internal resources working together with outside experts are laying the foundation for enhanced design, development and manufacturing processes.

This is a key next step in our drive to achieve a higher level of excellence in these areas.

At the same time, Zimmer's pipeline of new and innovative products remains robust which will help pace growth in future periods.

Selling, general and administrative expenses were $438 million in the third quarter, and at 40.8% of sales were 110 basis points below the prior year.

In the quarter, savings from our transformation initiatives were partially offset by increased selling, marketing and distribution costs associated with the commercialization of a number of new products.

As well as direct sales integration in certain key markets.

In the quarter, the Company recorded pretax charges of $46.4 million in special items, and $43.8 million in cost of products sold, pertaining to global restructuring, quality and operational excellence initiatives, certain litigation, and recent acquisitions.

Our adjusted results exclude the impact of these charges, which include $39.1 million associated with the broad based product rationalization program, $33 million related to quality and operational excellence initiatives in manufacturing, logistics and sales, $12 million connected with certain litigation and $6.1 million in integration and other costs.

Product rationalization will aid in the achievement of our quality and manufacturing excellence goals, as well as reduce inventory requirements in future periods.

Adjusted operating profit in the quarter amounted to $301.9 million, a 28.1% our adjusted operating profit, the sales ratio was 10 basis points higher than the prior year third quarter.

Net interest expense for the quarter amounted to $13.3 million, which was favorable when compared to the prior year quarter.

Adjusted net earnings were $215.6 million for the third quarter.

An increase of 6.7% compared to the prior year.

Adjusted diluted earnings per share increased 8.7% to $1.25 on 172.2 million average outstanding diluted shares.

These adjusted earnings per share are inclusive of approximately $0.04 of share-based compensation.

At $0.90, reported diluted earnings per share decreased 11.8% from the prior year third quarter reported EPS of $1.02.

Our adjusted effective tax rate for the quarter was 25.4%, and was 50 basis points favorable when compared to prior year.

Our reported effective tax rate for the quarter was 22.3%, as the majority of restructuring and other special items charges are incurred in higher tax jurisdictions.

During the quarter, we repurchased 0.2 million shares at a total purchase price of $17.5 million.

Approximately $536 million of authorization remains under our share repurchase program that runs through December 31, 2014.

The Company had approximately 170.5 million shares of common stock outstanding as of September 30, 2013, down from 173.5 million as of September 30, 2012.

Additionally, 1.6 million stock options were exercised in the quarter, resulting in $108.7 million of cash proceeds.

Through the end of the third quarter, 5 million stock options had been exercised in 2013, resulting in $325.4 million of cash proceeds.

In contrast, on average less than 1 million stock options were exercised in each of the last three years.

As a result, the Company now estimates diluted weighted average common shares outstanding for the full year to be approximately 171.5 million shares.

The higher expected share count resulting from the unusually high volume of option exercises this year causes us to modify our outlook for adjusted diluted earnings per share from a range of $5.70 to $5.80, to the low end of that range, or approximately $5.70.

Operating cash flow for the quarter amounted to $297 million, a decrease of 13.9% from $345.1 million in the third quarter of 2012.

The decrease is driven in part by the ongoing build out of inventory and support of new products, the impact of the medical device excise tax, as well as increased cash outflows associated with certain claims, restructuring actions and quality and operational excellence initiatives.

Net inventories were $1.082 billion at the end of the third quarter, an increase of $29 million from June 30, 2013.

Adjusted inventory days on hand finished the quarter at 284 days, flat as compared to the prior quarter.

As of the end of the third quarter, net receivables increased $899 million from $875 million in the third quarter of 2012, or 3% over prior year.

Our adjusted trade accounts receivable days sales outstanding finished the quarter at 73 days, an increase of 1 day when compared with the prior year.

Depreciation and amortization expense for the third quarter amounted to $91.9 million.

Free cash flow in the third quarter was $206 million, $75.4 million lower than the third quarter of 2012.

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

The decrease in free cash flow reflects the ongoing investments in our new product inventory, capacity related investments and the acquisition and deployment of instruments to support the full release of Persona and other new products.

Capital expenditures for the quarter totaled $90.8 million, including $49.8 million for instruments and $36.9 million for property, plant and equipment.

I'd like to turn now to our guidance for 2013.

In our earnings release this morning we updated our sales guidance noting that the Company expects full year 2013 revenues to increase approximately 4.5%, constant currency when compared to 2012.

Previously, we had estimated full year revenues would increase between 4% and 5% constant currency.

We now expect foreign currency translation to decrease our reported 2013 revenues between 1.5% and 2% for the full year.

Therefore, on a reported basis, our revenues are projected to be between 2.5% and 3% above 2012 results.

Previously, we had estimated foreign currency translation would decrease revenue by approximately 2%.

Our earnings release also indicates that our full year 2013 adjusted diluted earnings per share guidance has been modified to approximately $5.70.

