Zimmer Biomet Holdings Inc (ZBH) 2014 Q2 法說會逐字稿

Good morning.

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

Mr. Marshall, you may begin your call.

Thank you, Regina.

Good morning and welcome to Zimmer's Second-Quarter 2014 Earnings conference call.

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

Before we start, I'd like to remind you that our discussions during this call will include forward-looking statements.

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

Please refer to our SEC filings for a detailed discussion of these risks and uncertainties.

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

Reconciliations of these measures to the most directly comparable GAAP financial measures are included within the earnings release, which is available on our website at Investor.

Zimmer.com.

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

Thank you, Bob.

Good morning, everyone, and welcome to our earnings call for the second quarter of 2014.

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

Jim will then provide additional financial details.

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

In the second quarter, Zimmer recorded solid sales gains across various categories of our differentiated portfolio of musculoskeletal solutions.

Most notably, in key overseas markets.

Consolidated net sales for the quarter were $1.18 billion, an increase of 0.9%; and our earnings per share were $1.49, an increase of 4.2% over the prior year period.

In the second quarter, Americas sales declined by 2.7% year-over-year while Europe, Middle East and Africa increased by 4.9%, and the Asia Pacific region grew 6.9%.

I'd like to remind you that these results include the consolidated impact of one less billing day in the quarter.

We sustained healthy traction overseas, inclusive of strong performances in key emerging markets.

In the second half of the year, we'll heighten our focus on improving US performance by leveraging our comprehensive portfolio of clinically-proven solutions, as well as our robust pipeline of new and recently-commercialized products.

Those familiar with Zimmer's value creation framework will know that we're dedicated to consistently creating and returning value for our stockholders.

In keeping with that strategy, Zimmer once again delivered against our financial commitments in the second quarter of 2014 while increasing the quarterly dividend and expanding operating margins relative to the prior-year period.

Our operational excellence programs also continued to drive disciplined expense management, as highlighted by the ongoing successes from our strategic sourcing initiatives.

And as part of Zimmer's ongoing commitment to quality improvement, we continued to fund enhancements of all aspects of our quality management system.

As we've communicated in previous quarters, this focus work will continue as part of our quality and operational excellence agenda.

Before discussing our results in greater detail, I'd like to first comment on market and pricing conditions.

In the second quarter, underlying global market dynamics were stable and generally consistent with sequential seasonality experienced in previous operating periods.

Turning to pricing, Zimmer experienced a price decline of 2.8% in the quarter, which was in line with expectations coming into the year.

The sequential movement from the first quarter of 2014 was largely attributable to the anticipated biannual Japanese price adjustment.

Turning now to our business units, knee sales for the second quarter increased 3.5%, reflecting positive volume and mix of 7.3% and negative price of 3.8%.

Our Americas segment reported a sales increase of 0.5% while Europe, Middle East and Africa grew by an impressive 9.4%, and the Asia Pacific region delivered 5.3% growth compared to the prior-year period.

Our strong results in the Europe, Middle East and Africa region were supported by new market introductions of Persona, the personalized knee system, which continues to gain commercial traction and competitive conversion at a premium price point across the globe.

We've also been extremely pleased with the notable overseas performance of our market-leading, clinically-proven NexGen knee replacement system.

In addition, Zimmer continued to leverage our intelligent instrumentation portfolio in the second quarter, including the iASSIST personalized guidance system, patient-specific instruments and our digital templating solutions.

These advanced offerings are designed to enhance intraoperative precision and efficiency while delivering ongoing economic and operational benefits to orthopaedic service lines.

Lastly, our early intervention portfolio continued to achieve sales growth and increased adoption in line with our expectations.

The performance of these products, most notably Gel-One and Subchondroplasty, continue to validate our investments into early-stage intervention and joint preservation.

Zimmer's hip business grew sales by 0.4% in the second quarter, reflecting positive volume and mix of 3.4% and negative price of 3.0%.

These results include a 1.9% sales decrease in the Americas; a sales decrease of 0.8% in Europe, Middle East and Africa; and an impressive 7.8% sales increase in the Asia-Pacific Region.

Our strong performance in the Asia-Pacific Region was led by the M/L Taper Hip Prosthesis with connective technology, the Continuum Acetabular System and BIOLOX delta ceramic heads.

We believe that the ongoing contribution of these and other premium constructs will create additional growth opportunities in future periods, in part by leveraging differentiated technologies such as the Avenir Hip System, Vivacit-E Advanced Bearing Material, and the Synovasure biomarker test for periprosthetic joint infection.

Zimmer's Extremities business recorded growth of 5.2% in the second quarter, led by strong performances in the Asia-Pacific and Europe, Middle East and Africa regions, with 19.4% and 18.0% sales growth respectively.

Despite facing challenging sales comparisons in the United States, as well as competitive product launches which drove some trialing of other systems, extremities continued to benefit from robust sales of our Trabecular Metal Reverse Shoulder System.

Together with this leading upper extremities solution, which now includes a patient-specific instruments platform, our recent introductions into new anatomical sites are broadening our offerings in this fast-growing category.

