Filed by Zimmer Holdings, Inc.
Pursuant to Rule 425 under the Securities Act of 1933
Subject Company: Centerpulse AG
(Registration No. 333-105561)
Subject Company: InCentive Capital AG
(Registration No. 333-105562)
The following is a transcript of a conference call conducted by Zimmer Holdings,
Inc. on July 24, 2003.
ZIMMER
MODERATOR: RAY ELLIOT
JULY 24, 2003
7:00 AM CT
Operator: Good morning. My name is (Leslie) and I will be your
conference facilitator today. At this time, I would like to
welcome everyone to the Zimmer second quarter 2003 financial
results conference call. All lines have been placed on mute
to prevent any background noise. After the speaker's remarks,
there will be a question and answer period. If you would like
to ask a question during this time, simply press star then the
number 1 on your telephone keypad. If you would like to
withdraw your question, press the pound key.
This presentation contains forward-looking statements based on
current expectations. Estimates, forecasts and projections about
the orthopedic industry, management beliefs and assumptions made
by management. These statements are not guarantees of future
performance and involve risks, uncertainties and assumptions that
could cause actual outcome and results to differ materially
from those in the forward-looking statements. For a list of the
risks and the description of the risks and uncertainties see the
disclosure materials filed by Zimmer with the U.S. Securities
Exchange Commission. Zimmer disclaims any intention or obligation
to update or revise any forward-looking statement whether as a
result of new information, future events or otherwise.
This presentation also contains non-GAAP financial measures. A
reconciliation of such information to the most directly
comparable GAAP financial measures will be furnished in our form
8-K filed with the SEC and may be accessed from the Zimmer
website at www.zimmer.com. This presentation is neither an offer
to purchase nor solicitation of an offer to sell any securities.
Zimmer exchange offers for shares of Centerpulse and InCentive
Capital are being made only through registration statements and
related materials.
Zimmer and its directors, officers and other members of its
management and employees also are soliciting proxies from Zimmer
stockholders in connection with the exchange offers. Investors
and security holders should note that the exchange offers have
not been agreed to by Centerpulse or InCentive Capital and are
subject to certain conditions. In connection with the exchange
offers, Zimmer has filed registration statements on form S4, each
containing a prospectus offer to purchase and a proxy statement
on Schedule 14A with the U.S. Securities and Exchange Commission
and submitted Swiss offer prospectuses to the Swiss take over
board. Investors and security holders of Centerpulse and
InCentive Capital and Zimmer are advised to read these disclosure
materials including other disclosure materials when they become
available.
Because these materials contain important information, investors
and security holders may obtain a free copy of disclosure
materials and other documents filed by Zimmer with the U.S.
Securities and Exchange Commission at its
website at www.sec.gov. These disclosure materials and other
documents of Zimmer may also be obtained from Zimmer upon request
by directing such request to Sam Leno, Senior Vice President and
Chief Financial Officer of Zimmer. You may proceed.
Ray Elliot: Thanks very much (Leslie) good morning everyone, welcome to
Zimmer's second quarter 2003 conference call. Please
(unintelligible) in this call and discuss the solid quarter and
continued good beginnings to 2003. Today's call will be scheduled
for one hour. Joining me on the call today are Sam Leno, our
Senior Vice President and Chief Financial Officer and Jim Crines
our Vice President and Corporate Controller.
Hope you received a copy of last nights earnings released. If not
you can obtain a copy from our website at www.zimmer.com.
Alternatively please feel free to contact to Sam, who will have a
copy faxed to you as well as add you to our email distribution
for future releases. We will begin today's call with brief
comments related to our second quarter results including and
update on operations followed by a Q&A discussion. All results
discussions are based on an asset method of accounting for
instruments for 2003 and an expense method for 2002.
We will be focusing our conversation with you on our results and
it's not our intention to devote time at this session to our
proposed acquisition of Centerpulse. Having said that, I do want
to contribute one thought with respect to our Zimmer team. The
ability and task of taking 55 full time people 100% from their
job and delivering more than 10,000 man hours of due diligence
composed of 200 Centerpulse interviews and some 2,000 pages of
original material in less than three business weeks without
allowing the company to become defocused from it's quarterly
financial goals and
obligations is a real and rare accomplishment. And I particularly
wanted to publicly commend out team.
Let me begin with the fundamentals of our consolidated P&L and
balance sheet performance. Consolidated sales for the second
quarter were 411 million and increase of 19% over prior year, a
sequential increase of more than 5% form the first quarter and
approximately $5 million higher than current consensus street
expectations. Worldwide sales and constant currency increased
14%. This continues to (unintelligible) our performance was
importantly led by real volume mixed growth of 12% in the quarter
which was 1% better than prior years second quarter.
Worldwide price improvement remained firm at 3% and the America's
at 4%. We believe price is beginning to settle end up rates
closer to what we expect to see in 2004. Our America's business
continues its excellent growth in the quarter at 17% and Europe
has dramatically increased reported growth and gain verses prior
year to 43%. More on Europe later.
We experienced improvement in each and specific sales growth to
11%. On a year to date basis, worldwide sales increased 21%
reported to 801 million and 16% constant currency, with the
America's and Europe delivering the strongest results at 18% and
44% respectively. For your reference, all year to date earnings
related discussions exclude the cumulative discussion of 55.1
million relating to the change in accounting policies for loaner
instruments implemented during the first quarter.
Diluted earnings per share for the second quarter were extremely
strong at 45 cents, and increase of 32% over the prior year and 3
cents better than first call consensus street estimates. Year to
date diluted the (unintelligible) results were 85 cents and
increase of 37% over prior year. We continue to be very
pleased with our companies efforts to drive each line of the P&L
to an earnings growth always greater than sales and of course an
excellent free cash flow.
In the second quarter, costs of goods sold increased by only 16%
verses a 19% increase in sales. As noted in our press release,
Industry Week just named Zimmer one of the 50 best manufacturing
companies. Gross profit donors increased by 20% and gross profit
margin verses prior year improved by another 80 basis points to a
record 76%. This gross profit margin of 76.1% was sequentially an
increase of an additional 90 basis points from first quarter
2003.
We believe that at 75.6% year to date our gross margins remain
the best in the industry. SG&A expenses continue to be very well
managed at 37.8%. A 210% basis point improvement over second
quarter 2002 and a sequential improvement over 60 basis points
from first quarter 2003. For your reference, over a full
three-year period, we have delivered exactly 400 basis points of
cumulative improvement in SG&A, from the 41.8% ratio recorded in
the second quarter of 2000 to the 37.8% this quarter.
Thirty seven point eight percent is Zimmer's lowest quarterly
SG&A ratio to sales since we began the turn around in 1998. For
the quarter and consistent with the type of performance that
we're looking for, SG&A expenses increased only 13% despite a 19%
sales increase. Year to date SG&A expenses to sales are 38.1% a
230 basis point improvement over prior year. We continue to be
very pleased with the positive earnings drop through gained from
new sales. Each incremental sales dollar in the second quarter
costs only 27 cents of incremental SG&A spending. Our lowest cost
per new sales dollar since we became a public company.
This consistently translates into as our current gross profit,
almost 50 cents in new operating profits for each incremental
dollar of sales above our prior year base. While our ability to
lower significant positive drop through operating earnings
eroding the sales dollar has long been a driving force behind our
strategy and I would add a crucial EPS creation edge, it also
provides broad flexibility for potential reinvestment.
We continue to successfully operate another key strategy a
working dollars model, defined as driving down cost of controls
G&A expenses and cost of working capital while simultaneously
investing in high ROI sales and a prolific pipeline, through
premium products and procedures developing. This particular model
is entering its fifth year of successful use of the metric,
consistent with that working dollar splicing, we are exiting our
plans to invest in RSE at the top of the class. With our target
approximately 6% of sales and this quarter is at 5.5% albeit
against a higher revenue base.
Perhaps a better measure of this quarter our R&D investment at
$23 million increased by 3.5 million or 18% in absolute terms
verses the second quarter of 2002. On this base, we are very
close to annualizing at $100 million per year in R&D investment.
Our year to date R&D ratio is also 5.5% with real R&D dollar
spending up 15%. We're please to report that operating profits
three and a quarter by 30% above prior year an increase of 290
basis points. These results continue to reinforce our strong
believe in the capability of Zimmer and the industry to
repeatedly deliver accelerated earnings in a positive sales
environment without sacrificing any key sales, marketing or R&D
investments.
These results represent significant overachievement of one of our
original internal milestones, a 30% operating margin. This
quarter we delivered an all time Zimmer record of 33% operating
margin to sales with year to date not far
behind at 32%. Net earnings in the period were strong and
increased by 35% based on solid operating profits, declining
interest expense, down to only $900,000.00 per quarter and the
reduction to a prior year tax rate to from 34.2% to 33.5%.