To arrive at our anticipated reported GAAP earnings per share, you should subtract total charges for inventory step-up and other inventory and manufacturing related charges, certain claims and special items of $335 million pretax, or approximately $1.30 per share on an after tax basis.

Our gross margin ratio is now expected to be at or slightly below 74% for the full year.

R&D as a percentage of revenue was still expected to be approximately 4.5% for the full year.

SG&A guidance as a percentage of revenue remains unchanged at approximately 39.5%.

We expect interest expense for the full year to be approximately $56 million.

Moving down the income statement, we now expect the 2013 full year adjusted effective tax rate to be around 25.5%.

And as indicated, our average diluted share count for the year is expected to be approximately 171.5 million shares.

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

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

Thanks, Jim.

Zimmer's strong performance in the Americas and Asia Pacific geographies, as well as in several key product categories contributed to our accelerated top line growth in the third quarter.

These results continue to validate the Company's strategy for growth, quality and operational excellence, and disciplined capital management, while ground-breaking new offerings, such as Persona, the personalized knee system, continue to build our profile as the world leader in reconstructive orthopedic technologies.

Our expansion into early intervention solutions and adjacent product categories is extending our reach across the continuum of musculoskeletal care.

We're confident that these critical elements of our value creation framework will help support our continued growth.

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

(Operator Instructions)

Joanne Wuensch, BMO Capital Markets.

Seems to be going very well in the United States.

And how you're approaching that to your current physician base versus new physicians?

Joanne, I think that you came in a little bit delayed.

Do you mind repeating the question, please?

Of course.

I wanted to talk about your knee sales in the United States which were much stronger than we had expected.

Wanted to understand the Persona launch in the United States and what percentage of that is coming from current physicians versus new physician trials?

Sure.

We're excited about the success of that launch and probably the most exciting thing is that it's still early in the process of such a large system launch.

As you know, these things roll out with paced by instrument sets and those deployments take time and it will be multiple operating periods and furthermore, there are technologies that will be integrated into that system in a phased approach as part of our multi-year generational product development plan.

So there are more great things to come under the Persona umbrella.

To date, it's been a balance of a mix of legacy Zimmer clinicians that have come from next gen use or NK2 use, as well as competitive surgeons.

I would tell you that the competitive surgeon usage is not insignificant, even at this stage in time.

If you look at and we're not going to break out in a detailed way the percentage of units or revenues that are flowing from those different sources, but rest assured that we're tracking that and deploying a very careful and methodical strategy as it relates to that mix.

If you look at where we started the year, particularly on the US knee performance side of things to where we progressed in the third quarter, it's pretty apparent that not all of that could possibly, by way of improvement, come from mere mix and premium charge by transitioning legacy Zimmer surgeons over to the Persona system.

So there's a healthy portion of that acceleration coming from competitive surgeons.

Terrific.

If I can squeeze in a follow-up.

Can you just give a brief update on Europe?

That seems to be the weaker of the three or the weakest of the three geographies and how do we fix that?

Thank you.

Sure.

I mean, we address the macroeconomic conditions fundamentally to fix that geography.

I think it continues to be a slow geography, particularly in several of the developed markets, and we have a large presence in those markets, marketshare-wise.

So that makes it difficult for us to post the kind of numbers that we have been posting over the last several years as those developed markets slow down.

We continue do very well in the developing markets.

And then our performance within the primary five developed markets within Europe is a bit mixed.

I would tell you that there are certain of them where we're doing well.

Others where we have more work to do.

And I think that we've got the right plan in place to accelerate our performance.

Obviously, within the product categories we're going to put a lot of energy towards improving our hip performance in the coming quarters.

But I think we have the right portfolio, the right leadership and the right strategic plans to make those improvements in the coming quarters.

Terrific.

Thank you.

Bill Plovanic, Canaccord Genuity.

If I could, the contribution from Gel-One into the US business in the quarter?

Yes, we're not going to break out that contribution, but relative to the category growth it's not material.

Okay.

Just your thought, just a broader view here, just -- we've seen acquisitions in the space with Stryker buying MAKO and some talk about by bicruciates bearing knees just kind of your thoughts on that longer term?

Well, I think that the whole category of bringing technologies, both for pre operative and inter operative purposes to advance the outcome of these procedures is a valid one.

And I think if anything the deals that are getting announced support the strategy that we've been executing over the last half dozen or more years, and that is to develop implant systems that are much more personalized, that offer broader options in a clinically relevant way.

And part of what will enable the deployment of those systems are these pre operative and inter operative technologies that can lead to more precise planning beforehand, more precise implantation alignment, soft tissue balancing in the OR.

And address the patient satisfaction opportunity that is out there, particularly in the knee category.

So the major premise is sound.

Now, people can take a different course on that ocean and a course that we've taken and continue to believe in is that something that is technologically advanced but sort of smaller, faster, cheaper, is going to be the winning path towards success in that environment.

