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Executives

Robert J. Marshall - Vice President of Investor Relations and Treasurer

David C. Dvorak - Chief Executive Officer, President and Director

James T. Crines - Chief Financial Officer and Executive Vice President of Finance

Analysts

Matthew Taylor - Barclays Capital, Research Division

Bruce M. Nudell - Crédit Suisse AG, Research Division

Kimberly Weeks Gailun - JP Morgan Chase & Co, Research Division

David R. Lewis - Morgan Stanley, Research Division

Derrick Sung - Sanford C. Bernstein & Co., LLC., Research Division

Matthew S. Miksic - Piper Jaffray Companies, Research Division

Kristen M. Stewart - Deutsche Bank AG, Research Division

Lawrence Biegelsen - Wells Fargo Securities, LLC, Research Division

Michael Matson - Mizuho Securities USA Inc., Research Division

Zimmer Holdings (ZMH) Q3 2012 Earnings Call October 25, 2012 8:00 AM ET

Operator

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.

Robert J. Marshall

Thank you, Regina. Good morning, and welcome to Zimmer's Third Quarter 2012 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 turn the call over to David Dvorak. David?

David C. Dvorak

Thank you, Bob. Good morning, everyone, and welcome to Zimmer's earnings call for the third quarter of 2012. This morning, I'll review our third quarter financial results, providing commentary on the year's progress to date and highlights from our performance. Jim will then provide additional financial details. As in previous quarters, I'll state all sales in constant currency terms, and I'll discuss all earnings results on an adjusted basis.

At the beginning of the year, we articulated a goal of generating 8% to 12% growth in earnings per share in an environment of low to mid single-digit top line growth. We indicated that this goal would be achieved through the successful execution of strategic initiatives, including significant product introductions across the portfolio, the continued execution of our transformation agenda and rigorous management of capital. I'm glad to report that we remain on track to deliver against this commitment in 2012. Further, we believe progress across each of our strategic priorities will position Zimmer to achieve our value-creation objectives through the remainder of the year and into 2013.

Consolidated net sales for the third quarter were $1.03 billion, an increase of 2.5%, and our earnings per share were $1.15, an increase of 10.6% over the prior year period. Compared to prior year, Americas sales grew 0.5%, while Europe, Middle East and Africa delivered growth of 7.9%, and Asia-Pacific recorded sales growth of 1.6%. For the third quarter, our Americas sales were negatively affected by 1 fewer billing day, while our Europe, Middle East and Africa and Asia-Pacific sales benefited from an additional billing day.

In the quarter, we recorded strong performances in Europe, Middle East and Africa and in certain emerging markets in Asia-Pacific. These results reflect the benefit of operational and sales force investments in these regions. We continue to pursue similar commercial excellence efforts in the United States to ensure at or above market performance across our sales territories both here and abroad. Progress in these efforts, combined with ongoing and upcoming new product introductions across the portfolio, will contribute to improved performance in the future.

Turning now to the results of our product categories. Knee sales for the third quarter increased year-over-year 0.5%, reflecting positive volume and mix of 3.3% and negative price of 2.8%. Our international operating segments delivered strong knee sales growth of 8.7% in Europe, Middle East and Africa, and 4.3% in the Asia-Pacific region compared with the prior year.

During the quarter, we generated increased sales of our intelligent instrument offerings, including Zimmer Patient Specific Instruments for our NexGen and Natural total knee systems in the Zimmer Unicompartmental High Flex Knee System, as well as the eLIBRA Dynamic Knee Balancing System. In many markets, we're beginning to see accelerated adoption rates of these intelligent instrument systems, which offer hospitals the potential to drive more consistent clinical outcomes and procedural and logistical efficiencies.

Also in the quarter, we continued the limited developer release of our Next Generation Knee System, PERSONA, the personalized knee system. This exciting new system builds upon the tremendous clinical legacy of our NexGen and Natural Knee Systems, leveraging fundamental aspects of these designs, while adding new technologies and innovations that allow for much greater personalization and improved performance. Coupled with our intelligent instrument offerings, the PERSONA Knee System will allow surgeons to personalize the best possible fit for each patient, which we believe will lead to a more natural-feeling knee. We look forward greatly to the benefits of the broader release of PERSONA in 2013.

Hip sales in the third quarter increased 1.6%, reflecting positive volume and mix of 4.4%, and negative price of 2.8%. In the quarter, our Americas and Europe, Middle East and Africa operating segments delivered an improved performance, while in Asia-Pacific, sales declined slightly compared with prior year due primarily to the previously discussed pricing pressure in Japan.

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

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

Extremities recorded above market sales growth of 12.3% in the third quarter. Recently introduced products supported by improved sales execution contributed to this performance. Globally, our Anatomical combined shoulder system and Trabecular Metal Reverse Shoulder System recorded impressive growth. In Europe, Middle East and Africa, the Sidus Stem-Free Shoulder System is providing opportunities for new account conversions in a growing category of the shoulder replacement market.