Net income has reached $89 million for the quarter but as
important driven by a 250 basis point improvement over prior
year; we have easily surpassed another original internal
milestone of a 20% ratio to sales. During the quarter, we
achieved a record 22% net earnings ratio to sales. As noted in
our press release, all three key margin indicators gross,
operating and net, delivered all time Zimmer records. As
previously mentioned, diluted EPS in the quarter increase 32% to
45 cents, with 199 million average diluted shares outstanding. We
are particularly please with that 45 cents, because it reflects
strong performance on not one or two lines but rather on every
single line of the P&L.
Year to date EPS was 85 cents and increase of 37%. At this point,
I'll provide some very brief introductory cash flow and balance
sheet highlights. Free cash flow for the quarter and year to date
was at the extremely favorable end of our expectations
registering 90 million and $162 million respectively. Operating
cash flow in the quarter was our best ever at 122 million and 227
million year to date. In the quarter inventory has been increased
from 15 million to 281 million and in the building of multiple
new product pipelines and as indicated from previous conference
calls, that 257 days remains within our near term forecasted
range of 250 to 260 days.
Consistent with prior quarters, our fill rate accuracy is more
than 98%, global forecast accuracy is more than 90%. Asset
management focus dedicated infrastructure and persistent working
class methods continue to drive effective performance. Our
industry leading receivables collections continues to
provide support for superior cash flow production and helps us to
define some of the top balance sheet metrics in the medical
device industry.
In the second quarter, we continued our U.S. receivables at a
record level of 31 days for a $1 billion hospital business with
terms of net 30. We would be remiss in not recognizing a
contribution of Zimmer's international businesses who have helped
to deliver a second quarter receivables number of 57 days
globally.
Also in the exciting news on the P&L is our record margins and 45
cents in EPS. The exciting news on the balances sheet is all
about net debt. We are extremely pleased to report that we are in
a net positive cash position of $39 million produced by the
combination of 115 million of cash on the balances sheet offset
by 76 million of very inexpensive Japanese Yen debt that we have
elected to retain. The reasoning is simple; we earn more on the
money from the spread of the U.S. excess cash than we pay in
Japan interest.
In approximately 21 months as a public company, we have fully
paid down our original net debt, a reduction of almost half a
billion dollars. For the 3,600 undoubtedly nervous Zimmer
employees staring at a somewhat unknown future and 450 million in
debt with no equity on August 7, 2001, they can now be equally
confident that the mortgage has been paid.
Let's review the quarter sales in a little more detail.
Reconstructive structure sales for Zimmer is the revenue
recognition of hips, knees, shoulders and elbows implanted into
patients during the reporting period. For the second quarter,
worldwide reconstructive sales increased to 327 million,
representing a strong reported increase of 22% over prior year,
17% constant currency and a 6% sequential increase over first
quarter 2003. The 17% constant currency increase over the prior
year in the quarter is a particularly important
accomplishment with the second quarter of 2002 verses 2001
comparison was a difficult 21%.
A 17% over 21% is the toughest local currency reconstructive comp
accomplishment in the industry and should prove to easily be the
top reconstructive growth in the quarter verses our major
competitors. This is a solid achievement in light of Zimmer's
reconstructive sales basis more than $1 billion. Year to date
reconstructive sales were 637 million and increase of 24%
reported and 19% constant currency.
Many analysts believe that on a reported basis, worldwide
reconstructive markets were approximately 15% for 2002. Based on
the public reports of our major competitors, we can assume local
currency worldwide recon market growth in the second quarter 2003
was approximately 14%. Based on this fact, Zimmer has again
expanded its rate of growing faster than the market by more than
20% this quarter.
Let's take a close look at each global product in geographic
segments. First product in the knee category, on a worldwide
basis in the quarter, knee sales increased 24% to 183 million
verses prior year and 18% constant currency. These results
include a sequential growth of 6% verses first quarter 2003 and
compares to a 22% constant currency growth achieved in second
quarter 2002 verses 2001. In other words 18 over 22 has a local
currency cost. In dollars on a reported basis, this represents
Zimmer's knee gains up more than $2.5 million per week verses the
prior year quarter, or stated differently there are many more
than 500 new Zimmer knees implanted every single week this
quarter that weren't there the same quarter last year. By
anyone's standards, that's a lot of new knees.
Our global knee strategies are obviously paying off with
consistent significant market share gains. Not a few countries
but literally everywhere. In the second quarter, the Zimmer
businesses in the domestic U.S., Latin America, Germany, Austria,
The United Kingdom, Italy, Spain, Norway, Sweden, Finland,
Russia, Central and Eastern Europe, Australia, China, the middle
East, Africa, and the Mediterranean, all remarkably delivered not
reported but local currency knee sales growth in excess of 20%
to prior year. The successful introduction of Prolong the
especially designed crosslinked polyethylene for NexGen cruciate
retaining knee articulating surfaces is simply delivering great
results.
In less than one year on the market, Prolong in the quarter
represent 11% of our total knee articulating surface sales and
nearly 35% of all cruciate retaining articulating surfaces. The
market uptake for craft linking and Zimmer NexGen CR Knees is
only very slightly below what early stage longevity cross-linked
poly liners were for hips. In addition to early Prolong success,
we have recently launched Trabecular metal mono block tibial
trays, the annual trend on this single product has doubled in
only three quarters to an amazing $20 million per year. With
demand at this point partly a stripping supply.
For the new NexGen Trabecular metal mono block tibial tray, this
represents not only immediate technological and commercial
recognition, but a real believe in a new porous fixation solution
for knees. Our terrific early success with Trabecular metal
tibial trays reflects a changing market less likely to tolerate
osteolisis created by backside wear. Last quarters down
classification of porous knees will only enhance what we already
know and expect to be a broader acceptance. Our Zimmer MISMG Unis
have grown on a worldwide basis another 14% in the quarter as
results begin to "lap" prior year consecutive 100% growth comps.
The Zimmer M/G UNI with both "EM" and "IM" minimally invasive
instrumentation finished the quarter with sales projecting to be
more than $40 million annually in 2003 and it remains the most
popular single brand in the world!
Our NexGen LPS-Flex knee, a Zimmer "lifestyle-design" product has
continued to gain share in dramatic fashion during the quarter.
On a worldwide basis, LPS-Flex femorals grew by another 54%
versus prior year but this is also a very powerful 11% sequential
increase from the first quarter. I'll update you on the progress
of its "sister" product, the CR-Flex during our project
development section. On a different version of our Flex knee and
thanks to some effective competitive subsegment marketing on
surface hardened knee femorals, we also enjoyed a 77% increase in
our NexGen Co-nidium Flex knee sales during the quarter. We are
now expecting to approach, surprisingly, $20 million in annual
Co-nidium flex sales for the most part without the domestic U.S.
market. Co-nidium is a 5 year old, Zimmer patented process to
harden the surface of a cobalt chrome femoral. Co-nidium is not a
coating but a permanent surface reaction caused by controlled
exposure to nitrogen. While Asia has been a successful proponent
of this product, we will, of course, take an aggressive and fresh
look at the large domestic U.S. market for Co-nidium Flex knees!
Zimmer revision continues it's upward trend with an the NerGen
LCCK system delivering a 21% increase over the prior year. Our
new RHK rotating hinge has quickly become a $10 million product
line in the very early stages of its product life cycle. Of
course there's considerable progress in the Zimmer minimal
invasive knee front and I'll update our activities later under
hot topics.
Let's take a close look a hip. On a worldwide basis in the first
quarter, hips and sales increase 19% to 133 million. A strong
sequential increase of 5% and grew 15% constant currency. On a
year to date basis, hips grew 22% to 250 million and 18% constant
currency. Zimmer forced them to continue to make meaningful
market share gains and to accelerate their more than two year
long growth run with an increase of 33% in the quarter. Zimmer
VerSys fiber metal taper-stem, long a standard in our line up,
grew more than 90% in the quarter. This product has become the
stem of choice for Zimmer MIS2 incision hip procedures, but more
on this later.
Porous revision stems, along with revision cuts and liners
continue to be an area of focus for Zimmer and our sales
supported that with an increase of 30%. These results include our
ZMR product line, which on a stand-alone basis remain well above
prior year. Our new proximal support design enhancements for ZMR
are expected for the late summer and we anticipate a continued
upsurge in sales for Zimmer's entire revision hip line but
particularly the ZMR in Europe.