And if you look at our internal and external development efforts over the last many years, they've combined to produce a really nice portfolio of pre operative and inter operative technologies that include portal technologies for digital templating and planning that include the iASSIST system that is a guidance system that is used intraoperatively, the eLIBRA system for soft tissue balancing, patient specific instruments and all of those systems are integrated into the launch of an advanced total joint opportunity in the context of Persona.

And you can see what we're doing that, even in the early stages.

So again, I think that the opportunity and the clinical need is out there, doing that, addressing that need and creating broader portfolio of opportunities to personalize solutions in the hands of surgeons without disintermediating those surgeons is where we're headed and we're well on our way towards addressing that need.

So we're excited about the space.

We think that there is room for innovation and we think it's going to be a difference maker.

The key is, we're deploying strategies that we're confident are going to be not only clinically relevant and address that need, but to do it in a cost effective way.

And on the bicruciates bearing, just general thoughts there?

Thank you.

Again, I think that very consistent with our continuum of care approach.

We've assembled, again, through internal and external development, earlier intervention strategies and we want to be the most comprehensive provider of solutions to the extent that one can -- we have a leading product in the uni category and the bicruciate concept is really an extension of uni, that is to address any of the three compartments of the knee that are diseased and to do it in the most bone conserving and tissue sparing way.

So the concept is absolutely consistent with our continuum of care and comprehensive approach and philosophy and you should assume that anything that we believe is going to work from a clinical standpoint, we're either working on internally or looking at externally.

Thank you.

Matthew Taylor, Barclays Capital.

It's actually Dan Whitaker in for Matt.

Just quick, first to ask about the general market, I mean, in past quarters you've indicated stability.

This quarter you talked about stability and then some I guess potential improvement.

Just can you comment on anything you're seeing in the market that led you to indicate that?

Sure.

Obviously, the unit growth that we're seeing is an acceleration and we're -- in the knee category, it's picked up on a global basis or all-in accelerated.

But the majority of that acceleration for us at least came out of the US marketplace.

And a little bit of that is challenging to disaggregate because we believe that we're taking share by surgeon customers with the Persona launch.

But again, the market is healthy within our existing and legacy accounts as well.

Hips look like they picked up as well on a global basis or as an all-in number, and that acceleration looks like it was spaced out geographically within and outside the US both.

Great.

That's helpful.

Then just one quick follow-up on the EPS guidance.

So most items that you called out in the release and on the call, they're (inaudible) the GAAP number.

The adjusted number comes down a little bit also.

Not to read -- just curious, is that I guess largely -- is that -- some of that is that the inventory step-up from the new product roll-out given the strong product cycle or is there anything else there to read into?

This is Jim.

That's really a function of the updated guidance on the average diluted share count for the full year, raising that share count to 171.5 million shares.

That compares with guidance that we provided very early in the year of about 170 million shares, and as I've looked at most of the analyst models that are out there, seems to me that's where most of them still sit.

Outside of that, we continue to drive operating leverage, the guidance with respect to what's going on above the P&L in terms of top line.

Obviously, that guidance relative to where we are in the beginning of the year it is now at the top end of the range we provided early in the year.

Feel very good about the progress we continue to make to drive operating leverage, even in the face of lower gross margin ratio.

Which is as we talked about a function of what's happening with both the geographic and product mix of revenues we're seeing this year.

So again, I mean, when you look at a top line growth of 4.8%, we're driving 5.3% growth at operating profits, 6% growth in pretax earnings.

6.7% growth in net earnings.

We're just seeing less leverage from the share repurchase program than we had expected to see coming into the year, because we're seeing option exercises that are frankly five times the average annual number of option exercises we had seen in the preceding three-year period.

Thanks a lot, guys.

Bob Hopkins, Bank of America Merrill Lynch.

One on gross margin and one on share count.

Just real quickly on share count, I was curious why wouldn't you be more aggressive with your buyback to offset the options?

Well, as you pointed out, Bob, we have taken in $325 million on the exercise of those options and it is something that certainly we have given consideration to.

We will continue to give consideration to and may very well choose to get more aggressive on the share repurchase program as a way to offset the impact obviously that those option exercises are having on earnings per share.

We haven't done that at this point, but obviously still an opportunity that we have going forward.

Does that mean there's potential acquisitions being contemplated?

Is that a read-through?

I wouldn't make any assumptions.

As I said, we've taken in quite a bit of money from the cash proceeds from those option exercises and among other things, we'll consider getting more aggressive with share repurchases.

We'll, as we have and continue to, look for other opportunities as well to invest that capital.

We've done a number of bolt-on acquisitions over the past couple of years.

We're still very actively looking for opportunities to expand the portfolio, so long as we can find things at the right price that fit within our focus on musculoskeletal health.

Thank you for that.

And then on gross margin, this is the second quarter in a row now where you've had to lower the gross margin guidance and so first of all, from a big picture perspective, I know there's a lot of moving parts here and you articulated those last quarter and the MEDTEC tax going forward is going to be a bigger hit.

Sounds like you think you are going to end the year a little bit below 74%.