These exciting products include our Nexel Total Elbow System, featuring Vivacit-E and the differentiated Trabecular Metal Total Ankle System.

Zimmer dental sales decreased by 1.4% in the second quarter.

We experienced steady demand across our broad dental implant offerings, including the Trabecular Metal Dental Implant and solid performances from our leading regenerative product lines.

Growth of 4% in the Americas was offset by continued softened demand for premium solutions in Europe, which slowed our overall growth this quarter.

However, the ongoing introduction of our PI-branded value-based offerings across Southern Europe tempered the impact of this market transition.

Trauma sales rose 6.4% in the second quarter, with our Americas segment reporting a sales decrease of 3.6%; Europe, Middle East and Africa growing sales by 14.9%; and the Asia-Pacific Region delivering 17.9% growth.

Our impressive results overseas were driven by strong performances across all major market segments, led by the Zimmer Natural Nail family, NCB Periprosthetic Plating System and the XtraFix External Fixation System.

As we look to future quarters, we'll remain focused on the commercialization of strategic portfolio additions including the existing launch of the Zimmer Distal Radius Plating System, a versatile trauma system with comprehensive instrumentation designed to conform to a broad range of patient anatomy.

Zimmer's spine sales decreased by 4.4% from the prior-year period.

This business continues to expand its diversified portfolio and in the second quarter, bolstered its cord fusion offerings with the 510k clearances and commercial launches of the Optio-C Anterior Cervical System and the Virage OCT Spinal Fixation System, both of which have experienced promising early results.

Combined with solid performances in key Asia-Pacific and European markets, we believe that Zimmer spine is well-positioned for growth in the second half of 2014.

Turning to our Surgical and Other category.

Zimmer posted a sales decline of 9.9% for the quarter.

It's worth noting that after normalizing our results to account for the exceptional performance in the capital sales of our differentiated Transposal Fluid Waste Management System in the prior year, our surgical business continued to post solid results.

Sales of both the Transposal System and its higher-margin consumables have remained in line with our execution plan.

Our overall results were also bolstered by strong sales of the ATS family of automated tourniquet systems, surgical consumable products, and surgical power equipment highlighted by our Universal Power System surgical instruments.

As we look to the rest of the year, we'll continue to leverage this differentiated portfolio for improved growth.

Before I close, I'd like to now make some comments about our planned combination with Biomet.

As we communicated in April, this transaction will enhance our position in the $45 billion musculoskeletal industry.

It will also allow us to offer a broader, more comprehensive portfolio of musculoskeletal solutions across the continuum of care, with both cross-selling opportunities and a revenue mix that is more diversified and predictable.

In the weeks following our April announcement, we finalized important financing details of this $13.35 billion acquisition, and met a number of key integration planning milestones to finish the quarter on track and on schedule with the process of closing this transaction.

Having worked closely with the leadership of Biomet over the course of the second quarter, we've gained invaluable exposure to their highly talented and committed business teams.

This experience has heightened our confidence in the value we'll be able to create and deliver as a combined entity.

Concerning the ongoing antitrust review of the proposed merger with Biomet, as we announced earlier this month, we received a second request from the US Federal Trade Commission.

We're in the process of complying with the request and will continue to work closely with the FTC as it conducts its review of the proposed transaction.

With regard to the review in Europe, we've been providing requested information to the European Commission and plan to file the merger notification in the near term.

We continue to expect the transaction to be clear, and remain confident in our anticipated timeline to complete this combination during the first quarter of 2015.

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

Jim?

Thanks, David.

I will review our second quarter performance in more detail and then provide additional information related to our updated 2014 sales and earnings guidance.

Our total revenues for the second quarter were $1.183 billion, a 0.9% constant currency increase compared to the second quarter of 2013.

As David noted in his comments, we had approximately one less billing day in the quarter on a consolidated basis.

Underlying growth rates would be approximately 1% higher on a consolidated basis and nearly 1.5% higher in the Americas.

Net currency impact for the quarter increased revenues by 0.2% or $2 million.

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

Our adjusted gross profit margin was 72.6% for the quarter.

The margin ratio declined 70 basis points compared to the second quarter of 2013.

In the second quarter, we recognized approximately 70 basis points of charges related to the medical device excise tax.

Increased pressure from price, coupled with the recognition of negative manufacturing variances associated with our quality and operational excellence programs, were partially offset by ongoing benefits from our cash flow hedging program and reduced year-over-year excess and obsolescence charges.

The Company's R&D expense decreased 12.6%, or $7 million, to 4.1% of net sales when compared to the prior year.

The decrease in R&D expense continues to reflect focused efforts on our quality and operational excellence initiatives and related dedication of resources.

Selling, general and administrative expenses were $456 million in the second quarter; and at 38.5% of sales were 70 basis points below the prior year.

The improved ratio reflects the ongoing benefits from our operational excellence programs including, among other things, strategic sourcing of indirect supplies and services, as well as the establishment of shared services leveraged across multiple reporting units.