In the quarter, we also received FDA clearance for our new Trabecular Metal Total Ankle replacement system, which provides us with an entry point for the lower extremities market. This exciting new system that incorporates our Trabecular Metal technology is designed to support a novel innovative lateral surgical approach. First surgeries have taken place for this product over the past several weeks, and we're excited for its broader commercial introduction in 2013.

Our Dental business delivered sales growth of 3.5% in the third quarter amid a challenging market, which continues to be impacted by suppressed procedure volume in key European and Asia-Pacific markets in particular. In the quarter, our Americas growth was attributable to the revenues associated with the Exopro acquisition, the Brazilian manufacturer of differentiated dental implant products in the P-I Brånemark Philosophy.

Globally, sales growth in the third quarter was supported by a number of recently introduced products, including the Trabecular Metal Dental Implant, the IngeniOs value line of synthetic bone graft, and Zfx Digital Dentistry Solutions.

In the third quarter, we again delivered above-market sales growth in all geographic segments in our Trauma business. Sales increased 10.8% over the prior year period, including standout 24% growth in Europe, Middle East and Africa. Globally, new products in the Trauma portfolio are driving significant growth in this business.

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

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

Zimmer's Spine business reported a sales decrease of 7.4% in the third quarter. We continue to face significant challenges in this business related to pricing and utilization.

In the Cervical Interbody and Outerbody segment and in Minimally Invasive Solutions, we are developing a competitive portfolio. Recently introduced products in these categories continue to deliver solid sales results. This week at the North American Spine Society meeting, we are highlighting our differentiated InViZia cervical plating system and the Trabecular Metal Ardis Interbody System.

In the third quarter, Zimmer's Surgical and Other business category again delivered above market sales growth of 10.7% over the prior year period. Recently introduced products contributed meaningful growth in this business. Specifically, the Zimmer surgical power equipment line and Synvasive line of surgical blade continue to present significant opportunities.

At the end of the third quarter, Zimmer further expanded our surgical products portfolio through the acquisition of Dornoch Medical Systems, a medical waste management technology company. Dornoch offers a comprehensive range of medical waste fluid disposal equipment and accessories, including its patented Transposal integrated infectious fluid collection and disposal system.

We continue to generate encouraging growth rates from our early intervention technologies, which include a broad range of products across the continuum of care. In particular, we're seeing increased utilization of our DeNovo and Chondrofix cartilage repair products.

Another early intervention technology for patients with knee arthritis is our Gel-One injectable hyaluronic acid product. In an important development in the quarter, we successfully defended Gel-One in patent litigation. We're pleased that the jury returned a verdict in our favor. Gel-One offers further opportunities for us to expand our reach earlier in the continuum of care for knee arthritis, which is a strategically important area for the company.

Turning now from our product category results, I'd like to discuss several broad market factors. Reconstructive procedures in the third quarter were slightly lower than expected in certain key markets around the world due to uncertainty in the macro environment. As Jim will discuss, we've adjusted our outlook for the fourth quarter and full year accordingly, yet we remain confident that a robust product pipeline will enhance our revenue growth as we look beyond 2012. Specifically, revenue growth is expected to improve as we make necessary investments in our sales channel and other areas concurrent with the launch of many new products, including the PERSONA knee system, VIVACIT-E Highly Crosslinked Polyethylene for hips, the Sidus stem-free shoulder, the Trabecular Metal total ankle replacement, the Gel-One single injection hyaluronic acid product and Zimmer's surgical power equipment, as well as the recently acquired Transposal waste management devices.

We experienced price pressure of negative 2.1% in the third quarter, in line with our expectations. We're confident full year pricing for 2012 will remain at or near negative 2%, consistent with our guidance. The mix benefit of new product sales contributions across the portfolio, many of which incorporate premium price technologies, enabled Zimmer to partially offset price pressure in several of our franchises.

In the third quarter, we made further progress in the transformation agenda we're pursuing across our commercial and corporate operations. Notable steps taken included progress in strategic sourcing, distribution and advanced manufacturing activities. As well as making Zimmer a more effective and efficient organization, our transformation programs generate substantial cash flows. We're deploying this cash and capital in a disciplined fashion, returning excess value to our stockholders through our dividend and share repurchase programs and pursuing prudent acquisition opportunities.

Finally, this quarter, we celebrated 15 years of clinical success for Trabecular Metal Technology, and we're truly only just beginning to scratch the surface of its potential. This technology has now been used in more than 750,000 procedures helping literally hundreds of thousands of patients return to active lifestyles. In many applications, Trabecular Metal Technology offers a unique solution for patients who might otherwise lose their mobility.

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

James T. Crines

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

Zimmer's total revenues for the third quarter were $1,026,000,000, a 2.5% constant currency increase compared with the third quarter of 2011. Net currency impact for the quarter was negative, decreasing revenues by 3.1% or $31.8 million. Our euro-denominated revenues were the primary driver of the negative impact. Adjusted gross profit margin in the third quarter was 75.1%, consistent with the first and second quarters, but down by 70 basis points compared to the third quarter of 2011. The positive effect of lower foreign currency hedge losses was offset primarily by negative price and excess and obsolescence cost in the quarter.