When you take into consideration all the moving parts that will affect gross margin, that are affecting it now and will affect it in the future, is this a line item that you can generate leverage on as we look to 2014, just in light of the again, the two lowerings of guidance here, I'm just curious if you could give us any preliminary thoughts on whether you think from the high 73%'s, whether there's leverage going forward into 2014 as we think about all the puts and takes?

Sure.

So on the last call we had indicated an expectation for gross margin -- for the gross margin ratio that it would be at or slightly above 74%.

That was predicated on a set of assumptions with respect to mix of revenues, anticipated hedge gains and all the other factors that impact on margin.

Our updated guidance now at which is at or slightly below 74% reflects the updated outlook that we've now provided on currency which has come down a little bit relative to where we were last quarter.

As well as our latest expectations with respect to mix of revenues and other factors.

I can tell you that the kind of things that will provide us with opportunity to get leverage on margin ratio going forward for one thing would be to sustain the performance that we're seeing within our highest margin portfolio, that's our knee portfolio, particularly as we see the kind of growth we're seeing in developed markets where we tend to have higher margins.

Markets like the US, Japan, Australia, where we're seeing really healthy growth with that knee franchise.

We will in the short term have to, just given the way we're accounting for the medical device excise tax, absorb the -- what will amount to somewhere in the neighborhood of, you know, approximately $10 million a quarter in charges.

That's not fully reflected in this year's gross margin.

That will be fully reflected obviously in next year's gross margin, one of the things that we'll have to take into account as we develop our operating plans for 2014.

But as far as beyond 2014, when we do get that fully reflected in our margin ratio, we absolutely believe there's opportunity to get leverage on the margin line, particularly again with the kind of performance we're seeing within our highest margin franchise.

Okay.

So just to be clear, in 2014 you think there's more tailwinds than headwinds relative to the -- where you're going to end up for 2013 when it comes to gross margin?

Just not prepared today to really get into what our expectations are for the margin ratio for 2014.

That's something we will address on our next call.

Okay.

Thanks, guys.

Larry Biegelsen, Wells Fargo Securities.

Hi, it's actually Craig Bijou on for Larry.

First question, at recent investor conferences you said door knock sales were about $20 million in Q2.

Just wanted to see, should we assume that sales during this quarter were the same and then how should we think about door knock sales going forward?

Is it peaking in Q3 given the mix of capital and disposables and I guess what's the view, would it potentially be a drag on growth in 2014?

Well, I don't want to get into too much detail in giving product line revenue guidance.

I will say that the peak was really Q2, not Q3.

We saw still obviously very healthy growth within that surgical products business in the third quarter, continue to make very good progress in penetrating new accounts with that product line.

We saw a better mix of revenues as between capital and the single use disposable in the third quarter.

That's something that as we said on the call we expect is going to continue to evolve.

The comps do get a little tougher as we get into the fourth quarter.

We closed that acquisition early in the fourth quarter of last year.

And certainly the comps are going to get tougher as we get into 2014.

Okay.

And then just a general follow-up on 2014 growth.

Can you talk about any puts and takes on the business and any major product launches?

We can talk about that, Craig.

We can talk about that in January when we give you specific guidance on 2014.

We're going through at this point in the year and obviously doing a lot of work on the operating plan to lock that down and we're extraordinarily excited about the new product pipeline.

We rattled through some of the opportunities that we have by category.

Obviously Persona is going to continue to be a big driver for growth and probably the single most significant driver for growth.

But that coupled with our intelligent instrumentation launches will be -- continue to be the theme within the knee category.

Joint preservation and early intervention will obviously include continuing to take share with products like Gel-One, our premium products that are already launched on the hip side, such as Vivacit-E.

As we described, we're really excited about the Avenir hip stem within that product category as well, and the opportunity to get after some of that anterior and interior lateral procedural approaches within hips.

We've got a bunch of new products out in extremities, via internal and external acquisitions including the Trabecular Metal Total Ankle.

Our NORMED foot and ankle product lines, the same NORMED portfolio on the hand and wrist side is augmenting our trauma offering and then within spine both through internal and external development, a whole host of products that are launching, have launched, and then dental, executing on some of the opportunities that we have with the TM Dental implants, Efx digital dentistry solutions and we just spoke about fluid waste management on the surgical side but also expanding the launch of the universal power tools in that portfolio.

So a lot of launches that are ongoing, some that will be new to 2014, but I think that you should expect to see a pretty consistent cadence going forward and what all that rolls up to, let us finish the lockdown of the operating plan and come back to you in January, okay?

Okay.

Thanks for taking the questions.

Mike Weinstein, JPMorgan.

It's Kim here for Mike.

A couple -- I guess couple questions for us.

Just a follow-up on the gross margin side, just as we look sequentially from the third to the fourth quarter, I guess what's driving when you think within your guidance for the flat to slightly down for the year, you have to be looking for still a pretty nice sequential step-up third quarter to fourth quarter.

I assume most of that is the FX piece.

Could you break out just what the FX impact was on gross margin here in the third quarter and what you think that looks like in the fourth?