In the quarter, the Company reported pre-tax charges of $64.7 million in special items; $9.6 million in cost of products sold pertaining to global restructuring, quality and operational excellence initiatives and recent acquisitions; and $10 million of interest and financing costs associated with the pending Biomet transaction.

Adjusted second-quarter 2014 figures in the earnings release exclude the impact of these charges, which include $55.4 million related to quality and operational excellence; initiatives of manufacturing logistics and sales; and $28.9 million in integration and other costs.

Additionally in the quarter, we increased our provision for certain claims related to the Durom Acetabular Component by $21.8 million before taxes.

This reflects an increase in the total estimated liability for projected worldwide claims related to Durom, offset by anticipated insurance recoveries.

Adjusted operating profit in the quarter amounted to $355.4 million.

At 30%, our adjusted operating profit to sales ratio was 50 basis points higher than the prior-year second quarter.

The continued expansion of operating margin reflects our ongoing financial commitment to our stockholders through disciplined execution of our growth in operational excellence goals and objectives.

Net interest expense for the quarter amounted to $12.9 million, which was favorable when compared to the prior-year quarter.

Adjusted net earnings were $254.7 million for the second quarter, an increase of 4.6% compared to the prior year.

Adjusted diluted earnings per share increased 4.2% to $1.49 on 171 million average outstanding diluted shares.

These adjusted earnings per share, inclusive of approximately $0.05 of share based compensation at $1.03, reported diluted earnings per share increased 15.7% from the prior-year second-quarter reported EPS of $0.89.

Our adjusted effective tax rate for the quarter was 25.8%, which is 60 basis points favorable when compared to the prior year due to a higher mix of earnings from lower tax jurisdictions.

Our recorded effective tax rate for the quarter was 25.5%, as the majority of restructuring and other special items charges are incurred in higher tax jurisdictions.

The Company had approximately 168.8 million shares of common stock outstanding as of June 30, 2014, an increase over the 167.8 million as of March 31, 2013.

Operating cash flow for the quarter amounted to $254.1 million, an increase of 34% from $189.7 million in the second quarter of 2013.

The increase is driven primarily by favorable accounts receivable trends in our Europe, Middle East and Africa operating segments and lower tax payments relative to the same period prior-year.

Net inventories were $1.147 billion at the end of the second quarter, an increase of $21.3 million from March 31, 2014.

The increase is due primarily to the support of ongoing global commercialization of new product offerings, as well as the effects of going to a direct sales model in certain Eastern European markets.

Adjusted inventory days on hand finished the quarter at 304 days, an increase of 20 days as compared to the prior-year same quarter.

As of the end of the second quarter, net receivables increased to $950 million from $943 million in the second quarter of 2013 or 1% over prior year.

Our adjusted trade accounts receivable day sales outstanding finished the quarter at 69 days, flat when compared with the prior year.

Depreciation and amortization expense for the second quarter amounted to $91.3 million.

Free cash flow in the second quarter was $159.5 million, $51 million higher than the second quarter of 2013.

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

The significant increase in free cash flow was driven by increased operating cash flows while still supporting the ongoing launch of new products through rolling instrument deployments.

Capital expenditures for the quarter totaled $94.6 million, including $62.6 million for instruments and $32 million for property, plant and equipment.

I'd like to turn now to our guidance for 2014.

In our earnings release this morning, we updated the Company's expectation for full year 2014 revenues and now forecast revenues to increase between 2% and 3% constant currency when compared to 2013.

We continue to expect foreign currency translation to decrease our reported 2014 revenues by approximately 0.5% for the full year.

Therefore, on a reported basis, our revenues are projected to be between 1.5% and 2.5% above 2013 results.

For the third quarter, we expect revenues to increase between 2% and 2.5% constant currency and between 2.5% and 3% on a reported basis when compared to the prior year.

We expect to recognize gains on hedge contracts in the second half and continue to see positive comparisons related to inventory obsolescence charges and manufacturing variances.

Consequently, our guidance for the gross margin ratio for the year remains unchanged and is expected to be between 73% and 74%.

Our guidance for R&D, SG&A and interest expense for the full year remains unchanged.

However, as you refine your models for the third and fourth quarters, please consider the seasonally higher ratios typically experienced in the third quarter.

We expect our SG&A ratio in the third quarter to be in a range of 40.5% to 41%, while R&D expense as a percentage of sales is likely to be at or near 4.5% for the quarter.

Moving down the income statement, the estimated full-year tax rate remains at 25.5%.

The previously-guided fully diluted share count of approximately 172 million shares is now expected to be in a range of 172 million to 173 million shares due to higher expected employee stock option exercises.

Full-year 2014 adjusted diluted earnings per share guidance has been updated to be within a range of $6 to $6.10, taking into account our updated expectations for full-year revenue growth as well as a slight increase in the fully diluted share count.

As indicated in our earnings release, to arrive at our anticipated reported GAAP earnings per share, you should subtract total charges for special items in certain claims of $250 million and $70 million of Biomet transaction-related expenses on a pre-tax basis, or approximately $1.35 per share.

Taking into account the seasonality associated with the third quarter and other factors, third quarter adjusted diluted earnings per share are expected to be in a range of $1.29 to $1.31.