Zimmers' primary acetabular shells grew 24% in the second
quarter. Trabecular metal mono block cups alone has quickly
become a new $10 million plus product line. Despite extreme tough
comps, significant penetration and the second quarter U.S.
competitive introduction of ceramic on ceramic alternate bearings
premium-priced longevity highly crosslinked in polyethylene shell
liners increased by 33%. Sequentially after a very strong 7% over
the growth
that we saw in the first quarter and the annualized for the first
time ever to be a $50 million product line.
We now believe competitive surgeon acceptance is growing with a
continuing stream of scientific analysis from in vivo retrieval,
new RSA studies and differentiations specifically as it relates
to Zimmer's Longevity brands.
We released our national marketing campaign titled Limit Wear
that favorably reviews longevity highly cross-link poly
capabilities verses ceramic on ceramic limitations to a great
reception from our surgeons. The proof of course is always in the
pudding. All Zimmer liners in the quarter, regular poly,
cross-link and revision were up 28% the prior year, a nice
quarter.
In upper extremities joint, Zimmer Biglian-Flow replacement
shoulders continue to take market share in the world with 24%
growth in the first quarter - excuse me in the second quarter and
27% year to date despite the release of several new competitive
shoulders over the last 12 months. Based on our year to date
results, our annual sales projections for shoulders and elbows
continues to easily exceed $50 million.
Our worldwide basis trauma sales for us has continued somewhat
soft with second quarter sales up 8% and year to date 9%in
markets that we believe are growing 10 - 11%. Our review of the
market, schedule of new products, early surgeon response to new
ITST retrograde mail, as potential account convergents has not
seemed to indicated any significant negative long term underlying
issues, provided that the ITST can recover some lost mail share
in both the U.S. and Japan. With or without Centerpulse, Zimmer
will strategically require a titanium nail line to compete more
effectively.
Several sub segments in our trauma line are notaring excellent
results. Our Zimmer perioticular plates are continue their strong
penetration against the trauma market leader with 51% growth in
the second quarter. In orthopedic surgical products, ortho pads
or perio-operative other transfusion systems designed
specifically for RSP increased by 53% in the quarter and
continues to generate sales of 28 million - $20 million annually.
Let's look for new product development update. As you know we
currently have more than 30 active major projects and a robust
pipeline with most of those scheduled for release during 2003.
Including in the 30 plus projects are 12 new projects added to
full development and another half dozen or so that are under
pre-phase 1 review for 2003 alone. Our goal is to provide you
with project name, scope and whether we will release to continue
on schedule.
In these developments and commercializations, our patented our
rotating hinge knee the RHK was released and is already scoring
some strong sales successes. Trivexian metal xgen tibial
components, 32 million plans were released and similar to the RHK
have shown very strong early sales. We have of course in recent
times initiated three new knee projects as follows; both the CR
flex 6 and mobile continue on plan, following the footsteps of
our highly regarded LPS flex our first implantation was concluded
successfully December 2, 2002 in Utah. Since then some 575 CR
flex 6 additional surgeries have been performed. We anticipate
strong acceptance of CR flex 6 141 new implants.
There's some great news on our launch pattern. The cemented and
porous products will now roll out late this summer, with only the
porous HAT coated scheduled for January 2004. The opportunity is
a huge one. Globally the knee market is still almost 50% crucient
retaining and as a precedent, we already have sales of more than
20,000 posterior stabilized flexing on an
annual basis. In addition to prolong, craftsman is calling for
the LPS flex posterious stabilized remains on scheduled for the
2004 new product release.
A new portella femoral project with some potentially unique
clinical solutions completed a full cadaver development session
at the Zimmer institute in June and continues on schedule. Our
new fixed and mobile bearing unit incorporating both Trabecular
metal and prolong cross-link poly completed two full cadaver
sessions and the 148 new instruments remain on schedule as 2004
new products. Now our MISTKA systems of minimal invasious knees
or MIS mini and our QS or quad sparing knee updates will be
covered under hot topics.
Now lets move to hip development and commercialization. The
Apollo system project, 358 new porous hips stems due for stage
and release for 2002 and 2003. Almost 200 stems were released
along with full instrumentation during 2002. The new Apollo stems
that have been released have already jumped in sales to over $20
million plus product line. The remaining six inch full coat
extended off these stems as well as the eight inch and ten inch
straight and bowed stems are scheduled for the third and fourth
quarters of 2003 with the major new product impact in 2004.
Trabecular metal modular cup, this project has been increased in
size from 13 implants to 61 implants from the original 48. The
project release date has been delayed during our first quarter
conference call to the second quarter 2003. I am pleased to
report that we've implanted our first ten cups in June and there
are more than 2000 cups and finished good inventory with our
roller already initiated.
Our new MAYO conservative hip stem, with and without HATCP
coating and with new MIS instrumentation, will be launched in the
July to August period
of this summer. We have also just received high 10-K clearance
for the release of ZMR large junction composed of 58 implants for
the full launch of both the taper and porcelain components ahead
of schedule this month. An encounter development of
commercialization perioarticular to or contoured plating system
with 289 new implants for phase and launch has just completed
final release and is already quickly contributed in part to our
50% in plus growth in periplates.
Fracture crasher blade plates will be released this quarter and a
new foot and ankle set for next quarter. Importantly new
peri-locking style plates are being prepared as a key 2004 trauma
new product. A major license agreement will provide Zimmer with a
new external fixation wrist system called wristore, that we are
excited about for 2004 and of course during the second quarter,
we purchased 100% ownership of the Immedica TransFix and external
fixation products for better control development, manufacturing
and expanded margins through vertical integration.
We have initiated approximately 12 new internal R&D projects,
some of which we have already provided initial comments on.
Although for the most part, it's too early to provide real
project status reports, I would remind you of their contents. The
projects themselves represent a very specific insight into
Zimmers organic growth strategy. Trabecular metal stems,
dedicated MIS stems, Zimmer safe metal oncology system, new MIS
units, unique design concepts for three consecutive advanced
levels of our MIS total knee, a new techonology shoulder, MIS
spine, MIS transformational hip fracture solutions and a myriad
of co development and investment opportunities in biologics image
guidance and the operating room of the future.
In short, they represent innovative, premium priced products and
procedures, rich in Zimmer intellectual property and designed for
profitable market share gain and landscape change in Orthopedic.
In total on a rolling 36 month basis, new products represented
17% of our sales in the second quarter, consistent with our long
term strategic goal since 1999 to have internal new products
sales between 15 and 20% on an annual basis.
Let's look briefly at the geographic segment, first in the
America's. We delivered another excellent quarter in the
America's. Revenue for the second quarter was 274 million up 17%
over prior year and that's measured against the difficult top of
20% for the second quarter 2002 verses the second quarter 2001.
We continue to be very pleased with our progress. Thirteen
percent of our growth in the America's was driven by increases in
unit volume and mix a remaining 4% growth was derived from price
increase.
Our America's reconstructive growth in the quarter was 20%. This
would imply that in the America's during the quarter, we had
mid-teens level gains in surgical procedure unit volumes for
hips, knees, shoulders and elbows. Included in our 20% America's
reconstructive growth, knees delivered excellent results again
with a 22% increase to prior year. Most importantly though this
22% knee growth should be judged against the incredibly tough
comp of 26% knee growth in second quarter 2002 verses 2001. A 22%
growth over the 26% growth. (Unintelligible) to record metal
tibial components and NexGen LCCK revision knees all made
substantial contributions to the America's knee performance.
Since there is generally little mix associated with knees this
would indicate once more a surgical procedure unit growth in the
quarter for Zimmer knees in
the America's of close to 20%. Hips in the America's increased
19%, Zimmer porous stems at 63% of mix, surpassing for the last
trailing 12 months cemented stems in unit sales. In total, we
have been growing in the America's reconstructive product on the
average of 20% or more each quarter for three years now. Big
(unintelligible) public report of our three major competitors'
Biomed, J&J DePuy and Striker a market growth and domestic
reconstructive products for the quarter is estimated to be about
15%. It's clear therefore that at 20% reconstructive growth
Zimmer's continued as a rate or market growth to the America's
again by more than 30%.
Trauma product sales only improved by 5% impacted positively by
our new perioarticular plate offerings and very early IT&T
activities but significantly offset somewhat by solid competitive
IM nail releases. Although a much smaller segment, we have work
to do here both in IM nail penetration and new products. In
patient care, OrthoPat available only in America's continue to
attract acceptance and became a $20 million annual product line
as described in my earlier remarks.
Our overall sales success in the America's is truly broad based.
Every U.S. distributorship grew significantly but almost half of
our 26 distributorships grew to reconstructive business by more
than double the estimated U.S. market growth. Importantly the
America's operating profit margins in this quarter increased by
an amazing 410 basis points to a record 52.4% from 48.3% prior
year. This is the real earnings payoff for real market share
gains.
