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Zimmer Holdings, Inc. (NYSE:ZMH)

Q1 2010 Earnings Call Transcript

April 22, 2010 8:00 AM ET

Executives

Paul Blair – VP, IR

David Dvorak – President and CEO

James Crines – EVP, Finance and

Analysts

Raj Denhoy – Jefferies

David Roman – Goldman Sachs

Mike Duncan – UBS

Bob Hopkins – Bank of America

Mike Weinstein – JP Morgan

Adam Feinstein – Barclays Capital

Rich Mynahan – Leerink Swann

Bill Carlo (ph) – Morgan Stanley

Katherine (ph) - Credit Suisse

Joanne Wuensch – BMO Capital Markets

Derrick Sung – Sanford Bernstein

Matt Miksic – Piper Jaffray

Jimmy (ph) – Citi Bank

Operator

And sir, you may begin.

Paul Blair

Good morning. I am Paul Blair, Vice President of Investor Relations for Zimmer. I would like to welcome you to the Zimmer First Quarter 2010 Earnings Conference call. Joining me today to host this call are David Dvorak, President and Chief Executive Officer and Jim Crines, Executive Vice President, Finance and Chief Financial Officer.

This morning we will review our performance for the first quarter, provide you with an update on certain key matters, present an update on our outlook for 2010 and conclude our discussion with the question-and-answer session.

We understand that this is a very busy reporting day and we’ll do our best to keep today’s call close to an hour in length. Therefore, we ask that participants pose one question, with one follow up to allow as many callers as possible the opportunity to take part in today’s call.

Before we get started I would like to point out that this presentation contains forward-looking statements within the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 based on current expectations, estimates, forecasts and projections about the orthopedics industry, management’s beliefs and assumptions made by management.

These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that could cause actual outcomes and results to differ materially from those in the forward-looking statements.

For a list and description of the risks and uncertainties see the disclosure materials filed by Zimmer with the Securities and Exchange Commission. Zimmer disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

This presentation also contains certain non-GAAP financial measures. A reconciliation of such information to the most directly comparable GAAP financial measures along with other financial and statistical information for the periods to be presented on this conference call was included in the press release announcing our earnings, which may be accessed from the Zimmer website at www.zimmer.com under the section titled Investor Relations.

In addition we routinely post important information for investors on our website in the Investor Relations section. We intent to use this website as a means of disclosing material, non-public information and for complying with our disclosure obligations under Regulation FD. Accordingly investors should monitor the Investor Relations section of our website in addition to following our press releases, SEC filings, public conference calls, presentations and webcasts.

A rebroadcast of this call will be available from approximately two hours following the conclusion of today’s call through the end of the day on May 6, 2010 and can also be accessed from the Investor Relations section of the Zimmer website.

At this time I would like to introduce David Dvorak, President and Chief Executive Officer of Zimmer.

David Dvorak

Thank you, Paul and good morning everyone. We’re glad you’ve joined us on the call today. This morning, I’ll review our first quarter 2010 results and provide comments on highlights from the quarter. Jim will then provide additional financial details. Net sales for the quarter were $1.1 billion, an increase of 3.4% on a constant currency basis and our earnings per share were $1.02 on an adjusted basis.

Our sales performance reflects incremental constant currency growth over the fourth quarter of 2009 of 90 basis points. Sales results improved when compared with the fourth quarter in the Americas and Asia Pacific but remained under pressure in Europe, Middle East and Africa segment and large part due to the challenging economic environment in that region. For the quarter, we once again recorded year-over-year sales growth in all three of our geographic reporting segments. Americas showed 2.8% constant currency growth while Europe, Middle East and Africa grew slower as we anticipate at 1.1%.

Asia Pacific again let our geographic segments with a solid 10.8% constant currency growth. Knee sales for the quarter improved year-over-year 7.4% on a reported basis and 3.8% constant currency reflecting positive volume and mix of 5% less negative price of 1.2%. Sales of partial knee devices including the Zimmer Uni Knee and the Gender Solutions Patellofemoral Joint contributed to knee growth for the quarter. Also showing growth for the quarter were later stage devices like the NexGen Legacy Constrained Condylar Knee and Rotating Hinge Knee.

We’re confident that initiatives already underway will accelerate the growth of our primary knee systems and drive further improvement in performance of our knee franchise this year. At AAOS we debuted an expansion of our patient specific instrument portfolio by adding our natural knee brand to the recently cleared NexGen brand. Our patient specific instruments are proprietary toolset customized to the individual patient’s anatomy and our design is streamlined total knee replacement procedures by ensuring the successful implementation of the surgeons preoperative plan.

We’re pleased with the yearly clinical feedback on these instruments and expect to further leverage our industry leading knee systems with the continued rollout of patient specific instruments as well as other innovative instruments that we expect to launch midyear. Hip sales for the quarter improved year-over-year 5.4% on a reported basis and 1% constant currency reflecting positive volume and mix of 2.1% less negative price of 1.1%.

Sales of revision hip products such as the Zimmer Modular Revision Hip and the Trabecular Metal Revision Shell and Augment Cups were strong in the quarter when compared to prior year. As were sales of BIOLOX delta heads. With 140 basis points of incremental growth over the fourth quarter, we see positive signs in our hip business. The global launches of our Continuum System and MMC Acetabular products are underway. But as we described before we don’t expect to see a meaningful impact from these new product introductions until the second half of this year. After sets of implants and instruments are more widely deployed.

We are however on track with our expectations for the stage rollout of these products and the initial clinical feedback has been quite positive. The Continuum System further reinforces Zimmer’s commitment to providing surgeons with the most comprehensive flexible and integrated array of metal, ceramic and polyethylene solutions to meet the diverse and unique needs of (Erotola) hip replacement patients.