The company's R&D expense constituted 5.2% of sales in the quarter. This is lower than the prior year third quarter, but still within our target range of 5% to 6% of revenue. R&D spending benefited from operational efficiencies, as well as a natural decline related to certain large projects that are approaching full commercialization, including PERSONA, the personalized knee system, and the Trabecular Metal Total Ankle.

Selling, general and administrative expenses were $430 million in the third quarter, a decrease of 3.2%. At 41.9% of sales, SG&A expenses were 110 basis points below prior year, reflecting significant savings from our transformation and operational excellence programs. In line with the prior year's -- prior quarter's guidance, SG&A as a percentage of sales is expected to be approximately 40% for the full year. Special items accounted for $37 million of expense in the quarter. This included costs associated with our distribution and advanced manufacturing transformation initiatives, quality system enhancements and integration costs associated with recent acquisitions.

Adjusted operating profit in the quarter increased to $286.8 million, amounting to an operating margin ratio of 28%. This ratio reflects 120 basis points of improvement relative to the prior year third quarter. This improvement was driven by operational efficiencies in SG&A and R&D. Net interest expense for the quarter totaled $14.5 million, an increase of $2.8 million over the prior year period. This change results from our $550 million senior notes offering in November of 2011. Adjusted net earnings were $202 million for the third quarter, an increase of 2.5% compared to the prior year. Adjusted diluted earnings per share increased 10.6% to $1.15 on 175.3 million average outstanding diluted shares. These adjusted earnings per share are inclusive of approximately $0.06 of share-based compensation. At $1.02, reported diluted earnings per share increased 1% from the prior year third quarter reported EPS of $1.01. Reported diluted earnings per share for the third quarter include special items net of tax.

Our adjusted effective tax rate for the quarter was 25.9%, which represents an increase of 30 basis points from the third quarter of 2011. Based on the year-to-date geographic mix of earnings and profits, we now anticipate our full year effective tax rate to be between 26% and 27%. Our reported effective tax rate for the quarter was 24.3%.

As indicated in our earnings release, in the quarter, we acquired 1.6 million shares of company stock at a total purchase price of $98 million. Year-to-date, we have repurchased 5.5 million shares at a total spend of $345.7 million. As of September 30, 2012, approximately $1.15 billion remained authorized under a $1.5 billion repurchase program, which expires at the end of 2014. The company had approximately 173.5 million shares of common stock outstanding as of September 30, 2012, down from 180.4 million shares as of September 30, 2011. Operating cash flow for the quarter amounted to $345 million, a decrease of 1.6% from $350.6 million in the third quarter of 2011. Day sales outstanding finished the quarter at 72 days, an increase of 1 day over the prior year period. Adjusted inventory days on hand finished the quarter at 350 days, an increase of 2 days over the third quarter of 2011. The increased investment in inventories reflects the pipeline buildout of PERSONA, the personalized knee system, the Trabecular Metal Total Ankle, the second-generation XtraFix External Fixation System, Zimmer's surgical power equipment and Gel-One hyaluronic acid, offset by inventory reductions in our international operating segments.

Depreciation and amortization expense for the third quarter amounted to $82.7 million. Free cash flow in the third quarter was $281.5 million, $8.4 million higher than the third quarter of 2011. We define free cash flow as operating cash flow less cash outflows for instruments and property, plant and equipment. Capital expenditures for the quarter totaled $64 million, including $36.4 million for instruments and $27.1 million for property, plant and equipment.

I will now provide an update to our guidance for the fourth quarter and full year 2012. In our earnings release this morning, we announced that the company is updating its full year sales and EPS guidance. We now expect full year revenues to increase approximately 2% constant currency when compared to 2011. We have adjusted our outlook for the balance of this year in response to our refined expectations for the ramp-up of revenues associated with new product launches, as well as the apparent modest deceleration in musculoskeletal market growth. The company now estimates that foreign currency translation will decrease revenues by approximately 2% for the full year 2012, resulting in flat revenue growth on a reported basis. We expect our gross margin ratio for the full year to be in line with our prior guidance of approximately 75%.

Taking into consideration our current revenue expectations and line item guidance we have previously provided, full year 2012 adjusted diluting earnings per share are now projected to be in a range of $5.25 to $5.30. This guidance is consistent with the value-creation framework we outlined earlier in the year and that David referenced in his remarks. To arrive at GAAP earnings per share, you should subtract total charges for special items of approximately $135 million pretax or approximately $0.50 per share. Please note that our guidance does not include any impact from potential acquisitions or other unforeseen events.

Finally, I would like to make a brief comment regarding the medical device excise tax, which is set to go into effect in 2013. Pursuant to the statute, the excise tax is imposed on the first sale in the United States by the manufacturer, producer or importer of a medical device to either a third party or an affiliated distribution entity. Since we distribute the majority of our musculoskeletal products through a distribution entity, the tax generally represents an inventoriable cost for us. As such, we expect the excise tax expense recognized in 2013 to be lower than prior estimates and we'll report the expense in cost of goods sold on the face of our consolidated income statement.