In Asia Pacific revenue for the first quarter was $76 million
indicating a reported increase of 11% 2% constant currency and
146 million 15% reported and 6% constant currency year to date.
Asia Pacific had flat price in the second quarter as we
anticipated. Starting healthcare budget deficits in South
Korea and Taiwan has moderated a small positive growth increase
this quarter. While price reduced growth have a 1% as expected,
the SARS epidemic did have indicated in their press release
and estimated 5% or $3 million growth impact in the quarter for
Asian Pacific.
It just barely kept the worldwide Zimmer holdings from obtaining
a 20% growth in the quarter overall. Our strong number one market
share positions in Taiwan, Singapore, and Hong Kong and to a
lesser degree in China created a more pronounced impact on Zimmer
than perhaps on other competitors. The addition of these sales
would have turned Asia Pacific to our expectations at
approximately 16% growth. Having said this, the impact was not
material for our total global business. The worst of SARS seems
to be well over and we would anticipate easily recovering the
reduced revenues in the third and fourth quarters.
At the end of the day, second quarter reported revenues for the
Asia Pacific, sequentially were still an acceptable 9% increase
over the first quarter of 2003. During the second quarter, our
Asia Pacific business was led by reconstructive growth of 12%,
with knees up 15% reflecting strong growth and LPS flex knees,
particularly our conodium hardened femorals. Trabecular metal
tibial components and the NexGen CR knees. We expect the new CR
flex will be particularly successful in the Asia Pacifica region.
Hips increased 9% primarily due to poor stems and trilogy cups,
the longevity highly cross-linked polyethylene.
Trauma sales increased 5%. We are particularly pleased with
Japans strong knee product growth for the quarter of 18% and
trauma finally improving almost five for prior year. Both
Australia and the general China did over a minimum of
double-digit constant currency growth for Zimmer product segments
combined in the second quarter. Australia continues to show
exceptional local currency growth, of more than 25% in both the
quarter and year to date. Displaying excellent earnings dropped
through some sales, Asia Pacific operating costs has increased by
18% in the quarter while operating margins ratios increased by 30
basis points to 44.5% from 44.2% in 2002. We are very pleased
with out strong P&L management of Asia Pacific and with our
reconstructive growth particularly with knees in Japan.
Europe another exceptional quarter marked by substantial market
share gains across the board. In the quarter, revenue is $61
million represent a 43% increase over prior year an outstanding
22% constant currency growth and a strong sequential increase of
18% verses the first quarter. We believe almost twice the served
market growth was obtained by 13 of our 16 European businesses
for all product combined and 11 of our 16 European businesses
delivered reconstructive growth in excess of 20% of local
currency.
On the product front as you can anticipate, reconstructive
implants on a reported basis, grew by an outstanding 42% led by
hip growth of 45, and knee growth at 40%. Even with solid
competitive reconstructive numbers, for Europe in the second
quarter, it is clear that we are growing at more than double the
market with or without currency. These gains reflect the
continuing acceptance of Longevity highly crosslinked
polyethylene, the introduction of our European hip and cup
design, augmenting the ongoing market share gains for the NexGen
(unintelligible) and trauma up 18% of local currency.
Europe's performance proved to be consistent over time. If we
look at Zimmer Europe over the last several quarters in local
currency, every quarter is over 20% growth and the average is
24%. If we eliminate price, and look only at volume mix, the
average increase in the same quarters is more than 21%. So this
is very exciting ongoing sales story.
Although we normally don't disclose specific geographic segments
gross profit margins and we may very well not in the future,
Zimmer Europe for the first time ever generated a GP for the
quarter in excess of 70%. In addition we delivered improved
European operating profits that increased by 78% to 19.4 million
in the quarter and a record operating profit to sales ratio of
31.6%. This from a business that only five years ago lost money
most quarters on more than $100 million in annual sales. A
continuing exceptional performance by Europe.
I'll try to cover the following hot topics briefly. Mix an update
on the roll of mix change as reflected in Zimmer's global
results. Zimmer sales associate ads and update on our actual
additions for 2003 second quarter, year to date. And the
remaining plans for the year. Pricing our latest really unchanged
interpretations. And lastly of course, Zimmer's minimally
invasive efforts the detailed update on our activities and our
developments.
First mix, an update on the role of mix change reflected in
Zimmer's results. Mix continue to play a key role in improved
sales and profitability. For 2003, I would remind you that we've
expanded our discussion with you by adding Trivector metal
penetration as fourth category and also by combining knees and
hips together in both the revision and cross link poly conversion
analysis. For a standard polyethylene conversion to longevity to
highly cross-linked polyethylene, first in hips, we ended 2002 as
you may recall at 85% cross-linked penetration 15% standard. At
the end of the second quarter 2003, we are now 89% cross-linked
and 11% standard.
Prolong as I mentioned previously on articulating surfaces, we
did not measure last year and this year at the end of the second
quarter is 11% cross linked 89% standard. A cumulative shift of
four points to
cross-linked in hips for the second quarter verses year-end 2002.
Given our ongoing penetration and market share gains in hips,
cups and liners, it's evident that we continue to have the
potential for significant dollar and mixed growth through
competitive surgeon conversion to Longevity.
Since Prolong for the knee is only available in Cruciate
Retaining and Zimmer has a stronger share in Posterior Stabilize,
we have tremendous potential (mix shift) dollars still in front
of us. As a reminder, Prolong represents 34% of Cruciate
Retaining Articular services but as indicated is only 11% of
total Articulating services.
Prolong for (PF) procedures will be available for limited release
late 2003 with a major new product impact in 2004. Cemented hip
conversions to porous hips end of 2002 43% cemented, 53% porous
and the second quarter 2003, 41% cemented, 59% porous.
(Unintelligible) shifted two points to porous in units for second
quarter 2003 versus year-end and we believe the market in general
now is at approximately 66% or 2/3 porous. This still leaves us
with room to grow, with more than 100 remaining (Apollo) porous
stems still to be released.
The distribution pipeline complete for Epoch composite stems, the
potential growth in Trabecular Metal stem applications and
exclusive use of porous stems in Minimally Invasive (mini) and
2-incision hip surgeries, we have many more opportunities for
cemented to porous conversions.
For Zimmer a slow down in (unintelligible) factory is unlikely
due to maxing out. With a better than 30% growth in porous stems
in two consecutive quarters, we've moved only two points in
porous/cemented mix. That remains six to seven points below the
market's relative porous mix in total.
This is particularly noteworthy in the second quarter where
countries with strong cemented history such as the U.K., Canada,
and Australia had very robust performances. Revision of the
percent of Zimmer's first hip sales end of second - end of 2002
9%, end of the second quarter 2003 11%.
And in knee (femorals) we did not measure it last year as you
know but in the end of the second quarter 2003 we were 9%
revision, 91% primary.
In summary we over achieved our double-digit revision preliminary
goals 10% for combined hips and knees. And the second quarter of
2003, the hip revision progress from 3% of sales in 1999 to 11%
in second quarter 2003 has been excellent given the size of
Zimmer's sales base in total hip sales.
We continue to have tremendous knee potential with only 9% of
sales and both a new rotating hinge and international expansion
of our (Althe 2K) knee system well underway.
Trabecular Metal has a percent of recon sales at the end of 2002
was 1.6%, at the end of second 2003 is 3.1%. In summary,
Trabecular Metal has more than doubled in second quarter 2003
from 2002 as a percent of Zimmer's reconstructive sales.
This does not include the fact that demand currently is virtually
outstripping production. We clearly believe with good reason
that this is the next great porous platform. These results do not
as yet include seven new Trabecular Metal related projects
including the (Modular) Trabecular Metal cup just released.
A potential to grow this product line with premium pricing
and expand its utilization and not only traditional recon
but also spine and trauma will provide significant mix
expansion capabilities for several years to come.
On a second subject, sales associate ads for 2003 as you
may recall from our year-end conference call for 2002, we
hired 84 new sales associates, surgical techs, and
specialists. And we entered 2003 with nine unfilled
openings. In 2003, we expect to fill the nine openings and
hire an additional 80 to 90 representatives for a total of
roughly 100 additions.
During the first quarter 2003, we added a total of 20
international and 29 in the Americas for a total of 49
sales folks to give us a big jumpstart on the year. In the
second quarter, we added an additional 10 international
and 21 Americas for a quarter total of 31 and a year to
date total of 80.
We're in a nice position to benefit early from their
skills and abilities. Since virtually all our sales people
are either straight commission and/or performance based
Zimmer exclusive contractors, sales expense to revenues
tend to track in a linear rather than a front-loaded
fashion.