In combination with our comprehensive stem portfolio including our Fitmore Hip Stem and our M/L Taper with connective technology, the Continuum System offers surgeons tremendous flexibility and confidence to personalize the implant solution. Extremity products posted healthy results for the quarter with sales growth of 13.9% constant currency. Our Trabecular Metal Technology has played a key role on the success of this product line as the TM Reverse Shoulder and TM Glenoid continue their outstanding growth trends. Following a year of weaker demand caused by the global recession our dental sales increased 6.2% constant currency for the quarter.

Sales of our implants restorative components and regenerative products all grew in the quarter. The Asia Pacific region reported the largest increase in dental sales at 23.9% for the quarter, with distributors in the region restocking as demand begins to recover from the depressed levels of the prior year. Trauma sales in the quarter were up over the prior year period 2.7% constant currency.

Sales of Non-Contact Bridging plates, Cable products, Intramedullary Nails and locking plates and screws contributed to growth in the quarter. The comprehensive rollout of our natural nail system remains key to driving improved performance in Trauma. The rollout continued during the quarter with a limited release of a (circular-medullary) nail. The reception of the CM Nail System has been extremely positive with surgeons who have commented on ease of use due to the anatomical nail system, proprietary fixed angle locking screw technology and intuitive instrumentation.

Zimmer Spine reported a sales decrease of 9.1% constant currency in the quarter. Our spinal business continues to experiences challenges related impart to the Dynesys Dynamic Stabilization System. But we remain committed to the product category. We expect incremental growth opportunities for Dynesys in regions outside the United States. Overall, signs of improvement in our spine business are reflected in the growth reported by our international units and in the positive worldwide growth recorded for acquired spine products including the Pathfinder MIS platform, the Ardis Interbody System, the Universal Clamp and the Sequoia Pedicle Screw System.

For the quarter, spine sales increased 15% in Europe and 7.7% in Asia Pacific although our base is relatively small compared to our Americas business. Europe and Asia Pacific growth is coming from stabilization of our distribution channel, resulting from our 2009 integration efforts. In the first quarter, our orthopedics surgical products franchise experienced 18.3% constant currency growth. Sales of Wound Debridement devices were up over 65% in the quarter as our global sales channel continued to make progress on recovering market share in the category.

Bone cement and powered instruments also reported strong number in the quarter compared to prior year. I want to make particular note of the excellent performances for the quarter by our Dental and OSP businesses and by our Asia Pacific team. Each has faced considerable challenges for nearly two years. And I’d like to thank these teams for the work that they have done to turn their performance around. There are couple of other topics I’ll touch on briefly. Regarding pricing, consolidated average selling prices in the first quarter were down 0.7% compared to the prior year period. We experienced negative pricing of 1.1% in the Americas, positive pricing in our Europe, Middle East, and Africa region, a 0.2% and negative pricing in the Asia Pacific region of 0.4%.

Now please keep in mind that by annual pricing adjustments in Japan did not go into effect until April 1. The consolidated pricing for the first quarter was consistent with our expectations and we continued to anticipate moderate price erosion of minus 1 to minus 2% for the year. Volume trends across our geographic regions were largely in line with our expectations for the quarter. Volumes throughout our Europe, Middle East and Africa region continued to be suppressed but appear stable as contemplated in our guidance.

In the Americas and Asia Pacific regions, demand appears to be returning to pre-recession levels. Finally with respect to guidance, as we said in our earnings release this morning we are reaffirming our outlook for 2010. Jim will now provide further details on the quarter and our guidance. Jim?

James Crines

Thanks David. I will review our performance in the quarter in more detail and then provide additional information related to our 2010 guidance. Our total revenues for the quarter as David mentioned were $1.63 billion, a 3.4% constant currency improvement compared to the first quarter of last year. Dollar strengthened the quarter resulted in a tailwind from foreign currency translation which increased revenues by 3.7% or $36 million in the quarter. Our adjusted gross profit margined at 74.9% for the quarter was in line with our expectations and 230 basis points below the prior year. As expected higher unit cost of products sold and foreign currency hedge losses as compared with prior period hedge gains account for the majority of the change.

As we continued to build and deploy pipeline inventory of our recently cleared (Acetabular) Cup products and our new line of Intramedullary Nails as well as experienced steady growth in our quarterly constructive business we improved utilization across our manufacturing network. As a result and also taking into account the change in our outlook for foreign currency translation, we are now expecting our gross margin ratio to be between 75 and 76% for the full-year.

Moving down the income statement, R&D expense as a percentage of sales was at 4.8% and at $51 million for the quarter is 1.8% favorable on the total dollar basis when compared to the prior year. Our R&D spend in the prior year was higher due to the extensive development activities underway at that time related to the Continuum and MMC Cup products as well as the Zimmer Natural Nail.

We are expecting R&D expense to increase through the balance of the year as new development programs accelerate. Selling, general and administrative expenses increased to $447 million in the first quarter but that 42% of sales SG&A expenses were 70 basis points below prior year first quarter, Medical training and education expenses increased in the quarter as compared to the prior, spending related to certain operational excellence and growth initiatives also contributed to higher expenses in the quarter. As a consequence of accelerating these programs SG&A as a percentage of sales is now anticipated to be between 41 and 42% for the full year.