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

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

Thanks, Jim.

In the second quarter, Zimmer achieved solid sales across a number of product categories and geographic regions that are vital to our growth plan.

We're also able to return significant value to our stockholders by successfully executing on the ongoing commercialization of new clinically-relevant product offerings, realizing the benefits of our operational excellence agenda and demonstrating prudent stewardship for capital.

As I mentioned earlier, we're very excited about our planned combination with Biomet.

By leveraging the best of both companies, our combined entity will possess an organizational talent advantage that will distinguish us in our industry.

Our vision for this combination is to enhance our position as a leading musculoskeletal innovator, identifying new growth opportunities through a number of attractive portfolio additions and shaping future solutions for the evolving healthcare industry.

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

(Operator Instructions)

Matt Taylor with Barclays.

Thanks for taking the question.

I just wanted to ask one on the deal here.

So first of all can you update us as to whether there's been any change in your views of the net synergies or where they may be coming from with regards to the transaction?

And then also wanted to ask if you could provide anymore color on what these subsequent requests have been about and why you're still confident in the timing.

Yes, on the first part, Matt, there hasn't been a change in the view of our net synergies.

We're developing the detailed plans and we're very confident in what we expressed at the point of the initial announcement of the combination.

With respect to the regulatory process as well, the analysis that was the basis for our decision to move forward remains very much in line with what we're experiencing.

We see this as being an aspect of the process that is absolutely manageable.

We're confident that we're going to get the transaction cleared and look to consummate the combination in the first quarter of 2015.

So everything on both fronts is tracking very consistent with the analysis that led to the execution and announcement of the deal in the first instance.

Thanks, and then you called out pricing in your comments, certainly in line with the guidance for the year but toward the higher end.

I guess number one, why did you feel like you needed to exclusively call that out?

And are there any other areas of weakness or strength over the next several periods that you would note from a pricing or mix perspective that could change that dynamic?

Yes, I think that the dynamic has been pretty consistent.

As we said, we're very transparent and provide a fair amount of granularity on the pricing every quarter, Matt, and as we said, the sequential decline from about 2.3% to 2.8% in our case was principally driven by the biannual adjustment that was anticipated in Japan that came in within a range of what was expected.

So we're right about at the mid point of what we guided to back in January, our expectation was for the full year on price which was a range of minus 2% to minus 3%.

And I think that probably in the short-term commercial execution of new product launches and taking advantage of the mix opportunities are the area for us to focus on to offset some of the price pressure.

But again the price pressure has been pretty consistent.

Great, thanks a lot.

You're welcome.

William Plovanic with Canaccord Genuity.

Thank you for taking my question.

Just on the acquisition, one thing I'd like to ask is how are you thinking about the peripheral businesses and the disruptions in those channels?

As we look at what's going on in knees and hips you said you'll keep that distribution in place but how should we think about the peripheral businesses?

We're going to put plans together that are directed and focused on unique aspects of each of those businesses.

It's the case as we've had discussions with people that some of the fear around the distribution channel I think is more premised upon what one has seen through combinations outside of the large joint side.

And so we need to learn from those lessons, both ones that we've experienced in the past as well as ones that others have experienced.

I think the historic track record on the large joint side is quite good on combining the distribution channels and retaining the momentum of the businesses.

So we're going to look at developing these plans unique for each of those business units.

And we'll take a bit different approach as necessary and as is consistent with our longer term vision as to how we want those channels to be structured to make sure that we're growing at or above market in each product category, in each of the geographic segments.

Okay, thank you.

And then just on the trends in the business in general, we've seen you're the fourth player to report thus far.

It seems like Q1 was slow.

It was weather and maybe back end loading due to ACA.

As Q2 rolls out it looks like it's not coming back to the length that we had thought it would.

Do you think there's a different type of seasonality in the market today?

Do you think the market may be slowing a bit?

How should we think about this?

I don't think that the market is slowing.

I think that the market is in a range of something that should properly be characterized as stable, certainly across the global markets that's the case.

Within the United States, which has obviously been the area of a lot of focus coming out of the fourth quarter of 2013 with the uptick that we saw, I do think that you're going to see some shift in seasonality.

We clearly saw that as far as a percentage of revenues for the total year that were generated in Q4, that was a bit of an outlier.

And I do think that you're going to see some of that shift be retained in 2014.

It's a bit of a question as to how much or whether or not that trend will even continue further but it was something that we saw in the fourth quarter.

As you look at the sequential patterns from Q1 to Q2 in 2014, they are actually pretty consistent with historic trends.

So again, on a global basis this is a stable market, and I think that as we get into the second half we'll all gain insight as to how much of that seasonality shift is permanent and whether or not that's going to continue as an expanded trend.

Great, thank you.

You're welcome.

Bob Hopkins with Bank of America Merrill Lynch.

Thanks, can you hear me okay?

We can, Bob, good morning.

Great, good morning.

So first question is really on the performance in the quarter and then a little bit on the guidance.

So I'd love to ask you to comment on a couple things.

One just broadly, why are you lowering the revenue guidance?