I can give you some idea, Kim.

This is Jim.

When you look at year-over-year which is how we typically look at it, the hedge gains that we're running through cost of goods in the quarter relative to hedge losses that we had experienced last year, provide a boost of somewhere in the neighborhood of 50 to 60 basis points in the gross margin ratio and the fourth quarter gets a little better than that.

I would tell you the more significant contributor to expectations with respect to the fourth quarter is the continuing progress that we're making with the new product launches.

And again, we're talking about most significantly Persona and the impact that, that has on our gross margin ratio as we see higher growth, again a high margin product within a developed -- within our developed markets where we tend to have higher gross margins as well as the mix with respect to the surgical products continuing to move towards higher margin disposables versus the lower margin capital sales which really dominated the surgical products revenue growth in that second and third quarters.

Okay.

Great.

So that comment would probably also suggest that the Persona momentum that you're seeing in the fourth quarter is pretty solid if you think that kind of increase is as a percentage of the mix?

As we talked about with respect to our third quarter results, very pleased as David said with the progress we're making and expect to sustain that momentum as we get into the fourth quarter.

Okay.

Great.

And then just a follow-up to -- on the acquisition front and uses of cash.

Just curious as you think about deals and the Company's cash position and just kind of internal capacity, how do you think about the capacity of Zimmer to do larger type deals?

We've always said Kim, and our strategy hasn't changed with respect to M&A.

We're going to remain focused on musculoskeletal health.

Two, we need to take a very disciplined approach looking at any opportunity, making sure that whatever price we would have to pay is going to provide us with the opportunity to get to a certain level of return on invested capital within a reasonable time frame.

We have -- it is the case that we find more of those opportunities when we look on -- when we look at both smaller sort of bolt-on transactions because of the way that we can leverage the sales channel -- the global sales channel infrastructure that we have, pushing these products that we acquire into our global sales channels and leveraging the existing relationships we have with orthopedic, generally orthopaedic surgeon customers.

We're not opposed to doing a large deal.

We consider it.

But again, those same disciplines are going to apply.

Okay.

Great.

Thank you.

Derrick Sung, Sanford Bernstein.

Just to start out with, in terms of the sales acceleration, very nice sales acceleration that you saw this quarter.

I believe you had an extra day in the quarter as well.

So could you give us a sense for how much that contributed and then as we look to next quarter, your guidance implies a bit of a deceleration from what we saw this quarter.

How much of that is just the selling day versus door knock acquisition versus any other drivers for that expected sort of deceleration?

Sure, Derrick.

I think that on a consolidated basis globally there was not a full billing day but when you work through the weighting of it there was sort of a half billing day all-in, and you can calculate that out to be something in the range of a 0.5 point of the growth that you saw.

So obviously that doesn't carry into the Q4.

I think Jim outlined one of the categories that obviously will anniversary as we get into the fourth quarter with the growth rate that we've been seeing out of the surgical business, and there are some others but we would expect to continue the overall momentum and progress that we're making within all these product categories, and would expect in particular to see continued good performance coming out of the two main geographies that we saw in the third quarter.

That is, the Americas and Asia-Pacific.

Okay.

Thank you.

As a follow-up, I was wondering if you could talk a little bit more about how the Gel-One launch is going.

Last quarter you kind of had that in the $5 million to $10 million range.

I presume from your comments that we're still kind of in that $5 million to $10 million range in sales.

How do we -- at what point does it break out from that range?

Can you talk a little bit about where you are in putting the distribution channels in place and just overall adoption in the category?

Thanks.

It's a good question.

We are in that range that you described and within that range pretty consistent relative to second quarter.

But we're making progress in establishing the various elements of the distribution channel.

It just needs to be viewed as a multi-year process to establish those channels because there's a cadence to that throughout the operating year to get on and get the opportunity for scripts to get written and to get on the preferred list within some of those networks, and so that is going to be a multi-year process for us.

I think that the launch is going well relative to our plans and our expectations and we continue to believe that this is going to be a nice opportunity for us for multiple operating periods going forward to help generate growth.

Great.

Thank you very much.

David Lewis, Morgan Stanley.

Steve Beuchaw here in for Dave.

Jim, I wonder if you could take a step back and give us a sense for where we are within the context of the broader operational excellence program, the $400 million savings program.

Are we roughly halfway there, maybe not quite halfway there and how does the savings trend going forward, I believe it's through 2016, is it ratable?

Are we accelerating, decelerating from here?

Sure.

So, we came into the year with an expectation that we would generate about $80 million of incremental savings on top of what we had already achieved in the prior two periods.

And in the prior two periods we were at about $120 million run rate.

So we made good progress with this year's initiatives, and do expect to exit the year where we thought we would be, which is somewhere in the neighborhood of just over $200 million of savings, towards that $400 million target.

It is the case that both in this operating period and again this is something we'll look at as we work our way through the development of our final operating plan for next year.