Pricing - Zimmer's position on pricing is unchanged since
we spun the business out in August of 2001. We have been
pleasantly surprised by the 4% global price and 4 to 5% in
the domestic U.S. market.
Our own theory has been that price in 2003 to 2005 period
will stabilize as positive 2 to 3% with most major
geographies and positive price territories and the U.S.
leading the way at 3% or so. With a few exceptions such as
Korea and to a lesser degree Taiwan, we see absolutely no
sign that price will not remain (meaningfully) positive.
Internally our business (is built) and budget around a
little price with the exception of known and previously
contracted major hospital chain agreements. The primary
concern that we've heard seem to be two fold.
One - will the 2004 (DRG) be negative and two - will new
premium price dur-eluting stents for other premium
non-orthopedic products effect global hospital budgets to
the extent that orthopedics will be directly impacted. As
we explained in some detail last quarter, we do not
believe this is the case.
Zimmer's (used) to the conservative 2 to 3% guidance
reflects a reasonable belief that hospitals will (seek)
share, will be slightly less profitable, will be a little
more sensitive to appropriate demand matching, and that
our collective success in recent times with 5% per year in
the U.S. will catch the attention of most hospital
administrators.
Whether (DRG 209) was plus 5% or minus 5% in (204) would
have had little bearing on our list price increase and the
(stick) rate. In short for Zimmer our guidance for almost
two years since our (stint) has in fact in advance already
incorporated these potential concerns.
I would note for us during the second quarter of 2003
price is 2.6% globally and in the middle of what we
believe is a sustainable 2 to 3% range already guided to.
(Minimally) Invasive surgery activities we're very pleased
with our progress in our four-year-old MIS program. During
this section of the call, we'll update you on several
different aspect of the MIS program.
First the 15,000 square foot Zimmer Institute officially
opened on schedule at the end of the first quarter. And we
held our first cadaver-based class on April 8th. We have
increased our full time approved institute staff to 15
employees.
Year to date since January we have trained 159 surgeons on
the Zimmer 2-incision hip and 46 (PA)'s and nurses. Since
inception we have trained more than 200 surgeons and their
staff. In June alone globally we trained 40 surgeons
including 10 from Europe.
Before attending cadaver training at the Zimmer Institute,
most surgeons prefer to visit one of our surgeons
currently performing our (analyzed) procedures. The
numbers are staggering. Year to date we have accommodated
more than 200 visits.
We currently have a total of 320 official and as of yet
for the most part unfilled visit requests outstanding
composed of 213 MIS hip and 109 MIS knee requests. In June
alone, we entered new requests for 45 hip visits and 33
knee visits.
Both AAOS - the American Academy of Orthopedic Surgeons
and the generally more conservative AOA - American
Orthopedic Association are taking notice. AAOS cadaver
course at their request we demonstrated a new Zimmer Quad
(Spare QS) uneventfully with the patient having 105
degrees average normal (flexion) within two hours of
surgery.
Surgeons were impressed and referred to the procedure as
very slick and very compelling. Prior to Zimmer Institutes
Quad (stirring) training classes for a total of 50
surgeons have now been planned for the (QS) roll out in
the fourth quarter of this year.
At the annual AOA meeting in Charleston, SC, surgeons from
three separate medical centers reported on the first 300
Zimmer MIS 2-incision hips. The procedure achieves safe
and effective results with 80% of the patients' discharged
in less than 24 hours.
This was a 4.1 day drop in patient stay for the hospitals.
And with the introduction of full regiment and physical
therapy programs the same day of surgery. At the (Presby
St. Lukes) series, the average patients were walking with
no support in eight days instead of six weeks. And back to
work in two weeks instead of the standard 12 weeks.
While we're still tracking activity manually, we can share
with you that the previously mentioned standard Versys
Fiber Metal Taper stems in our portfolio for more than
five years are expected to increase in sales this year by
a remarkable $25 million and we've only just begun.
On the communications side this summer, we'll begin in the
U.S. in 26 cities Zimmer MIS 2-incision national ad
campaign with the top 17 markets in the summer and the
next nine markets in the fall. More than 100 doctors will
participate in this campaign with both professional videos
and consumer education package. This is a level of
exposure that will really get the word out on the Zimmer
MIS brands.
Speaking of getting the word out on Zimmer MIS brands,
I've long felt that real patient quality of life
improvements can not only move market share, but
ultimately our surgeons would be recognized financially
for their unique contributions.
Upward reimbursement changes in the Medicare system are
complex and difficult. Upward reimbursement changes in
third party private insurers have
to almost always denote significant patient improvements
and materially improvements for the overall cost
structure.
If you work long enough in this business and long enough
with surgeons, you occasionally get the chance to read a
paragraph like this: "The potential for dramatic patient
benefits with the Zimmer Minimally Invasive Solutions, MIS
2-incision hip replacement procedure has been recognized
in a recent decision by a major U.S. private insurer.
The insurance has elected to more than double the
reimbursement payment to a physician practice whose member
surgeons have now demonstrated their ability to deliver a
significantly improved patient outcomes. The decision
applies only to Zimmer's new patient - patent pending
muscle spearing 2-incision hip technique."
We'll not be disclosing specific additional details until
a press release that follows in the very near future. On
that exciting news, let me turn the call over to Sam for
his comments.
Sam Leno: Thanks, Ray. I'm also very pleased to be able to report
another terrific quarter for Zimmer. I'll try to add a
little more granularity to Ray's comments while focusing
on a few key areas of the profit and loss statement, the
balance sheet, the cash flow statements, all for the
second quarter.
In the area of foreign exchange, the continued weakening
of the U.S. dollar across most currencies compared to
prior year contributed 4.7% or $16 million to our sales
growth for the quarter. The Yen strengthened by 8% over
the second quarter of last year while the Euro
strengthened by 24%.
In the current - if the current foreign exchange rates
hold for the balance of the year, the affect on sales
growth will be $16 million or 2.2% in the second half of
the year compared to $31 million or 4.6% during the first
half.
We have four (hedge) contracts in place this year for the
Yen at an average for the year of 126 compared to 115 for
2002. And for the Euro at .95 compared to .87 for 2002.
As a result of the (news) of these contracts, the
weakening U.S. dollar had only a modest effect on our
operating profit growth. We also have (four) contracts in
place for 2004 including the Yen at 119, the Euro at 1.05,
the Australian dollar at .64 and the Canadian dollar at
1.40.
We use these simple hedging tools to manage risks from
year to year and we wanted to take full advantage of
locking in the current position of the U.S. dollar as we
begin the creation of our operating (plan) process for
2004.
I'm pleased to report that we are now debt free as Ray
indicated. When we spun out from our former parent, we
established a goal to be debt free by the end of 2003. And
given our consistent sales performance and our focus on
relentless managing of our investments and working
capital, we've accomplished our goal six months ahead of
schedule.
At the end of the first quarter, we have $77 million of
total debt on the balance sheet and $44 million of net
debt - total debt net of cash. We now have $39 million of
net cash on the balance sheet consisting of $115 million
in cash offset by the $76 million of Japanese debt.
To fund the Centerpulse acquisition, we put in place a new
fully committed and underwritten $1.75 billion credit
facility with three financial institutions including
Credit Suisse First Boston, J P Morgan, and the Bank of
America.
This new multi-currency facility, which has (grid) based
pricing consists of a $400 million, 364 day revolver, a
$800 million, three year revolver, and a $550 million,
five year bank term loan.
Based upon our (split) ratings, the 364 day and three year
revolver will be priced at (Liborg) plus 87-1/2 basis
points. And the year - the five year term portion will be
priced at (Liborg) plus 112-1/2 basis points. The
estimated all (in) interest (grade) for this facility
approximates 4% excluding the amortization that
capitalized financing costs.
We estimate that the draw down on the facility at the time
that we close the transaction currently targeted for late
September will be a little over $1.4 billion. With the
expected cash flow from the combined company, we're
targeting to be debt free again in three years after the
close of the transaction.
We also visited both Standard & Poor's and Moody's a few
weeks ago to present our financing plans for the
Centerpulse transaction and we are very pleased with the
outcomes. As some of you may have read, Standard & Poor's
issued a press release indicating that if we are
successful in completing the Centerpulse acquisition with
the existing offer, they will likely upgrade our credit
rating from BBB- to BBB flat.
Moody's also issued a press release that they were
affirming their BAA3 rating on our current bank facility.
And are also rating our new bank facility at BAA3.
Zimmer's effective tax rate for the second quarter was in
line with the first quarter at 33.5%. This compares to
last year's second quarter tax rate of 34.2% and last
year's full year tax rate of 33.7%.