Continuing down the income statement, acquisition, integration, realignment and other amounted to $2.6 million in the quarter and included cost principally related to prior period acquisitions. Adjusted operation profit in the quarter increased to $298 million, a 27% our adjusted operating profit to the sales ratio is a 130 basis points below prior year first quarter largely due to higher product cost. Net interest expense for the quarter amounted to $14.6 million compared to $3.7 million in the prior year quarter mainly due to the $1 billion senior unsecured notes offering we completed in November of 2009. Adjusted net earnings were $207.4 million for the quarter, a decrease of 1.2% compared to the prior year. Adjusted diluted earnings per share increased 7.4% to $1.02 on $204.2 million average outstanding diluted shares.

These adjusted earnings per share inclusive of approximately $0.05 of share based compensation. At $1.01 reported diluted earnings per share which include the items reflected in acquisition, integration, realignment and other increased 11% over the prior year first quarter reported EPS of $0.91. Our effective tax rate for the first quarter was 26.8% in line with our expectations. During the quarter, we repurchased 1.5 million shares at a total purchase price of $94 million. As of March 31, 2010 approximately $180 million remained authorized under our $1.25 billion repurchase program which expired at the end of 2010. The company had approximately 203 million shares of common stock outstanding as of March 31, 2010 down from 204 million as of December 31, 2009.

Operating cash flow for the quarter amounted to $260 million, up 41% from a $185 million in the first quarter of 2009. In the prior year quarter, we resolved outstanding payments to healthcare professionals and institutions resulting in substantial cash outflows. The strong results for the quarter also reflect the benefit of our continued efforts to streamline inventory investments. Overall, the operating cash flow for the first quarter is representative of our expectations for continued strength in cash flow.

A $209 million in the first quarter free cash flow, defined as operating cash flow as cash outflows for instruments and property, plant and equipment is in line with our expectations at this point in the year. Adjusted inventory days on hand finished the quarter at 302 days, a decrease of 71 days compared to the first quarter of 2009 as a result of field and central warehouse base inventory reductions achieved in the second half of 2009. Our adjusted trade accounts receivable day sales outstanding finished the quarter at 60 days, a decrease of one day from the first quarter of 2009.

Depreciation and amortization expense for the first quarter amounted to $84.9 million. Capital expenditures for the quarter totaled $50.9 million including $39.3 million per instruments and $11.6 million for property, plant and equipments. We expect capital expenditures to be higher in each of the subsequent quarters for the remainder of the year as we replace machinery and equipment in the normal course and invest in instruments to support our new product launches. Cash outlays associated with investing activities during the quarter includes $2.9 million for certain international distributor acquisitions.

I’d like to turn now to our guidance for 2010. In our earnings release this morning we reaffirmed our full-year constant currency sales and adjusted earnings per share guidance. Full-year revenues are expected to increase between 3 and 5% on a constant currency basis assuming foreign currency exchange rates remained near recent levels, the company estimates that foreign currency translation will increase revenues by 1.5% for the full-year of 2010 resulting in expected revenue growth on a reported basis between 3.5 and 5.5%.

2010 full-year adjusted diluted earnings per share are projected to be in a range of $4.15 to $4.35. David, I’ll turn the call back over to you.

David Dvorak

Thank you Jim. In the first quarter we made progress that will enable us to accelerate our growth. Our improving performance and incremental manufacturing throughput are allowing us to increase investments in several strategic initiatives. We’re also encouraged by improvements in working capital management which help generate strong cash flows during the quarter.

In addition, our new product launches are progressing and we’re continuing to deploy instruments and implants and the medical education associated with the new systems. As mentioned earlier, the clinical feedback we’ve received both in the early launches domestically and in jurisdictions outside the U.S., where they’ve been in use for a number of months gives us further optimism that these products are providing surgeons with excellent solutions for their patients.

More broadly our organization has a sense of excitement coming off the AAOS meeting and we’re driving our strategic plan and moving forward with confidence. And now I’d like to ask (Celeste) to begin the Q&A portion of our call.

Question-and-Answer-Session

Operator

(Operator Instructions) Your first question comes from the line of Raj Denhoy with Jefferies.

Raj Denhoy

Well hi, good morning guys.

David Dvorak

Good morning.

James Crines

Good morning.

Raj Denhoy

I wonder if I guess about the hip and knee business, it’s still broadly lagging the other competitors that have reported so far. I’m curious if you could maybe just give some thoughts around what’s happening there, I know you still had product launches that come later this year, by our tally you should have anniversary this year losses, particularly on the hip side and from about a year or so ago. Why is that business still suddenly lagging the market?

David Dvorak

Yes, we’re looking to make material improvements in the performance of those two franchises Raj and a lot of this does relate to those product launches that you mentioned. On the hip side, the Acetabular Cups are going to give us great opportunities to pair those up with what we believe to be industry leading technology on the stem side and we’re already seeing early indications that (hypothesis) is going to prove very much true, those sets do take time to get out and as we’ve said it really is a second half for the year productivity story for us on the deployments, in the jurisdictions overseas where the Cups have been launched and I’d probably see that early period six months into the process, we’re already seeing improvements in the performance in those markets.

So the uptake has been attractive. I am absolutely confident that we’re going to see the same experience in the U.S. markets. On the knee side, it’s much the same story. We mentioned PSI, we’re getting good up-tick in that already. I would tell you that I think it’s going to be a growth driver for us principally in the U.S. marketplace, but there are other instruments that we’ll be launching midyear that we’re going to put us in a much more competitive advantage for instruments to be responsive to what the surgeons are looking for. They’re looking for simpler instruments that take time out of the OR, lead to reproduce more results for more ergonomically design and we have a great solution that we’ll be launching in midyear in that category.

So we’re very optimistic about the prospects for improving both of those key franchise, key franchise performances within the year.