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

David C. Dvorak

Thank you, Jim. Continued above-market performances in a number of international markets and emerging businesses supported year-over-year sales growth in the third quarter. A substantial amount of this growth was attributable to the new product introductions in existing and adjacent categories across the portfolio. Going forward, we remain on track to increase value for stockholders through the ongoing commercialization of innovative new products, continued progress in our operational excellence programs and disciplined capital deployment.

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

Question-and-Answer Session

Operator

.

[Operator Instructions] Our first question will come from the line of Matt Taylor with Barclays.

Matthew Taylor - Barclays Capital, Research Division

I guess the first question is on guidance. You had a nice quarter here coming in at 3%, and we're calculating it at 2.6% for the first 9 months. So I wanted to understand, the 2% for the year, does that imply roughly flat to 1% growth in the fourth quarter? And if that's right, can you just talk about what your expectations are for the quarter and if you've seen a slowdown since the third quarter?

David C. Dvorak

Sure, Matt. What we're doing is revising the guidance for the year in accordance with what we've seen in the market really through the third quarter, which -- there is some slowdown within the market that's apparent in the large joint side, probably at least 0.5 point, maybe a bit more than that on a global basis. And then in addition to that, just refining our view as we get further along with these product launches is to what the uptick is going to be. So it is a broad range understandably when you frame out the math the way that you do on the downside, but we're being conservative, and we think appropriately conservative relative to the timing and the ramp-up of those products that are being introduced. And the largest of those is the PERSONA knee system. We are about to move forward with the broader release of that system, but we want to get that broad introduction just right at the point of launch. And as a consequence of that timing, any instance that we have to take competitive business, those customers are going to be more interested in moving directly to the PERSONA system than the likelihood of them moving through 2 transitions of knee systems. And so there's a bit of a lull until we move forward, but again, we are absolutely confident that all of these product launches are going to lead to accelerated revenue, and we're being conservative as to our views on the Q4 guidance.

Matthew Taylor - Barclays Capital, Research Division

Okay. So is it fair to say that it's more of a timing issue? On a prior call, you had talked about a little bit of a step-up in the fourth quarter leading to some higher growth next year. I guess, you still view these products leading you to higher growth but you may have just a air pocket here.

David C. Dvorak

That's exactly right. We absolutely are confident that we're going to see accelerated top line growth, and that may begin in Q4, but we want to be conservative in managing expectations as to when we're going to find that traction point. But it's going to happen, if not in Q4, as we get into 2013.

Operator

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

Bruce M. Nudell - Crédit Suisse AG, Research Division

You guys did very well in U.S. Hips. There was sluggishness in U.S. Knees. What's that telling us if anything about the status of your kind of sales force adjustments in the United States?

David C. Dvorak

Well, I think, Bruce, you're right. We had categories that performed very well within the Americas. We had super performance in Surgical. We had a good performance in Hips, as you point out, within the Americas. More work to do in Knees. But again, as I was just explaining to Matt, Bruce, some of this is a bit of a lull before we move forward with what will be the biggest system launch in the company's history. And we're trying to get those details buttoned down just right and launch that system with absolute precision. So that's going to create that kind of a lull. I think we're weeks or maybe a couple of months away from seeing the traction of that new knee system, and that combined with the effort that we have undergoing to improve our commercial execution in the United States is going to put us in a really good place in the coming quarters.

Bruce M. Nudell - Crédit Suisse AG, Research Division

I guess just to follow up on that point. Should we -- what I was trying to say, I guess, is should we say that the -- should we look at the good performance in Hips, which may have been influenced by Vitamin E, as an indication that you've really made some progress in the U.S. sales force situation? And then my follow-up question really has to do with PERSONA because one of the -- could you just shed any light on how the more natural feel is accomplished? And is it something that could be kind of empirically demonstrated as opposed to kind of a word of mouth? Yes, it does feel better patient by patient.

David C. Dvorak

Sure, Bruce. I think on the first question or the first subject, I think we are making progress on the sales force side, but I would tell you that with the portfolio that we have and the products that we're rolling out, there's a lot more opportunity. I think if within our own world you want to score out a performance at a level that is consistent with our expectations, the Europe, Middle East and Africa performance is the one to highlight. They're in almost every product category and almost every country we're in a share-take position. And that's what we're going to strive to in all of our geographic segments. So while we're seeing some improvement in certain areas within the Americas in certain product categories, that needs to be consistent and across the board, and we're going to keep striving until you start to see some of the numbers in the Americas that you're seeing in EMEA relative to market growth rates. The second question on PERSONA, I would tell you that in due time, Bruce, we're going to come back to you and get much, much more granular about the benefits of that system. We're excited about it, but we're going to be disciplined about how we roll that out and how we make the disclosures around the benefits of the system. So bear with us a bit longer.

Operator

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

Unknown Analyst

This is Robbie in for Bob. Just wanted to know if you could give us a sense of how the Gel-One or power tool launches are going. I know you referenced it in your prepared comments, but how are those launches progressing? And if you could give us a sense of what you think the potential contribution from those products could be over the next 6 to 12 months, that would be great.