The 20 basis point improvement from the full year 2002
rate is the direct result of establishing a more tax
efficient U.S. structure in the middle of 2002 combined
with continued strong growth of production from our Puerto
Rican manufacturing facility. Thirty-three point five
percent should continue to be a good rate to us in your
forecast models for the balance of this year.
Overall our profit and loss results for the second quarter
continue to demonstrate our commitment to deliver sales
growth in excess of market growth and also to leverage
cost of goods sold and expenses to grow at a slower rate
than sales.
As a result in the second quarter, we are able to deliver
sales growth of 19%, 14.3% (constant) currency, gross
profit growth of 20.1%, operating profit increases of
30.3% and (net) was scaled down to 20 point - 27.4%
without the benefit of the change in accounting (for
instrumentation) year to year and diluted EPS growth of
32.4%.
Due to rounding and the change in accounting (for
instrumentation) had no effect on diluted EPS growth
rates. With the expansion of our traditional GAAP margins,
we believe that at 38.1% our corresponding EBITDA margins
are better than any of our direct, major competitors.
Turning to the balance sheet, we continue to deliver best
in class performance in DSO and particularly true in the
United States. Consolidated DSO for the second quarter was
57 days, which is equal to the same period last year and
two days higher than the first quarter of this year.
The increase in DSO from the first quarter is in part due
to continued rapid growth in Europe and our longer payment
terms as well as the translation effects of the quarter
and balance sheet weaker - and weaker U.S. dollar rates
and the average rates used to translate second quarter
sales. Continuing to highlight our strong performances,
our U.S. collection team finished in the quarter at
slightly over 31 days sales outstanding.
Days inventory on hand were 257, three days higher than
the end of the second quarter of last year and up 10 days
from the first quarter of this year. The increase in days
is a direct result of continuing to build inventory to
support new product introductions. Results for this
quarter fall right into our target average between 250 to
260 days of inventory. Accounts payable days have
increased to 62 days up two days from 60 days at the end
of last quarter.
Operating cash flow for the quarter was $122 million.
Capital expenditures for the quarter were $32 million
consisting of $25 million for instruments and $7 million
for all other fixed assets positions. Free cash flow,
which is operating cash flow less capital expenditures,
was $90 million for the quarter.
The $14.8 million of investments and other assets on the
cash flow statement represents the acquisition of
(Immedica's External Fixation) business as Ray mentioned
earlier. This is Zimmer's first acquisition since our spin
off from our former parent and vertically integrates this
product line, which was introduced as a distributor
product line in the first half of 2002.
As we have seen in all previous quarters, our balance
sheet continues to strengthen. We are now debt free as we
previously mentioned and our equity position has grown to
$648 million.
To date we have incurred $22 million of costs to support
our initiative to acquire Centerpulse. Primarily on
external professional fees such as attorneys, tax
advisors, due diligence professionals, legal filings,
underwriting fees, printing and mailing costs.
Four point seven million dollars of these costs were paid
out in the second quarter and the remaining $17.3 million
are expected to be paid out in the third quarter. A more
modest level of incremental costs would be incurred in
third quarter and the process is expected to be completed
towards the end of the third quarter.
Our expectation is that we will be successful in
completing this acquisition. As a result, $1.5 million of
these costs were recorded as expense in the second quarter
and the remaining $20.5 million has been capitalized for
the balance sheet in accordance with U.S. GAAP accounting
rules from (unintelligible) accounting.
In the event that we are unsuccessful in our attempt to
acquire Centerpulse, any of these cost incurred that has
not been previously expensed will be expensed and
disclosed as such as a one time item in which ever quarter
it becomes apparent that we will not win the deal.
As it relates to guidance in our press release last night,
we provided an update to our 2003 guidance for both sales
and earnings per share. We expect sales for the full year
to increase approximately 18% over 2002 implying sales for
the full year of $1,620,000,000.
As a reminder the comps get increasingly more difficult
throughout the balance of the year and the favorable
effect of foreign currency on year-to-year growth
rates will diminish due to the weakening of the U.S.
dollar throughout all of last year.
Our guidance incorporates the expected effects of volume
growth, mix, and pricing and assumes that foreign exchange
currency exchange rates remain at constant levels for the
balance of the year.
We expect that we will continue to grow revenue at a
minimum of 1 to 2% above anticipated reported market
growth and consequentially we expect third quarter sales
growth of approximately 16% implying sales of
approximately of $390 million for the quarter and fourth
quarter sales growth of approximately 15% implying sales
of approximately $425 million for the quarter.
We also expect diluted earnings per share to increase
approximately 29% for the full year 2003 over 2002
implying diluted EPS of approximately $1.69 per year. In
light of our quarterly sales guidance, we expected diluted
EPS of 40 cents and 44 cents in the third and fourth
quarters respectively.
EPS guidance incorporates the effect of using the
asset-based model in 2003 for (instrument) accounting and
the expense (based) model in 2002. Our EPS guidance also
incorporates the fact that we will be doubling our direct
global investments in Zimmer's Minimally Invasive
Solutions this year over last year to more than $20
million in 2003, with materially greater MIS spending
levels occurring in the second half of this year than we
saw in the first half.
Our quarterly earnings per share guidance also excludes
the future expenses and any costs incurred related to the
potential acquisition of Centerpulse. And also excludes
accumulative (effects adjusted) reported in the first
quarter related to the change in the accounting (for
instruments).
Additional capital expenditures for the year have still
targeted to be $35 to $40 million for traditional
(property plant) equipment plus an additional $80 to $85
million for instruments. Of the $30 to $40 million we
consider approximately $25 million of maintenance capital
and the additional $10 to $15 million of capital required
to continue to fund our unit volume sales increases.
And finally as I mentioned early our effective tax rate of
33.5% for the first half should be a good rate to us in
your model for the balance of the year. And now I'll turn
it back over to Ray for a few final comments.
Ray Elliott: Thanks, Sam. There's no doubt that the second quarter for
Zimmer was proof that we live in interesting times. It was
a quarter that all of us at the company are really pleased
with and only two weeks from now we will have been a
public company for two years. It's hard to believe but a
good time to reflect.
Sales have compounded since our public inception at more
than 16% with worldwide reconstructive implants at a
compound growth of 21%. Our sales growth directly collates
to the fact that we continue to invest in R&D at the top
of the class on or near 6% of sales.
In our first two years we have built with the world's
highest rated sales force more than $500 million in new
products that weren't there even three years ago. These
products are the creations of more than 350 R&D people
operating at any point and time more than 30 pipeline
projects simultaneously. It's a far cry from Zimmer's new
products in the mid-90's that totaled little more than $50
million per year.
It's clear that Minimally Invasive Surgery is leaning more
towards fame and fortune than fad. Our careful attention
to manufacturing costs and mix combined with real
stinginess in G&A has allowed us to produce the best
margin metrics in the industry culminating this quarter at
70% - 76% gross margin, 33% operating margin, 22% net.
Since August 7th, 2001, net earnings have grown at more
than double the sales rate. At 38% EBITDA must be close to
if not the highest in all of medical devices, not just
orthopedics. ZMH on the New York Stock Exchange has been
rewarded with 60% plus price per share increase, a market
cap approaching 9 zillion, and more than 20 sell-side
analysts to watch over us.
Though same sales, industry leading margins, and earnings
have been combined with the gold standard in orthopedics
working cap management to create two year operating cash
flows of more than half a billion dollars. Better still
we're net debt positive with more than $100 million in the
bank and some $650 million in shareholder equity where
there was once none.
We've been fortunate enough to execute these results with
virtually the same management team that delivered the
turnaround and the spin off. In the end, we've built a
solid and sustainable base that allows us to confidently
launch a cross border $3 billion plus acquisition offer to
create the number one pure-play orthopaedics company in
the world. Confident enough in fact that while we'd like
to do this deal, we don't have to do it.
Well, so much for reflection. My favorite (mentor) wisely
told me that your most important quarter is the one you're
in but not for long, it's always the next one. Good
advise.
On that note, the second quarter's $411 million in sales
and a very strong 45 cents in diluted EPS are now history.
As Sam indicated, we've adjusted our guidance for sales to
$1.62 billion for the year, an increase of 18% and
including the accounting principal change for instruments
we've increased our diluted EPS for the year to
approximately $1.69. Both guidance indicators point to a
very successful 2003.
Thank you for your time. We look forward to your
questions. (Leslie), I'll turn the call back over to you
for Q&A.
Operator: Thank you. At this time, if you would like to ask a
question, please press star then the number 1 on your
telephone keypad. We'll pause for just one moment.