Raj Denhoy

So you think maybe by third, fourth quarter you’ll be back to market growth rates whatever those may be at that point, but you think (you’re back to the market)?

David Dvorak

Yes, I would expect this year that we would be back to market growth rates in both those franchises and we’re going to be working towards and expectation of delivering above market growth rates in hips.

Raj Denhoy

OK, and then just for my second question, I just want to ask you a bit, you made a comment towards the end of your prepared remarks about how improvements in manufacturing profitability is allowing you to increase investments in other areas of businesses. I may have not gotten that correct, but something to that effect and I am curious into this broadly speaking how that plays out in terms of your business, I mean one of the real opportunities here is that your margin structure is still significantly lower than where it’s been, and I’m curious as we move to the year and as manufacturing productivity starts to improve, how do you balance allowing some more of that to potentially fall to the bottom line to potentially increasing investments again in some of the other areas of the businesses, how you really manage that dynamic going forward?

James Crines

Yes, there are – Raj, this is Jim and there are couple of questions there, I’ll attempt to answer. We mentioned as you indicated that we are accelerating investments and certain operational excellence in growth initiatives. Without going into too much detail, those investments are generally in the area of sales and marketing support for new products and included just by – just to give one example of sales planning and scheduling tools that could be used to optimize field inventory and instrument appointments as we get into these major and new product launches.

So I guess the other thing I would tell you is that, just given where we are with these new product launches in this operating period and the focus of those investments is now actually going to be on sales and marketing. I think we – you can expect coming out of this operating period, we’d like to be investing more money in research and development to accelerate new product development programs, but as we look forward into future operating periods we would look to fund any increased in our R&D spending with savings from SG&A.

Raj Denhoy

So I guess this – broadly speaking and I guess you guys reiterate your guidance on the bottom line this year, like it sounds like you’re maybe seeing better productivity improvements but your spending those, to put bluntly.

James Crines

In this operating period given the opportunities that David talked about with respect to the new product launches, we are investing in going after those opportunities. Again that’s in the context of this current operating period.

Raj Denhoy

OK, great. Thanks a lot.

David Dvorak

You’re welcome.

Operator

Your next question comes from the line of David Roman with Goldman Sachs.

David Roman

Good morning everybody, thanks for taking the question. Just, Jim in your prepared remarks you referenced I think you took gross margin guidance from about 75% net off 75 to 76, and I think the two factors you said were better product mix and also foreign currency. Can you maybe break down for us what the drivers are for the 100 basis point increasing in guidance. How much of that is mix, how much of that is FX?

James Crines

Sure, so again with the build out of the pipeline for our new Acetabular Cup products as well as our new line of Intramedullary Nails, we’re seeing increase throughput across the manufacturing network. We expect that to continue through the first half for the year. So we’re now putting lower cost inventory to the shelf and anticipate that inventory is going to turn in the second half for the year.

So in part, that’s what leads us to a higher expectation for the gross margin ratio for the second half. Now I said, pointed out that product volumes are expected to peak in the first half of 2010 with these pipeline inventory builds and then (Taper) off perhaps in the second half for the year and there is about a six month lag in recognition of those efficiencies, across to that work.

Now how much of it (tapers) off will depend in part on the success we have with penetration in those new products as well as procedure growth rates across our core markets. So and that accounts for about half of the improvements David, that’s reflected in the updated guidance that we provided. The other half is related to the change in outlook that we have for foreign currency.

David Roman

OK.

James Crines

So, yes if you use the rates that were in effects, at the time that we gave our guidance at the beginning of the year, we clearly had a different outlook with respect to hedge losses we were projecting at the time relative to the gains that we had experienced last year.

David Roman

OK, and then on the guidance of 450 to 435, you kept the same queue, you give us as to what the drivers are at either end of that, in the 435 number how much is dependent on Continuum and MMC gaining traction versus an improvement in the overall market than at the 415 level, is that assumes really no uptake from mix and it continued slower recovery in the end user market?

David Dvorak

Those are the principal drivers, that’s right David, I mean really is top line driven and those are the biggest product categories that we have. The one that I would add into that in addition to the instruments on the knee side and the cups on the hip side would be the nail launch within trauma.

David Roman

OK, and then lastly David, you talked about the spine, just trying to more aggressively go after the U.S. piece of it. Can you maybe talk us through some of the investments that you’re making and what type of catalyst or data points we should look for, I mean in the next six to 12 months to give some more clarity on the status of that business.

David Dvorak

Yes, I think that in the short term we had good opportunities to grow above market rates (OUS). We have a good product portfolio, it’s actually broader because it includes some of the non-fusion solutions that we have within that bag at this point in time. And then what we’re looking to do is correct out that performance so that we’re exiting this year back at market overall and that’s going to obviously require some pretty significant improvement in our U.S performance and that’s going to come in the form of new product launches. We’re excited about some of the things that we have going on, especially in the MIS category there and just better sales execution as well. So I think that what you want to look for and hold us accountable to is a continued performance improvement trend through the year, exiting the year at about market growth rates and then a good cadence of new product launches thereafter that are going to sustain that growth as build the business out.

David Roman

OK, thank you very much.

David Dvorak

Thank you, David.

Operator

Your next question comes from the line of Bruce Nudell with UBS.

Mike Duncan

Thank you, hi this is actually Mike Duncan for Bruce. What product gaps do you feel like you have in knees that would kind of explain I guess the slightly below market growth rate you have there?