What's going on in the business that was different than you thought 30 days ago?

And also Jim if you could comment on why gross margins were weak this quarter especially relative to Q1, just trying to understand that a little bit better.

And then finally, to get it all-in in one thing, on the selling day issue not to nit-pick but last quarter you said you had an extra half day and now it's an extra full day.

I just wanted to kind of reconcile that, thank you.

The last of those I think what we said we had an extra half day in the first quarter, what we said in Q2 Bob was that we had one less billing day.

So with respect to the guidance a lot of that is just math relative to where we've been for the first half of the year.

We came in with the mid point of 4%, we're now revising to 2.5%, a lot of that is just the reality of the US performance in Q2 and the consolidated results in Q2 and what it would take performance wise in the second half of the year to push up towards that mid point of 4%.

So we're guiding at 2% to 3% and if one does the math there's obviously some sequential improvements in growth rates that is embedded in the potential for that guidance for the second half of the year.

But it's another quarter of insight.

Some of that is market but I think we've got some work to do frankly in the United States to fully exploit the opportunities that we have with the new product introductions.

In the second quarter we did a better job of exploiting those opportunities outside the United States as is evidenced by for instance the strong performance in knees within the Europe, Middle East and Africa, geographic segments and the strong performance in hips within the Asia Pacific region.

So the portfolio is there and we're going to redouble our efforts to focus on taking advantage of what the market gives us in the United States in the second half of the year and hope that we generate some positive trends in our performance sequentially into Q3 and Q4.

You want to grab the margin question?

Sure, Bob this is Jim.

Just on the gross margin question, we guided coming into the year a gross margin ratio at 73% to 74%.

We're still guiding to that same range, so we had good visibility coming into the year as to what the opportunity would be on gross margin and frankly still have good visibility to how we're going to achieve that.

In the second half, as I indicated, the lower anticipated manufacturing variance is really the principal difference in getting from kind of where we are in the second quarter to where we expect to be in the second half of the year.

There is also some differences, some favorability and hedge gains second half relative to the first half.

But I would tell you the more significant contributor to the difference in gross margin ratios between both the first and second quarters as well as the step up from second quarter into the second half have to do with manufacturing variances and those are largely connected with the operational and quality excellence initiatives that we have under way.

Those variances, the negative variances were largely incurred in the second half of last year, that's why we have good visibility as to how they were going to impact on this year.

Those are largely amortized off now through the first half of the year and we have visibility now to the actual variances that were incurred in the first half that will impact the second half and why we feel confident in the step up we're anticipating in the second half of the year relative to the second quarter.

And on the Americas business is that a little early Biomet disruption do you think or is there something else going on?

I don't at all believe that, if you look at the announcement date we announced the transaction and entered the agreement for the transaction on the 24th of April and so you essentially had two months.

And we're just not seeing signs of that, Bob.

I think that this is for us to improve our performance relative to the opportunity that we have with the product bag and the new product introductions, and so as I said, big area of focus for us is in the second half of the year.

Okay, thank you.

You're welcome.

Derrick Sung with Sanford Bernstein.

Thank you for taking my question.

Just a follow-up on the performance in the Americas.

Is the launch of the Persona knee, I know there was high expectations for that or relatively high expectations for that going into the year and that was going to be a big growth driver.

Is that one of the areas that you're looking to improve upon or maybe one of the areas that it isn't quite meeting your expectations versus what you thought about going into the year?

And then last on the call, last quarter, you talked about your expectations that the combined Zimmer Biomet organization would be able to grow sort of revenues at market post integration including kind of any sort of revenue dyssynergies.

Is that still your view given your new outlook on your business or has that changed also?

Thanks.

Sure, Derrick.

The launch of Persona continues to be a success story for us.

We've got some other categories in some of the legacy knee business that we need to improve our performance upon.

But we're tracking in a consistent manner with expectations on the capability to take that system into competitive accounts and not only get trialing but convert business.

So the promise of Persona is unchanged relative to the prior conversations and discussions we've had.

And as far as the go forward view is to on a combined basis we absolutely believe that we're going to be able to in the initial stages grow the combined business at market.

And obviously as we complete the integration post closing in the quarters, an operating period or two thereafter, we would expect to accelerate above market growth rates within the musculoskeletal industry.

Okay, thanks.

You're welcome.

And on the deal, now that you've had a chance to look more deeply kind of into the financial aspects of it et cetera, are there any tax opportunities that maybe you didn't call out on when you announced a deal that might be available?

I'm thinking in terms of perhaps inner company loans or any sort of rationalization or optimization of the manufacturing footprint that might leave any tax opportunities in the integrated business.

Derrick this is Jim.

I think it's fair to assume that we have teams that are very focused in working with outside subject matter experts helping us identify where those opportunities are to either drive a lower effective tax rate for the combined entity going forward and/or just as importantly, to determine how we might be able to get access to the cash that's going to be accumulating offshore, connected with the businesses overseas and the revenues and profits that are being generated overseas.