Your first question comes from (Bruce Jacobs) with
Deutsche Bank Securities.
(Bruce Jacobs): Thanks so much for taking my question. Just first one on
the quarter - Sam, I don't know if you mentioned this but
can you quantify what the impact of that instrument
accounting change was in terms of EPS in the quarter if
you compared it to last year's number?
Sam Leno: Yes. As I mentioned because of rounding, it's - it had no
effect on EPS at all.
(Bruce Jacobs): Okay. Okay, sorry, I missed that. And then just on the -
if I could ask one on the Centerpulse acquisition, can you
- can either of you comment on how your feelings have
changed if at all since the - since you've had a chance to
do those hundreds of hours of man - of due diligence? Do
you feel kind of as you did going in or have you felt
better about the proposed combination as you've done more
work?
Ray Elliott: I think we feel the same. I don't know that there's any up
or down really in the change in feeling. As you know,
(Bruce), having dealt with us a lot, I mean, we're almost
boring on this kind of stuff frankly. I mean, we're very
disciplined. We do the analysis. We analyzed it well ahead
of time.
So I don't think anything's changed. I think the only
thing that's there right now is the anticipation and the
question mark in our mind of what Smith & Nephew will do.
And I think that's what we're all waiting for. So I don't
think we've changed here very much.
Sam Leno: I would also say (Bruce), that we were very pleased with
the reception that we got from the entire Centerpulse
team. They were very open with us.
Ray Elliott: Yes.
Sam Leno: Shared information freely. And that allowed us frankly to
get through a very thorough process in a very short period
of time.
(Bruce Jacobs): Okay. And just the last question on that topic, have - has
there been any kind of pre-merger integration activities
that have been undertaken? I assume it's too early but I'm
just wondering if you've done anything on that side of the
equation?
Ray Elliott: We've targeted a team - you know, the way we do these
things as I mentioned there was sort of 50 something
people from our organization plus outside advisors
obviously.
What we try to do is then construct an integration team
that's approximately half that size or so from our side of
things. A little less than that we presume
almost an equal number from the other party, Centerpulse
in this case and we would then go to work on a full time
integration plan.
Those people would be full time and would drop off the
list at any given point as their tasks and functions were
completed. So we've began the structural design of
(writing) integration plan. We're not going to write the
full-blown plan, which would probably be to get - to give
you a sense a couple hundred pages long.
We're not going to write full-blown plan because people
are busy focused on regular business at this point. So
we're only drafting the structure of it.
(Bruce Jacobs): Great. Guys, nice quarter. Thanks for your time.
Ray Elliott): Thanks.
Sam Leno: You're welcome.
Operator: Your next question comes from (Bill Plovanic) with First
Albany.
(Bill Morvonic): Hey, thank you. Fantastic quarter.
Sam Leno: Thanks, (Bill).
(Bill Plovanic): Just, you know, as we look at the numbers here in the
guidance, you know, it really looks like considering the
operating margins you put up this quarter, you know, if I
just run the numbers through the model, I'm really having
to pull back to get to your guidance.
Is there going to be a reason that gross margins would
pull back some? Or that (meets) (unintelligible) the SG&A
(spend) increase going forward?
Ray Elliott: No, I think the only thing Sam commented on, you know,
first of all the guidance that was out there we've
basically maintained for the quarter. Not for the year
obviously because we've added the gain in from the second
quarter.
So we've basically gone with the (streak), which we
thought was appropriate for the third and fourth quarters.
There's nothing unique going on that we haven't already
described. You know, we obviously all know we're going to
lose some foreign currency tailwind.
From an earnings point of view, we are going to invest
more heavily no question. Of that $20 million, a lot of it
is going to be in that second part of the year. So I think
all we're trying to communicate to you is it's going to be
a really great year but we want to invest in the second
quarter.
MIS is really starting to take off as you can tell from
some of the commentary I just gave. And we don't want
people getting way out in front of us without recognizing
the fact that we need to make these investments in MIS. So
I think it's not a caution on the market on us, its just
communication to you that we want to make these
investments for our own future.
Sam Leno: Also, I would say with the differentials and the hedge
contracts that we have throughout the four quarters of
last year and the four quarters of this year, we continue
to have a drag as a result of worst - simply worst hedge
contracts this year.
(If we come back) next year because of the lock in and the
(unintelligible) I mentioned earlier. But that plus we had
a very strong quarter with mix as you know and all those
factors together is what led to that guidance.
(Bill Plovanic): Okay. And then on the ceramic on ceramic, I know you did
address that a bit, the competitive landscape out there in
the marketing (bacon).
Ray Elliott: Yes.
(Bill Plovanic): I was just wondering, you know, has obviously (Stryker's)
has some supply issues and so has (Wright Medical) but I
was wondering if, you know - what you have seen relative
to have they scaled back on their programs because of
that?
Ray Elliott: I don't think we've seen anything in them scaling back
particularly. I think they've had some good early success.
I mean we haven't seen it as a huge impact on us to be
honest with you. But I think generally in the market they
look like they've done pretty well with the 40 year olds
and younger people.
And I think, you know, at best as we can tell from here,
its pretty good-looking product. And we compliment them
for that. It's, you know, as they do when we have good
products. So I think it's going to be a good product and I
think it's going to have it's niche and do reasonably
well.
But as you can tell from our results, I mean, we just
haven't seen it hit us that heavily but we're bound to see
it in some of the younger folks. I mean that I think is
probably common sense.
(Bill Plovanic): Okay, thanks a lot.
Ray Elliott: You're welcome.
Operator: Your next question comes from (Scott Davidson) with Piper
Jaffray.
(Scott Davidson): Hi, good morning and nice quarter.
Ray Elliott: Thanks, (Scott).
(Scott Davidson): First question is on the MIS that - Ray was just wondering
if you could just give us a few more numbers there? Maybe
talk a little bit in terms of the number of
instrumentation (sets) that you've got out in the field.
What are you seeing in terms of the utilization rates
among the docs that have been trained? Recognizing that
it's early in the process. And then any update to the
number of docs that you're hoping to train during the year
this year?
Ray Elliott: Okay. I haven't got an update tally on number of (sets).
I'm - that one I would have to look up for you. I'm happy
to answer that separately because I'd be guessing on - at
this point because they're going out all the time
obviously.
In terms of surgeons trained, it's - as I commented 159.
We plan to train - we can effectively train - now this is
at the institute, we can effectively train about eight or
so surgeons and their staff a week. We don't train every
single week because we also have to train sales reps and
do development there as well.
We would have - we're up to four major deals now. I feel
like I'm always promising this and never deliver it. But
because of Centerpulse and our lawyers and all of our
staff tied up, we have not completed the transaction
agreements with the big partners in the - particularly in
the U.S. So we're still using offsite support training
instead of our partners.
So we intend to get those signed up. In fact, there's
legal meetings - one of them is today in fact on one of
those to try and get those done, (Scott) so that we can
dramatically expand our training format there.
Our big issue at this point as you can tell from what I
said is we got 300 requests in, knee is coming up very
quickly on top of that, and we have to be able to put
proctor's and preceptor's out to support people in the
first few surgery's because you don't want them to be
uncomfortable.
So it is a massive effort and it's why I asked Sam to
emphasize - it's not so much a guidance issue, although I
think it's helpful there. It's why I asked Sam to
emphasize the fact that we have millions of dollars going
out in the second half to set ourselves up for '04 and
'05.
(Scott Davidson): Okay, great. Thank you. And then just on the reimbursement
(front) relative to MIS, you'd referenced the positive
data point of that one (payer) who's going to reimburse it
on higher level. Is that part of a broad program of
detailing these (unintelligible) or (these going to flush)
out, you know, what's going on it terms of the effort
there?
Ray Elliott: Yes, it's a good question. The - we have a role here. We
have a group of people here that are called reimbursement
(and) health strategy. And they are part of the group
that's managing if you remember the work we're doing at
multiple hospitals establishing economic value added and
the cost structuring of MIS and the impacts it may have
ultimately on reimbursement.
The - I hope I didn't underplay that paragraph when I read it.
That is the most exciting thing I've heard in a long time. I
don't mean it just because it's from Zimmer. It's just so unique
to me to see a major insurer come back and say, you know what,
we're going to pay you more than twice as much for doing this
because it's that important to patients and it has that kind of
cost system affects.
So we're very excited about that. We will now proceed to work
with that major insurer to go beyond the geographic coverage
that's currently implied in their letter of approval. We would
move forward through our existing 200 trained surgeons because
many of them in their hospitals have different contracts with
different insurers.