David Dvorak

I think that the instruments are the only gap of any significance at all at this point in time in our portfolio. We have the leading knee systems as far as clinical performance globally as evident side of the registry data that is continuously published in both NexGen, Natural Knee and then on the European front principally in Central Europe the Innex Knee System. So we have great primary offerings, we have good (pre-TK) as well as revision opportunities as well and those aspects of our franchise are growing at attractive rates so it’s really the primary side and its instrument driven and that’s something that as I said we’re going to be correcting out in short term here.

Mike Duncan

OK, great. And then did you talk about the trajectory of the U.S. trauma market now, historically it’s been low double-digits. Do you think it’s still that going forward or lower?

David Dvorak

I think that’s at the same range currently, yes plus or minus a couple of percent of where it’s been. So we haven’t seen any significant change, but again when you have to look at our participation in that market with 5% market share and so we had a little bit more of a limited perspective on that particular market.

Mike Duncan

Great, thanks so much.

David Dvorak

You’re welcome.

Operator

Your next question comes from the line of Bob Hopkins with Bank of America.

Bob Hopkins

Hi thanks, can you hear me OK?

James Crines

We can Bob, good morning.

Bob Hopkins

Great good morning. Jim, I wanted to start with the comments around SG&A for 2010. I’m just curious, should we be thinking of this 41 to 42% kind of range as the new structural norm going forward, or do you continue to anticipate that overtime, the structural norm is more backward it used to be in that 38 to 39% level.

James Crines

Yes, I would not categorize the 41 to 42% is the structural norm. I indicated we see some significant opportunities with respect to these new product launches and they are very significant. These are large systems that are getting launched both on the hip side and in trauma as well this year, that require us to make some investments in sales and marketing that support those product launches. So the 41 to 42% is not at all representative of the opportunity we believe we have to bring down that total spend over time and I would tell you that in part some of what we’re spending money on this year is directed at putting systems in place at reengineering business processes that will ultimately drive savings in SG&A.

And the savings combined with the opportunity we’ll have to leverage fixed components of our SG&A expense as our top line grows, we’re working combination to get us back to without putting a specific target to it, maybe perhaps an aspirational target at this point to get us back to that level that you referenced.

Bob Hopkins

OK, and then falling up for David I just curios, I mean it’s the Zimmer docs your primary customers, is that a stable customer base at this point and you talked a little bit about the hip launch and some of the confidence here and getting back to market growth and even above market growth. But I’m just wondering in light of the metal-on-metal controversy, is that if the confidence in that hip rollout been compromised in any way given what you’re seeing from your surgeon base or given what you’re seeing from metal-on-metal turns following the AAOS meeting?

David Dvorak

Bob, the surgeon base is largely stabilized, I mean there obviously isn’t any magic to turning a calendar month or even a calendar year on those things and so it isn’t going ever be a circumstance where all of that’s over and past. There are going to be elements of that to continue on, but I will tell you they are immaterial to the overall performance of the business and frankly I would characterize them as be much more in a norm of above (inaudible) you’re going to win some business and you’re going to lose some business overtime. So I don’t think that that’s a driving issue for our performance at this stage.

As far as the hip launch goes, I don’t see anything that’s happening with metal-on-metal as at all inhibiting our ability to execute on the opportunity that we have with these new cup systems. We were always quiet low relative to the market in our share of that metal-on-metal side of the things, down around 5% relative to a market that was probably 25 to 30% as measured by dollars and maybe 20 to 25% is measured by units and some of the competitors had 50% or maybe even north of 50% in mix. So while there is likely to be some settling of the composition of the overall mix of metal within the hip cup offerings for the market.

We have nothing but upside on that and we don’t believe that that segment is going to go away within the market. So this is all a great opportunity for us and the versatility of those cup systems make that a non issue as well, because of the various varying surfaces that are offered globally.

Bob Hopkins

Great, thanks very much.

David Dvorak

You’re welcome.

Operator

Your next comes from the line of Mike Weinstein with JP Morgan.

Mike Weinstein

Thanks, good morning. Two questions, first on the knee side and then on the hip side. So on the knee side that the rollout of the patient specific instruments, where are you in that rollout and how do we think about the spend in order for that to happen?

David Dvorak

The rollout of PSI, this is one that was cleared by just in late November of last year. So we’re just getting to the point where you can start to see a bit of traction, right and this is one where it is likely to be a little bit of lag because you have to get those MRI centers qualified, surgeons trained very specifically and then the patients have to get into the queue as well even after that so there is going to be a lag between the efforts that go into that and productivity of those efforts and realizing sales and even enhancing primary knee sales which that system will certainly do and that’s going to be just beginning of the second quarter, obviously didn’t see anything in a way of a significant impact in the first quarter, but just to reiterate more of a second half of the year driver for growth.

Mike Weinstein

And then on the hip side, David the Continuum launch had a hit a speed bomb early on, it looks like you got some feedback that you’re having – that surgeons were having some difficulty in planting the cup and then I saw that you had to recall the adapter liner which is part of the implementation process. So maybe if you can just spend a minute on that and then and give us a little bit of feedback on what you’ve gotten?

David Dvorak

Yes and so that’s why we do limited releases on these big systems and so you get the feedback and listen carefully to that feedback and then make whatever adjustments are necessary to optimize the performance of those instruments and that’s exactly what the team did. So they got on that issue very early, its completely insignificant to the success of the ultimate launching of that product Mike in our view.

And I wouldn’t describe it is a speed bomb whatsoever its normal course correction and we jumped on it very early in the process and we’re going to have a lot of success with that Continuum System.

Mike Weinstein

And so are you out there with a new adapter now?

David Dvorak

Yes.

Mike Weinstein

OK, thank you.

David Dvorak

You’re welcome.

Operator

Your next question comes from the line of Adam Feinstein with Barclays Capital.