David C. Dvorak

Sure. And we know Bob gave you this question, so early stages on both of those launches. And there are some staging items until we get to a point where we're fully exploiting those opportunities. I would tell you on the power tools side, the valuation response that we're getting from potential customers is good. There is time between converting those positive evaluations into POs, and so that's progressing. We're very confident that on a global basis, we have a terrific opportunity to penetrate that market, and I think that you probably point out those 2 launches in particular because they're among the examples of new product categories. For us, there's no cannibalization in those categories. And so it's one of the reasons that we're going to see top line acceleration as we find more traction with those launches. So well received on the power tools. Gel-One, we're just getting going on that in earnest. Obviously, there -- we were in a bit of a holding pattern prior to the completion of the successful patent litigation just a couple, 3 months ago. So it's ramping up, but we're very confident as we get into 2013 with both of those products that we're going to see good results. I don't want to get into characterizing and scoring out the opportunity there yet. But we'll take that comment in mind as we get back on the next quarterly call and we'll try to provide you with some color on the guidance front, okay?

Unknown Analyst

Great. And just one more quick follow-up. Understand the delay in the timing with PERSONA is kind of impacting the U.S. Knee performance. But I was wondering if you could just talk a little bit in more detail about what changes you're making to the business on the sales or operation side to turn around the whole U.S. recon business and get it growing at market rates again. And also, how long do you think that will actually take?

David C. Dvorak

I don't think it's going to take us long. There -- it's a territory-by-territory management matter, and that's no different than anywhere else in the world for us. And so we have many territories that are performing very well. And obviously, when you look at that with the same bag of products competing against the same companies, you're looking for that performance to be brought up in areas that are underperforming, relatively speaking. And so that's the work that we're doing. And in instances it requires more investment and instances it requires leadership changes within those territories -- but I think our effort is well underway, and you can see that positive result with some of the product category results that we're delivering at this point in time. More work to do, but that effort that is ongoing along with these product launches are going to come together nicely as we get into 2013. So I think from a timing perspective, you should expect us to put together sequential improvement as we get into 2013. And we're going to keep striving away to try to put numbers on the board again that look like the EMEA performance in this quarter within the Americas. Those are our expectations.

Operator

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

Kimberly Weeks Gailun - JP Morgan Chase & Co, Research Division

It's Kim in for Mike. So a question on the sales outlook, and appreciate your comments on the fourth quarter. But you indicated a couple of times on the call that sales growth is expected to improve going forward. Is that something in light of the new product launches that you could frame for us at all going forward? So kind of from sort of flat to 2%, what kind of growth outlook should we be looking for in '13 and beyond?

David C. Dvorak

Yes, please let us do that in the next quarterly call as we give you guidance. I would tell you that the baseline would be the kind of numbers that we're putting on the board at this point in time, and we ought to be accelerating up. And if you take what we were providing in the prior quarter guidance as far as the second half and the ramp-up, I think it's fair to push that out a quarter or 2 and expect us to step up 100 plus basis points from that level. But we're going to frame that out for you much more specifically as we provide you with 2013 guidance.

Kimberly Weeks Gailun - JP Morgan Chase & Co, Research Division

Okay. Just a follow-up for Jim on the excise tax commentary. Can you explain why you think that's going to be lower now versus the prior expectations, and maybe if you could kind of frame or quantify that piece at least for '13?

James T. Crines

Sure, Kim. And we had -- prior to sort of understanding how more precisely the tax would need to be accounted for and we've done some research on this and have gotten technical sort of literature out of the independent accounting firms that tells us that, in our case, as I said, where we -- our first sale of devices is from -- happens within our consolidated group between the manufacturing entity and a distribution entity. The tax is assessed at that point. And as a consequence, the tax initially will be capitalized. We'll be paying tax from the first of the year, but it initially will get capitalized as an inventoriable cost. And if we assume at this stage, and we have more work to do, admittedly, that our inventory turns 2 times a year, what we were estimating before in the order of $40 million to $50 million of expense for the full year, half of that gets deferred. It just gets pushed out 6 months. So at this point -- and as I said we have a bit more work to do, at this point, we'd be estimating an expense that would be roughly half of our prior estimate and then building up to the $40 million to $50 million of expense when we get into 2014. And having it sort of continue to run at that rate off of and growing at in line with sales growth for our U.S. business.

Operator

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

David R. Lewis - Morgan Stanley, Research Division

Jim, I wondered if you could maybe go down the P&L here and talk about leverage. It looks like even based on fourth quarter guidance you're still on pace to deliver perhaps 100 basis points of EBIT leverage, because obviously you had a strong performance for the year. And I just want to take David's comments about needing to reinvest in the U.S. You have a significant number of new products coming heading into '13, so how do we think about the ongoing cost initiatives relative to David's comments about the need to reinvest? And you're talking about reacceleration on the top line. When we think about your strong EBIT performance in this particular year, can we expect similar levels of margin performance in '13?

