Zimmer Holdings (ZMH) reported an adjusted EPS of $1.21 during the second quarter of fiscal 2011, surpassing the Zacks Consensus Estimate of $1.19 and $1.09 in the corresponding quarter of fiscal 2010.
Zimmer reported revenues of $1,137 million during the quarter, 7.5% higher than the year-ago period (2.1% at constant exchange rates, CER) and beating the Zacks Consensus Estimate of $1,129 million. While revenues recorded from Americas remained unchanged at $608 million, revenues from Europe and Asia-Pacific increased 17% to $325 million and 19% to $204 million, respectively.
Zimmer’s biggest segment, Reconstructive Implant, recorded a 6% increase in revenue to $857 million driven by growth in Asia Pacific (17% to $151 million), Europe (16% to $257 million), partially offset by a 2% decline in Americas to $449 million. Revenues from Knees (within Reconstructive), Hips and Extremities recorded growth of 4% to $471 million, 9% to $345 million and 7% to $41 million, respectively. In the past few quarters, Zimmer introduced several new products under the Knee segment which were expected to drive revenues.
Among the other segments at Zimmer, barring Spine that declined 3% to $56 million, growth was witnessed across all other businesses including Surgical and Other (13% annually to $88 million), Trauma (20% to $69 million) and Dental (20% to $67 million).
An 8% increase in revenues coupled with a 15% rise in cost of products sold resulted in a 160 basis points (bps) decline in gross margin during the quarter to 74.7%. Moreover, lower gross margin along with a 5% rise in research and development expenses and a 7% increase in selling, general and administrative expenses led to a 130 bps decline in operating margin to 28.4%. However, Zimmer benefited from a 31% decline in interest expense, lower effective tax rate and a 5% lower share count.
Zimmer exited the quarter with cash and cash equivalents of $624.1 million compared with $668.9 million as of December 2010. Debt burden of the company remained almost unchanged at $1,147.3 million. Operating cash flow for the quarter was $251 million. The company repurchased 1.8 million shares for $121 million during the quarter and is left with $848.6 million of authorization, which expires at the end of 2013.
Outlook
Zimmer updated its outlook for 2011. The company now expects to report adjusted EPS of $4.70−$4.80 (previous guidance of $4.60−$4.80) and $4.25−$4.35 ($4.25−$4.45) on a reported basis. The company now expects to report revenue growth of 2.5−3.5% (2−4%) at CER. Currency movement is expected to boost revenues by 3%, which in turn would lead to reported revenue growth of 5.5−6.5% (5−7%).
Our Recommendation
Zimmer offers a broad line of reconstructive implant and trauma products, as well as orthopedic surgical instruments and supplies. We believe that the company has embarked on its growth trajectory with new product launches, employment of new technologies and expansion into the emerging markets.
However, Zimmer continues to witness challenges in the form of pricing pressure and lower procedure volumes resulting from economic uncertainty. Moreover, the company faces tough competition from players such as Smith & Nephew (SNN), Johnson & Johnson (JNJ) among others.
We have a ‘Neutral’ recommendation on the stock, which also corresponds to the Zacks #3 Rank ('hold') in the short term.
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