Adam Feinstein

Thank you, good morning everyone.

David Dvorak

Good morning.

James Crines

Good morning.

Adam Feinstein

I guess, I have a couple of questions here, just mainly just with your if you can talk a little bit about that, obviously it’s been more challenging in Europe, at least off the more time looking at the U.S. market. So just curious if you can just give us some more color for what’s going on there, and do you think that the back half of the year will start to see positive growth there as the comps get easier. So just curious to get your thoughts in terms of just what was going on there?

David Dvorak

Europe continues to be flat overall in the primary developed markets at this point in time, you see numbers around plus or minus a couple of percent or so in each of those markets but when you weight them out it looks like a very flat market for the large showings right now, there obviously are good growth opportunity still in those developing markets in Europe but they’re not large enough to offset the flat nature of the large five within Europe.

And so as we described in our prepared remarks we see stability in that in that, I don’t think that it’s getting worse. I think that its stable and so at some point clearly those markets are going to improve but it really involves a fair amount of speculation as to when that’s going to occur because you’re looking for a more fundamental recovery in some of those economies and freeing up some of those dollars that are controlled by those centralized healthcare systems for those patients that are deferring receiving the implants right now can get in and get the benefits of those solutions.

And I still would project out the way we did in our guidance call earlier this year as far as Europe goes, and it’s going to be flat to slightly positive.

Adam Feinstein

OK, great. And just a quick follow-up question here, more of a bigger picture question. So it’s clearly things have picked up in the ortho business, you guys have done a good job in terms of the last of couple of years, you had some headwinds you were dealing with, things have turned, business is stable and growing again. So just, I guess the question is what’s the next step if you will, is now the time where you will see more mergers taking place, do you think we’ll see more consolidation, you guys did the Abbott Spine deal while back but just curious as you look forward, what’s kind of the next big step outside of just a regular new product launches.

David Dvorak

Yes, and you’re right I think that the primary focus for us right now is to ensure that our organic growth rate is very much on track and so that is all about the new product launches in the sales and marketing execution around those but beyond that we’re constantly looking at business development opportunities for in exploring inorganic growth and we think that there are good opportunities, I think that you’ll see more activity in that area as the economy stabilizes and people feel like they have greater clarity as to what those opportunities look like.

So we’re active in that area, it’s the first priority as far as redeploying cash and we’ll continue to be quite disciplined in how we go about that but I do think that you’ll see activity levels across the industry pick up, I’m not sure that those take the form of large consolidations, they’re only a couple of potential opportunities of significance in that regard. So I won't speculate as to what others might be thinking about doing in that context but I do think that generally speaking this will be a healthier year for external development across the industry.

Adam Feinstein

OK, thank you very much.

David Dvorak

You’re welcome.

Operator

Your next question comes from the line of Rick Wise with Leerink Swann.

Rich Mynahan

Hi guys, thanks for taking the question. This is actually Rich in for Rick.

David Dvorak

Hi Rich.

Rich Mynahan

I just had a couple of quick questions. On the patient specific knees, could you maybe just describe for me, I know you are little bit later than some of your competitors from the market, so you really haven’t even seen most of the impacts on that yet on your business. But is this something that’s applicable potentially to all knee procedures and across all of your platforms eventually and where do you kind of see this as in terms of penetration, across the industry and within your own product platform.

David Dvorak

I think that the application of these broader technologies of advanced instruments will certainly impact across all franchises. I think that this particular solution has some leveragability in other franchises, but I think that it will be augmented by other technologies that create more efficient reproducible procedure that give the surgeons even more confidence. So it’s an area of import, I think that it’s an area that we intent to improve and lead the industry in improving. As far as penetration rates, that is just going to depend upon the clinical success that people have with these procedures and importantly whether or not they solved some other challenges.

There is going to be cost challenge, there is going to be a reimbursement challenge and an income challenge on the surgeons part and so all of those instrument advancements are going to have to be crafted in a way where they resolved multiple issues and create value and multiple contacts and that really will dictate what level of penetration but I think it’s going to be significant in the intermediate term and the long term.

Rich Mynahan

Great, thanks. And then just on your extremities business. This is several quarters in a row, you guys have posted very strong growth rates, the market seems to be growing well there. I know and I believe you’re mostly in the upper extremities arena. Just wondering if guys have any plans to expand in to the lower extremities for ankle and where you guys were on that front. Thanks a lot.

David Dvorak

We defined the sort of sweet spot for our business is being the musculoskeletal space, so that clearly is within space. There obviously are good reasons for us to want to expand into those types of markets, we have distribution channels to leverage, we have internal product development skill sets to leverage, we have manufacturing capabilities to leverage and so we think we can create a lot of value and anything that is within that musculoskeletal space that we currently are participating is of interesting to us.

Operator

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

Bill Carlo

Hello guys.

David Dvorak

Hello.

Bill Carlo

It is (Bill Carlo) in for David Lewis today. Thanks for taking the questions.

David Dvorak

Sure.

Bill Carlo

Anyways, hoping that you guys I know you called a little bit already but if you could maybe give a little bit more color on strength and weakness in geographies outside the U.S., particularly how that may change across knees, hips, and spine?

David Dvorak

Well I think again, just start at the high level. We look at Asia Pacific and deem the procedure rates there to have returned for the most part pre-recession levels. And when you turn to Europe the five markets that we referenced clearly haven’t done that yet. They stabilized but we haven’t seen any improvement in those markets. And we have pretty significant market shares within those jurisdictions. So we feel like we have a fair amount of visibility.