James T. Crines

Let me -- I would just sort of to reflect back on what we communicated earlier this year in the context of our value creation framework, David, where we indicated in an environment where we see an opportunity for top line growth in low to mid-single digits, we're committed to run the business in a way where we deliver somewhere in the order of 8% to 12% growth in earnings per share. We've communicated that with respect to 2013 and EBIT leverage, it gets a bit more challenging to drive the kind of leverage you're seeing this year as we face into the medical device excise tax, which as we -- you know goes into effect in 2013. Now having said that, we now understand that, that tax is not going to be -- that expense is not going to be quite as significant as we -- as the $40 million to $50 million that I referenced in 2013. So that perhaps is going to provide us with some opportunity to invest in 2013 a bit more aggressively, whether it's in the sales channel or product development. But as we develop our operating plans for 2013, we sort of start with an objective that is aligned with those value-creation objectives that I mentioned.

David R. Lewis - Morgan Stanley, Research Division

Okay, that's helpful. And then David, just a quick follow-up for you on sales growth. It sounds like obviously the PERSONA deliberate delay here in the fourth quarter -- maybe delay is the wrong word, is the single biggest reason why maybe there's a slight depression in fourth quarter sales, and that should rebound next year. We've also seen in the last couple of quarters strength outside the U.S. and obviously some sluggishness in the U.S. Is it safe to assume that, that trend should reverse perhaps in the first quarter of '13 when PERSONA begins in earnest?

David C. Dvorak

I absolutely believe that in the first quarter of 2013, you're going to see the Americas business improve its performance. And I think that it'll continue to improve its performance sequentially throughout 2013, both by virtue of the commercial improvement efforts that we have undergoing that is to improve our execution within the Americas on the sales side, as well as the ramp-up of the product launches that we've been talking about.

Operator

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

Derrick Sung - Sanford C. Bernstein & Co., LLC., Research Division

So your pricing this quarter looks pretty stable, kind of similar to what we've seen, the declines that we've seen in the previous quarter. We have heard from some other companies perhaps a little bit of an optimistic tone. Maybe we're seeing a little bit of improvement in the pricing environment. I was wondering if you were seeing any of that. And kind of related to that, next year now that you will be facing that medical device tax, do you think that you'll be able to use that tax as any sort of leverage to at least maybe stabilize pricing or prevent further pricing declines next year?

David C. Dvorak

Yes, I think that from our perspective, it's a story of stabilization. We've seen very consistent trends in this regard throughout the full year as is evidenced by the fact that we've been within 10 basis points, that's the range, every quarter this year on a consolidated basis for pricing. So I understand the tone is maybe a hint at a more positive environment coming from some of the other competitive calls as they reported out their third quarter results. What we're seeing is stability rather than a reversal of those trends. And I think that in light of that, to carry that through into a belief that perhaps the med device tax is going to be capable of being passed on to customers, that probably is a bit of a leap forward in the pricing context for us at this point in time.

Derrick Sung - Sanford C. Bernstein & Co., LLC., Research Division

Okay. And then as a follow-up, the -- your Total Ankle launch, that's an exciting new launch. It gets you kind of new category for the first time. Can you talk a little bit about what -- whether you have a dedicated sales force that'll be selling that product, how you'll be incorporating that into your sales infrastructure and if you feel you have the infrastructure needed to -- that you need to really launch that product full force?

David C. Dvorak

That's a good question. We're very excited about this new product launch, obviously. This is a space that, frankly, is an area that is in need of a better solution, the standard of care being fusion. So the Total Ankle replacement system that we developed incorporates Trabecular Metal Technology. We're very excited about it. And furthermore, the surgical approach with a novel lateral approach is something that we think can be a real difference maker as well. So this is going to be one that we're very methodical at the launch of this system. The training on the technique is crucial. So it'll be a slow walk, a methodical process to get it just right as well. And as a consequence, any need to develop more focus or specialization within the sales force, Derrick, would be layered in as that product launches out. But it really will be the centerpiece and anchor to the beginnings of our lower extremity offering in that space that we look to expand as we broaden our extremities franchise as a whole.

Operator

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

Matthew S. Miksic - Piper Jaffray Companies, Research Division

I wanted to follow up with comments market [Technical Difficulty].

David C. Dvorak

Pardon me, Matt. You do sound like you're fading in and out.

Matthew S. Miksic - Piper Jaffray Companies, Research Division

Okay, so I did want to just follow up on one of your earlier comments on the market. Seen a lot of results this quarter and some good, some bad. But I had not heard folks on the ortho or spine [ph] talk of sort of a marked slowdown in the market per se, at least not in the U.S. I wanted to get some color on what it is that you're seeing, where you're seeing it. What do we think is driving the slowdown you mentioned?

David C. Dvorak

I think I got the gist of your question, Matt. So let me give you a little bit of perspective. Obviously, it's more difficult for us to give you better insights into the smaller product categories within our portfolio. We, just by virtue of the size of the business and the market share, can probably offer a bit of color in the large joint side. And that's a market that looks to us as though it slowed down sequentially from Q2 to Q3 by something like 0.5 point. And we believe that it was more profound in the case of knees within the United States. We believe that, that slowdown was probably more profound in the case of hips in the o-U.S. market.

Matthew S. Miksic - Piper Jaffray Companies, Research Division

Okay. Any -- and, I guess, any sense of sort of top-down observation? Or has it [ph] picked up any color from your folks in the field about this?