And so there is a real focus on it, a dedicated effort, smart people with a lot of expertise that are going to continue to work the issues and determine how we can optimize both the effective tax rate as well as our opportunity to access the cash flow that's going to be or the cash that's going to be accumulating offshore.

But beyond that I'm not, and we're not at a stage where we could provide any more specific guidance.

Okay, thanks Jim and if I could just slip a quick one in.

Could you give us a sense for the contribution of Gel-One this quarter in the early intervention portfolio?

You mentioned it was kind of tracking to expectations and I think a couple quarters ago we were in that $5 million to $10 million range, and maybe give us a sense for where we are with that launch?

We continue to pick up share with that product, really frankly very pleased with the progress that we're making.

There's more opportunity in front of us and that team is focused on taking full advantage of those opportunities to get that product listed on formularies where it's not currently listed on formularies just as one example.

I don't want to and we don't want to get into the providing brand sales information on these calls.

We have hundreds of brands, Derrick, so I know as much as you're interested tracking how that particular one is doing, I'm not going to provide anymore specific information than that.

All right.

Thanks, Jim, appreciate it.

Okay.

Mike Weinstein with JPMorgan.

Mike your line may be on mute.

Your next question will come from the line of Richard Newitter with Leerink Capital.

Thanks for taking the questions.

I was just hoping -- just going back to the lowered top line guidance.

David if you could maybe talk a little bit about how much, I appreciate that maybe you're revising it to see what happens to play out in the second quarter.

But how much of the step down can you attribute specifically to a change in your view of the pricing kind of environment and what you saw in Q2 in the first half versus kind of volumes?

Can you maybe parse that out a little bit?

Yes, I wouldn't say that any significant portion of it is based upon a revised view of pricing.

Again, if you go back to the January call, we provided some specific visibility to what we're anticipating for the year and that was a range of negative 2% to negative 3%.

We're bank on in the middle of that half way through the year.

So that really doesn't impact our go forward view.

So you pull that out and you're to volume and mix and both of those are highly related to our commercial execution and coming out of Q2 here that we're going to focus on obviously for improvement is the United States commercial execution.

Okay, and then just kind of adding on to an earlier question that was asked, with respect to the longer term outlook post the Biomet deal, assuming it goes through on time, as you think it will.

The question I have is, does the, perhaps a slightly lowered growth rate for some of your core recon businesses heading into that transaction impact what you think the kind of the top line dyssynergy impact could be and how that impacts the potential for the cost synergies to offset that and lead to your net synergy number?

Or is all of that fully intact and you feel confident that you can regain through execution whatever perhaps you didn't do as well as you wanted to do in Q2?

Yes, we're confident.

We're confident.

We've got all of the necessary ingredients.

Talent in the field, the right product offerings, a whole variety of terrific new products and innovative solutions that either are launched or in the process of being launched.

So we're going to be in good shape as we consummate the combination and move forward.

And I think that the other side, on the Biomet side they're doing good work and continuing their strong momentum.

So our goal is obviously independent of one another to maintain the momentum so that we hit that start line and with good boat speed.

I think that I'm very confident at this point that we're going to be able to achieve that objective and then take it forward from there.

And just one last one, on the competitive trialing that you called out in the shoulder arena, can you just describe what you're hearing?

And is this -- are they generally coming back to you or what's the feedback been, do you feel confident that that's transient?

Well I think that there are just a lot of new systems and the number of players within that space has broadened in a pretty significant way over the course of the last operating period or two.

So we've enjoyed a nice position historically within that market and we have some important new innovations including the PSI offering for upper extremities.

We continue to drive nice gains in growth with our Trabecular Metal Reverse Shoulder.

And suffice it to say that we have some other things in the pipeline that are going to help us ensure that the trialing doesn't become a permanent conversion in the go forward quarters, okay?

Thank you.

You're welcome.

Mike Weinstein with JPMorgan.

Thank you.

Let's try that again.

I apologize.

I jumped over to the other call.

I wanted to follow-up on a couple items.

First wanted to follow-up on Bob's question just on the gross margins.

Jim you talked about the benefit of your hedging program, it showed up a little bit this quarter.

It sounds like it will be there in the back half of the year.

Could you quantify what impact that will have in the back half of the year?

And then as those hedges rollover does that become a headwind for 2015?

How should we think about that?

I guess if you look to the year-to-year comparisons Mike, it's a modest improvement year-to-year.

But in absolute terms, it's probably somewhere in the range of 40 basis points in terms of contributions, in each of those quarters, in Q3 and Q4.

And yes, going into next year and we know with the hedging program what it does is provides protection for an operating period or sometimes a little more than an operating period.

And we have that much time to get whatever sort of things we need to get in place, whether it's adjustments in pricing or reductions in standard cost to offset whatever declines we might otherwise see in gross margins as a consequence of currency changes.

So it's only a headwind to the extent that we don't offset it with cost savings and/or price changes.

And then as I pointed out to Bob, you understand as well I think everybody understands the headwind associated with the medical device tax in this year's number which we'll not have obviously going into next year because it will be fully -- obviously fully reflected in the margin as we get through the end of this year.