The outside of those five developed markets, we are seeing good growth in Europe and so there are opportunities there and surely the emerging markets when you define those as a dozen or 15 across the globe, we’re seeing nice growth in all of those markets in those areas of emphasize for us is well.

Bill Carlo

OK, great. And I guess following up on that are there any significant differences you’re seeing especially in the emerging markets across hips and knees or spine?

David Dvorak

We are seeing higher growth rates in what we define as an emerging markets. We track our performance across to total it about 13 markets, including the BRIC countries and we are seeing double-digit growth across those markets on what represents still a relatively small portion of our total revenue base.

Bill Carlo

OK. Thanks a lot. And then I know you’ve already touched on this a little bit already, but just enough your current operating structure will allow you the flexibility to deliver on your way you can return to market growth rates. I guess to ask it in another way, is there any chance you would need to reinvest additional capital higher levels throughout the balance of the year to achieve that goal?

David Dvorak

It’s all contemplated by our guidance. Those plans are well developed and we’re executing to those plans and to the extent that there would be accelerated spending that would largely be driven by an expanded, still expanded viewpoint as to what the opportunity looks like, so I think that you can assume that that is all baked into our guidance.

Bill Carlo

Alright, thanks a lot.

David Dvorak

You’re welcome.

Operator

Your next question comes from the line of Kristen Stewart with Credit Suisse.

Katherine

Hi it’s actually (Katherine) for Kristen. I just have a couple of questions on mix. Can you tell us whether the U.S. net mix price was negative or positive for hips and knees this quarter?

James Crines

Yes, when we look at that in the aggregate, for the quarter a very slight positive.

Katherine

And for both hips and knees in the quarter.

James Crines

Again just looking at it in the aggregate for both hips and knees that’s right.

Katherine

OK, so worldwide. Alright, so and also what are you assuming I guess in your guidance in terms of the mix contribution?

James Crines

Yes, what we said coming into the year, that our expectation with respect to fewer price first of all would be that we would see something in the order of minus one to minus 2% across all of our product franchises and that positive mix that would offset that. So for the year, our expectation is that it will be neutral and that hasn’t changed.

Katherine

OK, and then quickly can you break out the U.S. dental growth?

James Crines

We on the…

Katherine

Just trying to see if the – if there is any improvements sequentially?

James Crines

Its low single digits, positive.

Katherine

OK, and then lastly on Japan pricing, are you still estimating at about 4 to 5% impact?

James Crines

That’s exactly right for us, that will be the impact.

Katherine

OK, great. Thank you.

David Dvorak

You’re welcome.

Operator

Your next question comes from the line of Joanne Wuensch with BMO Capital Markets.

Joanne Wuensch

Good morning and thanks for taking the question.

David Dvorak

Good morning.

Joanne Wuensch

(OSP) product line very – did very well this quarter, I know it’s a small portion of your business, but can we anticipate a nice recovery over the next several quarter, is this reflective of new products or just simply a sales force getting up together over easier comps?

David Dvorak

Well the re-launching of the products that were taken off the market is a big growth driver and so we’re executing well I will tell you on that front, 60 plus percent growth in some of those categories, but it isn’t just that aspect the (OSP) business that is performing well, we’re doing quite well in bone cement and accessories, we’re doing well with our (tuner kits). So it’s pretty broad base and the next for us there Joanne is to make sure that we have a good product development Cadence coming out, so that we sustain that growth, but right now it’s really driven by good execution of bone cement, of (tuner kits) and then the re-launching of those products that were off the market previously.

Joanne Wuensch

And for clarification purposes forgive me, your head loses they go through, did they go through COGS, they go through and impact your gross margins?

David Dvorak

They do.

Joanne Wuensch

OK, thank you. And then just a final question, in the area of spine, I understand Dynesys is a problem here in the United States, but is this a matter of just getting more feed on the street and more products in the bag or is there something else that would be necessary to get this area moving in a positive direction?

David Dvorak

Well we have a full portfolio at this point in time, but obviously it’s always a matter of getting more (critics) on the bag and more feed on the street. We have what we deem to be a platform business there and we would execute better with what we have but it needs to grow and we’re going to have to continue to invest to be a player with any critical mass within that stage.

So I would tell you right now I think that its new product development in sales and marketing execution that gets us back on track but then we’re going to be continuously investing in that business to get it back at a market growth very.

Joanne Wuensch

Thank you very much.

David Dvorak

You’re welcome.

Operator

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

Derrick Sung

Hi good morning. You mentioned in your comments that you saw sort of the U.S. volume demand also is returning to pre-recession levels. I was wondering if you could put some color around that by maybe running through each of the businesses and kind of giving us the sense for where they are in terms of volumes respective to pre-recession levels?

David Dvorak

Derrick if we look back at 2007, 2008 growth rates for we’re really principally focused on the hips and knees. We saw those categories, those product franchises across the market growing in high single digits and we look at least what we understand with respect to the first quarter at this stage with the companies that are reported publicly, we see growth rates that are back in at that level with knees obviously being higher than hips, but we’re seeing a return again how we would characterize it to high single digit growth for hips and knees in the U.S. market.

Derrick Sung

OK, and in terms of – and you had I think previously talked about deferred procedures and anecdotes about deferred procedures that you have been hearing from your surgeons early through 2009 during the recession. Can you comment on kind of what you’re hearing now about that from your customer base?

David Dvorak

Well I’m sorry that we had always indicated an expectation that the impact of those patients eventually working their way back into the system would be somewhat modest in what occurred in a kind of a linear fashion over time, that is we believe still the case. Anecdotally in pockets that you do hear that certain surgeons particularly those that perhaps are do less volume typically are getting a bit busier and so it is the case that those patients maybe coming back, but in the aggregates we don’t see that adding significant points of growth in those hip and knee markets within the U.S.