David C. Dvorak

No. You get all sorts of anecdotal explanations as to what's happened. And I think that there's no doubt that those summer months, people can speculate about the seasonality and whether or not that's changing. That's really difficult, and you get into a month or 2 of that. And you just need more time to examine whether or not there's a trend to be determined. So I think you just have to get deeper into the fourth quarter to better understand whether or not that's a procedural slowdown that is a blip or a bit longer in its duration. It's part of the reason that we're being conservative about the top line guidance for Q4. I don't think that there's anything fundamental about that in the sense that it's going to be a prolonged period or that this is a sign that the market is changing. I don't believe that at all. And then you can see some specific slowdowns in particular countries within a jurisdiction like our EMEA business. But again in EMEA, we're outperforming the market in a significant enough way to where that isn't affecting our results.

Matthew S. Miksic - Piper Jaffray Companies, Research Division

Okay. And then I wanted to just follow up with a product question. You talked a fair amount about eLIBRA. How does that -- I guess, we have an understanding of how custom cutting blocks or the PSI system benefits the company. If you could maybe talk about what's the revenue model or the benefit stream of eLIBRA. How does that work exactly. Just because it's a relatively new product for us.

David C. Dvorak

Sure. So it's incremental cost in the procedure, but the fundamental benefit of the eLIBRA system is it informs the surgeon when they're making their primary cuts, their initial bone cuts both on the femoral and the tibia side as to what that's going to get them by way of soft tissue balancing before they do their AP cuts. So whereas other systems sort of inform the surgeon after they've made all their bone cuts as to what they need to do with regard to soft tissue releases, the eLIBRA system allows the surgeon to have the information while they're in the bone -- the primary bone-cut phase of the procedure. It's integrated into their natural sequence and procedural algorithm. And the feedback information, because it's a sensor technology, allows them to get the bone cuts just right and mitigate the chance that they're going to come to the end of the procedure and have to do soft tissue releases. So when trained up and used properly, this can not only be a system that provides a better answer for the patient, a more natural-feeling knee because the soft tissue balancing is optimized, but it also can be integrated in a way where the surgeon is getting feedback at a point in time where they can become more efficient and avoid re-dos, avoid tweaking the soft tissue with releases at the end of the procedure.

Matthew S. Miksic - Piper Jaffray Companies, Research Division

And then the economics of this, I know you don't want to get into pricing, but is this -- should we think about it as something similar to maybe the premium that you get from PSI per case, something along those lines?

David C. Dvorak

Yes. That's the right way to think about it. That's the right way.

Operator

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

Kristen M. Stewart - Deutsche Bank AG, Research Division

I just wanted to go back again on this med tech tax and the rationale for why it's in cost of goods sold with the distributors. Is that just simply a function of the network that you guys have set up, just being these independently operated distributors? Because you're the only company so far that has kind of at least talked about putting it into cost of goods sold versus SG&A or even other expenses.

James T. Crines

Sure. Kristen, it's not that we have independent distributors. It's that within our consolidated group of companies, we sell from a manufacturing entity to a wholly owned distribution entity. We -- it's a structure we've had in place for many years reinforced frankly by the transformation initiatives that we're executing on where we have as, you may know, established a distribution hub for the U.S. market near Memphis. So it's really that the -- the inventory that leaves the manufacturing entity and is sold really through an affiliated company to the distribution entity is the point at which that tax is getting assessed under the statute. And it's really that, the fact that our supply chain is set up that way that leads us to account for the tax expense as a cost of goods. And this is very consistent with the way in which the excise tax that was imposed in Puerto Rico a couple of years ago was accounted for as well. It's a manufacturer's tax, which is why it ends up being accounted for as an inventory cost.

Kristen M. Stewart - Deutsche Bank AG, Research Division

And I assume it's still tax deductible at the end of the day too?

James T. Crines

Yes.

Kristen M. Stewart - Deutsche Bank AG, Research Division

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

James T. Crines

That's right. And I'd be surprised if we were the only company that has the supply chain set up in that way.

Kristen M. Stewart - Deutsche Bank AG, Research Division

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

James T. Crines

Sure. So coming into the year, we had talked about the actions that we would be able to get completed this year would generate $80 million of savings on an annualized pretax basis with an expectation that we would realize $30 million to $40 million of that in 2012. We communicated on last quarter's call that the programs are on track. I would tell you they're still, they remain on track. And when you take that $80 million that is generated out of this year's actions and add that on top of the savings that were derived or realized from the actions we took in 2011, we come out of 2012 at a run rate of $130 million to $140 million in total. Now admittedly, some of those savings are being reinvested in the business in the short term, as you know, to accelerate our certain technology and product development programs, a number of which we've touched on, on this call, also to cover some of the short-term dilution that comes with acquisitions. We've done a number of admittedly small but -- acquisitions, but typically, there is some dilution that comes with those acquisitions in the short term. And also continue to build out the channels in our emerging markets and support some of the other investments that we're making in those emerging markets. So that -- the extent to which we need to reinvest those savings is something that we look at in some detail as we go through the operating -- development of our operating plans. We haven't completed that yet for 2013, but we'll have decisions to make around how much of the $130 million to $140 million we can reinvest and how much needs to be dropped through to the bottom line to deliver on the goals that we have with respect to earnings growth. And we are still targeting $400 million in total by 2016 and are on track to hit that target.