That within the operating period some of those savings may get reinvested in support of new product launches, building out some of the sales, dedicated sales support for some of these new product categories that we're getting into, but we continue to feel very good about the $400 million, our ability to deliver on the $400 million target that we set for 2016.

As to how that's going to pace out, between now and 2016 and how much of that we're going to see in 2014, will be in a better position to address that once we get locked down on the 2014 operating plan and again, we'll be providing that, some of that detailed guidance on our next call.

Got it.

Thank you.

And then one for David.

David, I wonder if you could help us think about some of the -- I want to call it concerns.

That might be an overstatement.

Out there around physician reimbursement into 2014.

There are some who think that there might be a reduction to the rates that are paid to surgeons for hip and knee surgeries.

Could you give us the Zimmer perspective on that possibility, how likely is it and if it does happen, does it matter?

Sure.

We are familiar with the reference that you make to what may happen in the physician Medicare payment rule making.

I would tell you that to start with, what is rumored to be contemplated by way of a process in an administrative law context is very questionable.

I think that the idea of those rule making processes is to ensure that those administrative agencies follow a level of transparency and that there's an opportunity to be heard that ensure that whatever rules are promulgated are in the interest of the various constituencies that they are intending to serve.

So the concept of a rate reduction coming sort of in the eleventh hour in a way that has not been fully vetted through that rule making process is certainly disturbing, just by way of a process.

I think that causes me to have faith that, that would not occur in the manner that's rumored, but no one can have absolute assurance that it wouldn't happen.

If it were to happen, again, you're into another layer of speculation as to what the effect would be.

I don't think it would be helpful to patients that are in need of these solutions.

I don't think it would be helpful to attracting the next generation of surgeons, but whether or not that would have a quantifiable impact on the procedure rate is subject to, as I've stated, several layers of speculation.

So I don't really know how to characterize that at this point in time and I continue to have faith that people are going to follow a process that makes more sense than under the cover of darkness promulgating some substantial reduction to the reimbursement rates for the surgeons that perform these procedures.

Thanks, David.

Makes a lot of sense.

Thanks, Jim as well.

Matt Miksic, Piper Jaffray.

And maybe drilling into the knee number just a little bit and sort of your progress there, I mean, it looks like some of the best growth numbers we've seen in six or seven years.

So congratulations on that launch.

Taking a look at it, understanding that there's an opportunity that you're seeing materialize on the competitive front, maybe as we've struggled through the last several years and seen kind of the growth rates dip pretty significantly and now kind of heading back up, I think along the way we've all sort of guessed at where growth could be or how far are we into the recovery of volumes in total joint reconstruction.

Is this something that you feel like sort of we're back and we're stable and this is kind of the market is where the market is?

Or would love to get your thoughts on what you see for further improvements or what ought to be out there in terms of patients that have deferred over the years and so on?

And then I have one follow-up for Jim.

Sure Matt.

I think the quarter that we saw at least as it relates to the Americas and Asia-Pacific markets are consistent with the range of opportunity that I think most people have seen, just by sheer math of the aging patient population within those markets, and the need for these procedures.

Probably whatever the dynamics are, whether it's a perspective of stability within the economy or other behavioral drivers to go ahead and get the procedure done.

And you know as we've seen the knee procedure rate has been a little bit more volatile from quarter to quarter than maybe hips and there is some reasons for that, that make good sense as far as the pain characteristics for those patients that would drive that.

So I think that what we saw in those markets is in fact consistent with the opportunity and the need from a patient perspective.

Whether or not that's going to be sustained in a perfect manner in subsequent quarters is sort of anyone's guess at this point, frankly.

And it's just something that we're going to continue to monitor very carefully.

I think that there is opportunity to accelerate just by sheer demand and need within the EMEA market going forward.

Great.

And then just in terms of understanding that you do an awful lot of your own manufacturing and have for some time, I'd love to get a sense of two things maybe, and I don't know if you're willing to share where you are in terms of utilization, potentially (inaudible) run rates and sort of opportunity for just your highest margin businesses as you produce more implants off of your manufacturing base.

And looking out, I guess a follow-up on the restructuring also kind of relevant to margins and leverage.

Jim, if you could characterize what opportunities are out there in terms of inventories and optimizing the way that you're delivering these things to the market?

Sure.

I don't know that I can tell you for sure I'm not going to be able to give you a very detailed response to that question.

Matt, as we said in response to a couple of other questions, we're right now working our way through the operating plan for 2014 and some of what you're probing at we're certainly going to be examining in great detail as we develop the operating plan for 2014.

And we'll be able to provide at a high level at least some guidance and response to your questions when we provide 2014 guidance on our next call.

Certainly, the growth we're seeing in volumes is going to provide us with some opportunity to leverage our fixed costs across our manufacturing networks.

That in combination with all the work that we have still to do, frankly, on the operational excellences as part of the operational excellence initiative that is focused on both our quality systems and our manufacturing processes, will ultimately drive down our -- we believe will ultimately put us in a position to be able to produce in a more reliable fashion, in a more consistent fashion, components at what will likely be lower unit cost.