Derrick Sung

OK, so is it fair to say that kind of your view of market is that they’re kind of where they are today, they are kind of their back where they were before and so you wouldn’t expect any further acceleration from kind of what you’re seeing today based on your sort of knowledge of the market?

David Dvorak

Yes, I’d say that’s fair with respect to the Americas and the Asia Pacific markets, we would expect to still see a recovery at some point in Europe, Middle East, Africa markets which are still a bit depressed.

Derrick Sung

OK, thank you. And on your knee specifically in the U.S., the functional growth rates tick down by few points versus the fourth quarter, this quarter. Is there any reasons for that, that you can point to?

David Dvorak

We’re in the middle of executing a fair amount of work right now to get things setup for these product launches but I don’t think that there is anything that should be interpreted in a way of a trend there or a significant issue of any sort.

Derrick Sung

OK, and then lastly in trauma, one of your competitors had mentioned bad weather about in the U.S. and in Europe being positive for overall trauma volumes this quarter. It doesn’t look like we saw that near numbers. Is there any reasons for that that you can think of?

David Dvorak

Again I can't point to anything but again we have 5% market share and so a larger competitor may have a better basis to be able to characterize those types of dynamics.

Derrick Sung

OK, great. Thank you very much.

David Dvorak

OK, you’re very welcome.

Operator

Your next question comes from the line of Matt Miksic with Piper Jaffray. Mr. Miksic, your line is open.

Matt Miksic

Hi this is Matt.

David Dvorak

Hello Matt.

Matt Miksic

Thanks for taking the questions. So a follow-up on some of the new product launches that you have going, I just – I wanted to get a sense you talked about I think other manufactures have talked about mix obviously price tougher in this environment. As you rollout these new products we know that orthopedics launches have always taken a good amount of time to pick up speed as focus about these you get the instruments out in the field you need to sell on. Is that a dynamic that you feel in this market either because of the (DOJ) or because of hospital pressure or something is extending further? Are (docs) little bit more conservative now than it were a couple of years ago about picking up new products and adopting new products you’re rolling out?

David Dvorak

I don’t believe so Matt, I think that as you said its been a dynamic for some period of time in these rollouts and there is a lot to mobilize in a way of effort and obviously a large goal is on the manufacturing and operation side that you’ve been -- get these instrument sets and implant sets manufactured and deployed and then surgeon training that goes along with that is significant, obviously the sales force training even in advance of that is significant and so that’s really what we’re seeing here.

But I wouldn’t tell you that this field is different than other large launches from the past, that kind of six to 18 months time frame to seed the market and start to see some productivity and find traction is still what this one feels like at this point in time. They get early feedback on these products but as we’ve said the early feedback in all jurisdiction whether its early stage of the launch or later stage in terms of months for the (OUS) launches with these products has been very positive for us.

Matt Miksic

OK, and then so six to 18 months still the window for getting those kind of up to full head of steam or something we would see in the numbers.

David Dvorak

That’s fair.

Matt Miksic

And then one follow-up on the dental market. I may have missed any comments you made specific to how things were going there, but any color you can provide on what you’re seeing in the market, how much of the growth that you’re seeing is sort of an improvement in your later mater or do you think you’re gaining share notable products. Any kind of color would be great?

David Dvorak

Great, and this will tell you that I think on the general environment I would characterize it more as stabilizing a bit as opposed to restoration of pre-recession growth rates and obviously isn’t at that little at this point in time. So stability looks attractive relatively speaking to where that market has been over the last couple of years since the recession took affect and I think that that’s more of a driver, beyond that one quarter a trend does not make I think that we have a good management team out there and they are stabilizing their business and executing well and that’s a business in a market that we’re very interested in growing. So we’re going to be in a good position when there is a more full recovery and that will come but it hasn’t come yet Matt.

Matt Miksic

Alright, well thanks for taking the questions.

David Dvorak

You’re very welcome.

Paul Blair

(Celeste), in the interest of time, let's take one more question please.

Operator

Your final question comes from the line of Matt Dodds with Citi Bank.

Jimmy

Hello.

David Dvorak

Hello.

Jimmy

Yes, hi this is (Jimmy) calling in for Matt.

David Dvorak

Hi there.

Jimmy

Hi, so I was wondering you gave consolidated pricing, I was wondering if you could break it out to hips, knees and spine.

James Crines

Sure, so hips pricing for the quarter was down just over a point and knees as well, pricing was down just over a point in the quarter and spine pricing was flat for the quarter.

Jimmy

OK, and then at AAOS there was some negative data that was published on the NexGen, yes I was wondering if you could comments on what the feedback was amongst the surgeons regarding that data?

David Dvorak

That – it is a knee system that we’re very comfortable with, I will tell you that we’ve had great success with that system. We re-review investigative data and since the launching of that system the revision rates have been very low, so we don’t have concerns at this point as to performance of the product, the design of that product and we’ll continue to monitor it as we do with our other products but I will tell you that within the quarter is measured by the sales performance within that product line, it didn’t produce any issues for us. It grew at an attractive rate.

Jimmy

OK, that’s all I had. Thanks guys.

David Dvorak

Great, thank you. Well thanks again everyone for joining us today and for your continued interest in Zimmer, we look forward to speaking to you on our second quarter conference call 8 A.M. on July 22, 2010. At this point I’ll turn the call back to you (Celeste).

Operator

Ladies and gentlemen this concludes today’s conference call. You may now disconnect.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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Source: Zimmer Holdings, Inc. Q1 2010 Earnings Call Transcript
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