Let me shift gears, and I know you mentioned some of this earlier but I just want to understand the strategy around distribution, particularly in US with your US recon sales force.

So it sounds like David the plan for now is to try and keep everybody in place for some period of time post closing.

Can you just help us understand one, the cost of a program like that?

I know we see them in other companies so how much will you invest in order to retain distribution for some period of time?

And then two, how long do you think that period of time is?

Is there a point at which, is it year two, at which we would expect to see greater integration of the US distribution system?

Thanks.

Yes, I would tell you that from a starting point, we made the statements and commitments to retain all of the sales positions for both entities and that's really important because from our perspective, we're going to have a broader set of solutions and offerings.

And in order to fully leverage the cross selling opportunities that come with this combination we're going to need all of that sales talent and there's a pretty extraordinary level of sales talent on both sides of these organizations.

So the design of that distribution channel, all of that work is in process at this point in time with the leadership teams having been established.

And in the coming weeks, months, they are going to continue to make good progress on that front.

But it's premised upon retaining the sales positions and fully leveraging all of the products and solutions that the combined entity will possess.

So that is the fundamental value creator from the company's perspective on a combined basis.

It's also the primary value creator from the customers' standpoint and we'll align the sales folks opportunity to do really well economically in accordance with achieving the objective and realizing the full potential.

So I'm sorry, coming back to the question, do you know what the costs will be of retention, so you're going to put a retention program in place, do you have an estimate of what that cost would be?

And is that something that is in the P&L or is it something that is outside the P&L, Jim?

Yes, Mike this is Jim.

As we indicated when we made the announcement we anticipate spending somewhere on the order of $400 million on costs to integrate.

So that would -- within that would be an estimate of what we expect to spend on both retention and integration and it would be separated out, if you will excluded to arrive at our cash earnings measure.

Okay, thank you.

I'll let others jump in.

Okay.

Larry Biegelsen with Wells Fargo.

Thanks for taking the question.

I just wanted to come back to the assumptions for the Biomet deal.

So how should we think about the accretion from the Biomet deal in the first year?

Is it still the $1.15 to the $1.25?

And how should we think about the base EPS that's offered for 2015?

The mid point of your EPS guidance for this year is about 5%.

So how should we think about kind of the underlying EPS growth for 2015 and then I had a follow-up, thanks.

No change in the expectations with respect to year one accretion to still in a range of $1.15 to $1.25.

As you pointed out our mid point of our guidance for 2014 EPS on an adjusted basis is $6.05.

And we haven't at this stage obviously given guidance for 2015 EPS for Zimmer on a standalone basis, so you'll have to make whatever assumptions you feel sort of appropriate with respect to what kind of growth.

We're going to continue to run the business and we would certainly continue to run the business the way we have been over the past number of years, driving leverage, earnings growth off of a top line opportunity that still view to be somewhere in the range of low to mid single digits.

So that's hopefully provides you with at least a little bit of direction on how to think about the expectation that we have for the combined entity for 2015.

That's very helpful and then I just wanted to come back to pricing.

If we take a step back and we look at the pricing trends for you and your competitors in hips and knees over the past few years, it looks like there has been a degradation in pricing from about 2% in 2011, 2.5% in 2012 and 2013 and about 3% or so thus far in 2014.

Is that a fair assessment of the pricing environment?

And can you, Jim in the past you've talked about kind of pricing pressure going forward and this kind of reversion to the mean if you will.

Where are we in that process and what can you tell us to give us confidence that we won't see further degradation over the next year or so?

Thanks.

Sure.

Well as we talked about over the past couple of operating periods we continue to experience some pressure, particularly at the high end of our price curves and particularly in the US market which is traditionally just in terms of healthcare service providers has been a somewhat fragmented market.

It's becoming a lot less fragmented obviously with hospitals consolidating, large integrated networks coming together and doing their purchasing across those entire networks.

That will continue, but we have been able to provide very clear guidance on what our expectations are.

That guidance really hasn't changed.

Its been typically in that range of around minus 2% to minus 3%.

We do know with respect to the consolidated sort of outlook, and we'll again provide some guidance when we get to that point with respect to 2015.

But at least in 2015, we will again anniversary out of the Japan bi-annual price cuts.

So that will provide at least a bit of a tail wind as we get into the back half of 2015.

And it's hard to say sort of exactly when we would expect to see those pricing trends particularly within the US market begin to stabilize.

But that's, those are strategies that we're developing and the tactics that will be deployed within the US market will certainly be directed at bringing more stability if you will, particularly as we provide concessions to accounts that are at the higher end of the curve.

Thanks for taking the questions.

Sure.

David Lewis with Morgan Stanley.

This is actually Jon Demchick for David.

I know it's been covered a bit on the call but I wanted to try and jive some of the comments about seasonality and then also sales guidance.

It sounded like you guys weren't expecting a change in the seasonal trends which pushed sales higher in the back half.

But it looks as though when you adjust for the day growth is expected to be organically stable in the back half relative to the first half.

Are there any specific headwinds that you expect in the second half offsetting the increased seasonality that we would typically expect?

It sounded like pricing wasn't necessarily the culprit here.