But there's still a lot of work to do on that front.

It is without a doubt the most complex of all of our innovate and improve initiatives.

We have assembled a very strong team with we feel the right kind of expertise to be working through those changes, and look forward to the day when as I said, we're going to have more streamlines, more efficient, higher quality processes that are going to lead to as I said, lower unit costs as well.

So not only will we be able to take advantage of the opportunity of higher volumes across the network, but we believe more efficient and better quality processes.

That's great.

Look forward to hearing about it.

Thanks.

Kristen Stewart, Deutsche Bank.

So I just want to touch on the spine market.

Sales were lower, I think they were down 3%.

There's been some disruptions there from mergers from larger competitors and a lot of number of other players in the space have seen a benefit.

Can you speak to the dynamics there and can you compare and contrast that to what you're seeing in trauma?

Yes, I think that the spine market for us obviously that's a smaller business and we're in the midst in making a lot of progress with respect to our strategy to build out our core fusion offering.

So much of our progress is going to be measured by the launch of those products, the complete, the full offering and we're well on our way.

I would tell you that between now and the end of next year most of those fundamental systems are planned to be launched, and that bag should become quite full and so every quarter that goes by it becomes more of a sales execution matter for us than anything else.

I don't think that we saw substantial changes within the marketplace.

I don't think that we saw substantial changes in procedure rates or those market dynamics or pricing.

So I think it's more of a Zimmer Spine specific set of opportunities that are dictating our performance within that market.

But when you're looking for broader characterizations of the market, it just is more difficult for us to do that in that product category, due to our relative size as compared to large joints, for instance.

Great.

Thanks.

And just as a follow-up, can you talk about the distribution agreement you signed for the lateral locking cage and what do you see as the opportunity there?

Yes, that's a category that obviously has been one of the fastest growing over the last handful of years, and we haven't competed in that space and it's really a good example of what we're doing by virtue of the combination of internal and external development to build out that portfolio.

So it's an exclusive agreement that we've entered into, so this is a Zimmer branded product that we're going to be distributing on a global basis.

We like this system.

There are some differentiated features to the locking plate, and we think that we have some opportunities even for further claim expansion within that product category.

But it fits really well with our MIS focus.

We have a very nice base of MIS technologies and intellectual property within that space, and this -- the LCC is going to fit right into that area of focus and build out a category, that as I said we had not competed in really whatsoever historically.

Great.

Thanks, guys.

Bruce Nudell, Credit Suisse.

(inaudible) In for Bruce.

Thanks for taking the question.

Actually two questions for us.

The first is now that we're a little bit closer to implementation, was wondering if you could kind of share with us any update on your thoughts about how the Affordable Care Act might impact the US knee market next year?

Yes, I don't see that the Affordable Care Act is going to have necessarily a significant impact next year.

When you look at the timing for those exchanges to get up and running and folks to gain access to coverage and care that otherwise may not have had that access or at least as directly.

That's going to push into the year and then obviously to the extent that they're seeking some type of assistance and care through the physician network, and then ultimately referrals to specialists.

Just the staging of that is such that it's unlikely to have a significant impact in our view in 2014.

I think that the broader question is, is it going to have a significant impact even in the intermediate to longer term, and that's subject to argument as well relative to the average age for these patients.

But one can build out a model that draws a conclusion on both sides of that position as to whether or not it's going to be a procedural accelerator.

What we do know about the impact of the Affordable Care Act is we're going to, unless it's repealed, pay a significant amount of money in the form of the device tax and in our case because of the accounting for that, it will impact more significantly in 2014 than 2013.

Okay.

Thanks.

And then I guess knee performance was strong across the board but looking at hips it looks like you were a little bit below the market, US and ex-US.

Was wondering if you could kind of comment on where you stand in terms of your US sales force and distribution partnerships, the efforts you've made to enhance performance there and then ex-US if there's anything you're seeing that may have caused below market growth?

I think that the market -- the performances within the Americas and Asia-Pacific region were within a range of market.

The slowdown for us in the overall number really comes primarily out of the European market and again, we have a significant share and position within some of those developed markets that are at slow growth rates or contracting at this point in time due to some of the austerity measures, and even the price-down pressures within those markets.

I do think that those developed markets over time will stabilize, primarily because there continues to be patient demand and I think that, that demand is going to have to get satisfied.

So the longer term view of those markets is one of seeing it stabilize, and that's going to help our business.

But in the meantime, we need to sharpen our skills and our execution within those markets.

So, I don't think that there are significant product gaps.

I think that we can drive a better performance in all three geographic segments but probably have the most room for improvement within our EMEA business.

Okay.

Thanks for taking the questions.

Glenn Novarro, RBC Capital Markets.

This is Brandon on for Glenn.

Thanks for taking my question.

First, can you give us some updated thoughts on the value to Zimmer of the Dental and Spine businesses?

Are these businesses that Zimmer needs to get bigger in to be competitive and just in general how strategic are they for Zimmer?