Kristen M. Stewart - Deutsche Bank AG, Research Division

Perfect. And then just a quick last one, I guess, since you brought up emerging markets. I was wondering if you could give your perspective on how you're looking at China. I know Medtronic just announced that they were buying a company, orthopedic company there. How do you kind of see your China business shaking out?

David C. Dvorak

We are executing a plan that was developed several years ago in China, Kristen. It's a market that we're very focused on. We've had a terrific distribution channel team over there for years and years and then augmented that with the acquisition of Beijing Montagne almost 3 years ago now. And so I think that we have the building blocks of what we want to do at least on the large joint side within China, but it's a market that we're going to continue to make investments in both on the distribution channel and product side and likely as well on the operations side going forward. And we're growing that business at a very attractive rate at this point.

Operator

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

Lawrence Biegelsen - Wells Fargo Securities, LLC, Research Division

I just wanted to clarify, it's been asked on this call a few times, the value creation goal is 8% to 12% EPS growth. Do you still think you can get there in 2013 in light of the lower expense to the medical device tax that you articulated in this call in 2013? And would you be disappointed if the top line growth in 2013 was not higher on a constant currency basis than in 2012?

David C. Dvorak

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

Lawrence Biegelsen - Wells Fargo Securities, LLC, Research Division

Okay, great. And then in Europe, your results this quarter were very strong, even adjusting for the extra day. Can you talk about the sustainability of that, please?

David C. Dvorak

Yes. They were very strong, and that team deserves all the credit for generating those results. If you look at the last many quarters, they put terrific numbers on the board. And if you go back a couple of years, all of us were having discussions about what a drag the European business might be to our overall results, anyone within this industry. And that's a commercial team that is finding a way to get to the growth, and where there are natural opportunities because of the market growth rates, they're financed through share gain. So they're doing a terrific job. I would tell you that I have absolute confidence that they're going to be able to continue to grow above market rates. I think that this quarter is a pretty extraordinary accomplishment. I'm not sure that, that level of above-market growth rate is reasonable to expect every quarter. But with the momentum that they have, they're going to continue to do well relative to the market. Some of the ramifications or practicalities of that extraordinary result that they produced in the third quarter is a reason that we're a little bit cautious about our guidance in Q4 in the sense that you're asking them a lot to keep stringing those kinds of quarters together. But we're going to do very well in that European business for the coming quarters and years in my view.

Operator

Your final question will come from the line of Michael Matson with Mizuho Securities U.S.A.

Michael Matson - Mizuho Securities USA Inc., Research Division

I guess just with regard to the selling days, with 1 less selling day in the U.S., and I guess 1 additional selling day in some of the o-U.S. regions, I assume there was still a net negative impact to your revenue growth just given that the U.S. is so much larger. Is that a fair assessment?

David C. Dvorak

It's pretty close to a wash, Michael, on billing days in Q3. I mean, you're right, you lose a day in the Americas, pick up a day in Europe, pick up a bit more than a day in Asia-Pacific. And so the math works out to be essentially a wash within the quarter. And then looking at Q4, Americas is even year-over-year. We pick up part of a day when you average it all out in Asia-Pacific, but we lose 2 days in Europe in Q4, which impacts the growth rates sequentially there.

Michael Matson - Mizuho Securities USA Inc., Research Division

Okay. And then can you give us an update on your PSI instruments for your Uni Knee. Are you seeing any traction there? What's the initial uptake and demand for that system look like?

David C. Dvorak

That's a good question. We've been pleased with the uptake of PSI for our ZUK product. And we're looking to further develop the application of our intelligent instruments within the Uni space because we think it can be a difference maker. That, in our view, is an underpenetrated market, and in some of the medical training education as well as the intelligent instruments can be a difference maker in allowing more surgeons to take advantage of that solution where the appropriate or the patient presents in an appropriate way. So I would tell you that the uptake of PSI in the context of ZUK has been faster than it was in primaries as a percentage of total procedures that we're involved in. And I think that, that'll be a place where the -- again the total package of technologies within intelligent instruments will be a difference maker going forward.

Michael Matson - Mizuho Securities USA Inc., Research Division

Okay. And can I just squeeze one more in, the Dornoch acquisition? What's the revenue contribution for that or what was the run rate? Can you quantify that?

David C. Dvorak

Yes. In round numbers, it's a $10 million business at this point in time. And obviously, that's not the point of the acquisition for us. This rounds out our surgical portfolio, puts us in a very competitive position. It's good technology. That's another market that is underpenetrated in the sense that the standard operating procedure within the hospital systems is to red-bag the fluid waste that is developed through these procedures. And so we think that there's a lot of upside within that space. We have a much, much more comprehensive portfolio now than we did a couple of years ago. And so we're looking for big things from that division going forward.

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

We look forward to speaking to you on our fourth quarter conference call at 8 a.m. on January 31, 2013. I'll turn the call back to you, Regina.

Operator

Thank you again for participating in today's conference call. You may now disconnect.

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