No, there aren't.

I think that the toughest thing to predict is off of last year's uptick, how much of that seasonality shift that we saw last year will become baked into 2014 and future periods.

And as a consequence a permanent seasonality shift as opposed to more of a one-time acceleration in Q4 from 2013.

Thank you, very helpful.

And on the Biomet transaction just had a couple quick questions.

Was there any timing of expectations on complying with the second request?

And then also, what was going into the $70 million of additional expenses related to Biomet?

Is that just financing or is there anything else there?

Yes, everything that we've had by way of experience on the regulatory submission process and ultimately path towards clearance is very consistent with the due diligence that we conducted leading up to the announcement of the transaction.

So nothing at all out of line with expectations and the work streams are moving forward and the teams on both sides are being very responsive to the requests.

So we again would just express confidence that the transaction will be cleared and that from a timings standpoint the expectation continues to be the first quarter of 2015.

And just with respect to the $70 million, the majority of that is related to the financing which covers at this stage both the bridge financing as well as the bank syndication which is done in the credit facility.

As well, there's some significant fees associated with the integration planning process which is under way, legal fees associated with the application process here in the US and in Europe, as well as some financial advisory fees associated with the process we'll go through to begin to value the entity that we're acquiring.

So that covers what's included in the $70 million.

Okay, thank you.

You're welcome.

Regina, we have time for one additional question.

Matt Miksic with Piper Jaffray.

Thanks for squeezing me in here at the end.

So one on just the tone and the growth that you saw in the quarter, maybe for David.

Appreciate the color on the stability of the market.

You mentioned you have, I thought you said you had some work to do in the US to kind of exploit the Persona launch maybe more effectively.

If the market's improving sequentially here in Q2 what is it you think that created the challenge in the US, and what kinds of things can you do to sort of reinvigorate the growth behind that launch here in the second half?

And then I have a follow-up.

Yes, I think that what I was expressing is that the Persona launch continues on track, Matt and consistent with our expectations I, in response to one of the prior questions, was referencing the fact that the legacy business needs to be strengthened and our support for that business.

So some of that is probably naturally a high level of focus and energy on the Persona launch executing well on that front and needing to insure that at the same time we're taking advantage of the opportunities that we have in other product categories as well as providing a high level of attention and focus on the legacy business including the NexGen business importantly within the knee category.

So it's blocking and tackling on the commercial execution side that is going to lead to the improvement that we look to drive in the second half of the fiscal year.

And I don't think that there's anything related to the deal announcement of significance and I don't think that there's any big unknown in relation to that.

So I think we know what we need to do.

So we look at these knee system launches like Persona, it's like a three year or maybe a four year product cycle to fully roll it out and execute and this is year two.

I'm just -- with what you're saying it sounds like there's nothing in particular that's different about what you need to do this year than last year.

Is that fair, it's just continued execution?

Yes, I think that that's right and I think that if you look at our performance sequentially last year it improved as the year progressed.

I think that in the rhythm of the operating period there's a little bit of a bolus of activity on the front end of the year to get the compensation plans and instrument set deployments launched that are part of the operating planned year.

We've done that.

We would expect to get those turns up and to start to retrieve some of the benefits from those first quarter and second quarter activities.

And hopefully get on a track that looks a lot like the sequential improvement that we saw in the second half of 2013 within the United States.

I mean there's no doubt that we continue to track fine relative to the market, above market performance on a global basis in the knee category and likely, a bit above market performance in the United States as well.

The follow-up on the deal, on the Biomet deal.

I just wanted to push you a little bit on I know that you are confident in the messaging that you're sending down to distribution, but I guess I know that this did not factor into your comments on guidance, the change in guidance.

But should we not expect some distraction?

Should we not expect some, given that these are in many cases third party distribution?

Can you help me understand a little bit about how we should be thinking about the pace of the business or heading into that acquisition?

Yes, I think that there are always going to be dynamics that relate to the alignment and management across the different aspects of the business, Matt.

And whether it's a distraction because of the big launch in a large joint category on one side or the other or some other dynamic taking place, whether it's an internal organizational matter or something more significant like this combination, but winners are going to react as winners do.

They are going to step up and perform in those circumstances and we're going to see that prevail.

We're going to see people that believe in the promise of this combination and the capability not only to cross sell upon the day of closing but the broader promise of being able to innovate in a truly differentiated way because of what this combination brings and want to be part of that.

And I am absolutely confident that at the rep level and the territory leader level we are going to put together a team of talent that is going to be unmatched in the industry.

And whether or not there's some bump and grind along the way to getting there.

One would expect that there would be some of that but that's our responsibility to manage it.

Again, the closer I get to the talent, I know our group and learn more about the Biomet group, absolutely convinced that the capability resides within that channel.

And we're going to act in a manner that's consistent with the articulation of the promise of this combination in a manner to bring that out.

So we're very confident, Matt, that we're going to land in a good place.

All right.

Thanks for that.

You're welcome.

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

We look forward to speaking with you again on our third quarter conference call which is scheduled for 8:00 a.m.

on October 23.

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

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

You may now disconnect.