Those are business that along with a couple of the others that we have put underneath the umbrella of global businesses are obviously a bit more challenging because of the scale and size of those businesses.

One has to resource those businesses to ensure that there is the full complement of leadership team in place, that there's a reinvestment in research and development, in medical training and education, et cetera, and ensuring there really is a fully developed global distribution footprint.

So these are all businesses that we think technologies can be leveraged across from, whether it's bony in-growth technologies with Trabecular Metal biologic's capabilities.

And so they're very central to our musculoskeletal theme in that regard.

But at any given point in time, we're going to allocate our resources in accordance with the highest opportunity and the best opportunity that we have to create value, and so the relative positioning within our overall portfolio is going to be determined by a methodical strategic planning process to ensure that any of those business units is adequately resourced, but not at the same time crowding out our opportunities to create value even in the core franchise of large joints.

And that's a balance that we look to strike and rebalance every year as we go through and refresh our strategic plan, and then translate those determinations into an operating plan.

Okay and then separately, can you kind of talk about how you're thinking about Stryker's purchase of MAKO and what Zimmer -- what can Zimmer do to minimize the competitive impact from this acquisition as Zimmer is the market share leader in knees?

Thanks.

Sure.

As I spoke to that topic earlier in this call, I again believe that, that kind of a transaction if anything validates the major premise that we've been operating under, and that is that the right technologies, both preoperatively and intraoperatively can advance the cause towards providing more personalized solutions and putting those solutions and broader portfolio choices in the hands of surgeons.

We've been at this for a half dozen plus years in earnest through internal and external development and believe that our technologies that have been assembled, pre operative planning systems, our iASSIST, our iLIBRA, our PSI patient specific instrument offerings, are very consistent with addressing that clinical need to enhance the feedback data and capability for the surgeons to be very precise in the selection and implantation, alignment and soft tissue balancing.

And as we converge these technologies, we think that not only will it lead to a better clinical outcome, it will lead to a more satisfied patient, and be very much an enabler to continue down this path of expanding the options for surgeons so that the implant systems themselves can be brought in a cost effective way, and still improve into the future the patient outcomes and satisfaction rates.

So, we like the bets that we've placed and the progress that we're making and believe that we're very well positioned within that space.

Okay.

Thank you.

Tony, we have time for one additional question.

Mike Matson, Needham & Company.

I guess just wondering how we should think about the surgical business growth when you do start to lap the high growth that you've had this year and potentially your competitor comes back on the market in the waste management area.

Do you think you can still -- I know you're not giving guidance for next year but do you think that can still grow in that circumstance?

Absolutely.

This isn't a one year commitment on our part.

There's going to be continuity of commitment and that particular product line is one of several, both, again, through internal and external development efforts as we build out our portfolio and we've done so in past years.

We're going to have broader opportunities in coming periods in a category like the power tools and we'll look to both continue to advance in product categories where we already have a presence and add to those.

So we're quite confident that we're going to be able to continue to build on that business and see that as being a terrific platform for both growth and value creation in coming periods.

Okay.

And then in your spine business with this lateral cage deal, I guess I was wondering where you're at in terms of some of the other instruments and so forth, like retractor and other products to go along with that, to really provide everything that's needed to do a lateral fusion?

Part of our plan, and that's a good question.

We're in a good position, I would tell you, both as it relates to the retractor systems necessary for lateral access, as well as the neuro monitoring which is as you know an important enabler and aspect of that technology.

So it's part of a comprehensive strategy within that space, and we'll have all the elements necessary to enter that market and be successful.

All right.

And then finally, just looks like you had some very strong knee growth, obviously, but your hip growth looks like it may have been kind of below the market.

And so I guess obviously it's good that Persona's doing so well, but it looks like to me this could be the classic case of what we see with a lot of these orthopeeds companies where you launch a product in one category and it does really well, the sales reps kind of gravitate toward that and the other area languishes a little bit.

Is that what's happening here?

How are you going to sort of address that issue?

We think that we have a terrific portfolio on the hip side.

There is some natural dynamic along the lines that you describe that will send your message out to the sales force to make sure that they're allocating their time in an appropriate way.

I will tell you that we're very cognizant of that but behavioral dynamic and we'll build plans and have incentive systems to ensure that we're winning in all categories.

Because our overarching goal and expectation of ourselves is that we are going to outperform the market in every product category in every geographic segment and so that forms the basis for our discussions and refinement of our plans and no major gaps in our portfolio that wouldn't allow us to improve our performance in the hip category, concurrent with continuing to accelerate in the knee category.

All right.

Thanks a lot.

You're welcome.

So with that, I'd like to thank everyone for joining the call today and for your continued interest and support for Zimmer.

We look forward to speaking to you on our fourth quarter conference call which is scheduled for 8 am on January 30, 2014.

I'll turn the call back to you, Tony.

Okay.

Ladies and gentlemen, thank you again for participating in today's conference.

You may now disconnect.