We want to get this out there and obviously have it very focused
- in fact, exclusively focused on the 2-incision hip. We'll then
move on to knee. But it is a big process that's very organized
and very time consuming and as Sam referred to very costly at
times, too.
(Scott Davidson): Great. Thanks very much.
Operator: Your next question comes from (Rick Weiss) with Bear Stearns.
Mr. (Hsu): Hey, good morning guys. This is (Unintelligible) (Milton)
actually.
Ray Elliott: Hi (Rick).
Sam Leno: Hi.
Mr. (Milton): I know I sound like (Rick) but anyway, Ray, a couple of
questions. First you eluded to demand matching in the
hospitals.
Ray Elliott: Yes.
Mr.(Hsu): And certainly I think we've seen a little more of that
than there has been in the last five years as surgeons become
more collaborative with hospitals. What sort of effect do you
anticipate on (mix shift) as surgeons are becoming just a little
more diligent (in) demand matching their patients with premium
price products?
Ray Elliott: Yes, I don't - we're not seeing a lot of it that - the
point that I was making, (Milton), was that in our - we're
considered I suppose the more - most conservative of the people
on the pricing side of things and what I was saying is we're
speculating in those four or five examples I gave you. Hospital
administrators.
I don't necessarily think hospitals are going to be quite as
profitable as they have been. When it ran through that list,
that's a speculative (sic) list of things that we believe will
happen over the next two, three years as part of our strategic
planning.
I'm not indicating that I'm seeing those right now and frankly we
are not seeing them right now. So it's strictly a speculative
(unintelligible) but I think it allows us to plan our guidance on
a price where we want it to be.
Mr. (Milton): Okay, second question is on (pressed) components for knees.
You know, right now like you mentioned it's primarily volume
but could we see a greater (mix shift) component come in as,
you know, the market moves towards (pressed) components? And
do you anticipate something to the magnitude of what happened
in hips?
Ray Elliott: I think we do because I think if we can certainly deliver - if
you want to say Trabecular Metals tibial trays as an example and
it's a good one. If we can deliver a product that has the kind of
characteristics that surgeons have always wanted and have looked
for but not been able to get because they couldn't get, you know,
early fixation and (strength) and all the other things.
If we can deliver that, I think there'll be a significant
movement to the porous (trays). But the second issue there is the
fact is (unintelligible) said is a (model block) issue at least
in our context of the Trabecular Metal Tray. There is a lot of
issues as the market place right now with backside where created
by (Micromotions) - (backside) (unintelligible) (Micromotions)
and (osteolysis) and we think this solution may be one of the
very best.
So I think as you combine the (osteolysis) issues with surgeon
preference, there's a really good chance we'll get a strong shift
to this. The down classification subject material only adds to
that (feeling).
Mr. (Hsu): Okay and last question is can you just give us the approximate
price premium that the (Monoblock) carries over to the other
trades?
Man: I could but I'm not going to. No. We don't share that
(unintelligible).
Man: Thanks. But nothing ready.
Man: You're welcome (unintelligible).
Man: All right. Thanks.
Operator: Your next question comes from (Catherine Martinelli) with
Merrill Lynch.
(Catherine Martinelli): I have just one question (Ray) on the MIS funds and
maybe it's too early just given where you guys are in launching
it. But have you had an opportunity to get a sense of what the
use rates or the surgeon's use of the MIS procedures has been
post training. And if it's too early do you have a sense when you
might be able to start tracking that?
Man: Yes. Let me speculate and then I'll try to answer properly.
The answer to the second part is next year. We're still
trying to figure out the best. We know ways of doing it but
we're trying to figure out the best methodology, the simplest
and easiest in the operating room and then in the billing and
tracking systems we have to ensure that we can validate at no
cost and effort to anybody that truly was in MIF surgery as
opposed to simply having sales reps do manual reports based
upon surgical lifting.
So our ability to track and validate is important to this and
we're looking at several options. But the answer to your question
is it's going to be 2004 because we don't think we'll be able to
institute it. We may test it before then.
The answer to the first part of the question is it's all over the
place. We have surgeons who are trained and are nervous and
uncomfortable early and are looking for the perfect patient and
wait quite a while and do a few.
We have other people that are way up at the top of the scale,
over 50% as an example. I still believe my own honest belief is
that this is going to settle in as an opportunity for something
like a third of patients.
I don't argue that this is a niche at five percent and I'm hard
pressed to believe there's going to be a lot of surgeons doing it
on 80% of people, at least in the next few years and at least as
long as we don't have low-cost hand held in this
guidance to support many of these folks. So I'm not going to be
giving you a definitive answer but it's all we've got at this
stage.
(Catherine Martinelli): No. That's very helpful. And in terms of your MIS
investment in the back half of the year, did that, I think you
had mentioned that the bulk of it will fit in eight to two.
Did most of that get allocated to SG&A or did the portion of
it hit the R&D line?
Man: It's spread throughout the P&L. Some of it is in the cost of
goods sold.
(Catherine Martinelli): Okay. And then a clarification in terms of the
trauma business, where do you guys stand with an IM now and is it
fair to say that that is the primary issue right now in terms of
some of the other companies that have been getting very good
growth in that segment.
Man: Yes. There are a couple of things going on there. Our nail
pre-ITST, we went back and re-did some redesign issues
primarily with not much of a nail itself, which was a new,
it's a very good nail, but with some of the targeting
instrumentation, various other things.
That in conjunction with all the activities and things we did in
Japan. I think costs us over time last year to lose market share.
That was happening at the same time that a couple of people were
coming out with I think particularly Stryker's product with a
really good nail. And we cross-matched against those and I think
lost a nail share.
Now we're back with an ITST. We're looking some at adding some
advanced concepts. We're looking at new a new nail marketing
program. And at some point we're going to have to look at having
a titanium offering. We have
strictly stainless steel, which is very effective in some
countries but in other places with other surgeons will not get
you in the door.
We haven't driven that project dramatically forward because
(Center Pulse) has a titanium nail in their Sirius brand of
systems. So, you know, part of this is dependent upon what
happens to us with (Center Pulse). But if we lose we're certainly
going to build a titanium line. If we win it's far less likely
that we'll do that and obviously we would kill any stainless
steel project development they've got since we supply that.
(Catherine Martinelli): Does the stainless steel now that you have or more
importantly the titanium one you would get if (Center Pulse) goes
through, does that address that broad range of trauma fractures
in terms of being able to use a common set of instrumentation to
build Humerus and Femoral?
Man: Yes. That's the desired effect in developing it as a system
that way and I think that's one of the strengths with the
Stryker system in my opinion. So clearly to compete in that
market now that's obviously something we would have to have on
both stainless and titanium.
(Catherine Martinelli): And so I hate to beat this but just for my own
clarification. If the (Center Pulse) goes through would you get a
product line that is good to go in terms of having the titanium
nail that you need or would you then do some R&D work to get to
kind of get it to that platform level where it would compete more
effectively.
Man: My understanding is and obviously I'm not (unintelligible) the
terminator but my understanding is it's good to go but the
instrumentation set up, it clearly it would not be a single set
of instrumentation day one for obvious reasons. But
I believe the product line they've got to the best of my
knowledge is good to go from a competitive point of view.
(Catherine Martinelli): Okay. Great. That's very helpful. Thank you.
Operator: Your next question comes from (Mark Landy) from (Leerink Swan).
(Mark Landy): Good morning gentlemen.
Man: Hi (Mark).
Man: Good morning (Mark).
(Mark Landy): Just a couple of quick questions, if you could mainly comment a
little on the ceramic on ceramic out-take. Would it be fair to
characterize the two companies really upgrading their own product
rather than taking share?
Man: I think that's probably the case. We have certainly seen a little
of it and I expect competitors have as well because they, you
know, they clearly want to get out and focus on some of the key
surgeons.
I'm not clear at this point as to whether their supply issues are
driving their desire to obviously take care of their own surgeons
first, which would be logical to do when you're marketing your
product line you can upgrade your own people first obviously much
more easily or whether that's simply the strategy and the supply
issue is not a factor. I'm not purvey enough to their information
to know that.
We certainly seem to be active and we've seen it have some effect
on the very, very young patients. But again as you can tell from
our results it's not certainly been a huge impact right up to
this point.
(Mark Landy): You know it's just again, you know, your results really don't
reflect this. But, you know, from a lot of the hospitals comments
this quarter it appears that procedure volumes were down and they
highlighted orthopedics as one of the areas. Did you see any
decline in the procedure rates and, you know, is there a pent up
demand? You know, your results just don't reflect that.
Man: Yes. We of course we don't share it with you publicly but we
have a pretty sophisticated IT system here. We're able to get
actual unit, volume, bias KU et cetera, et cetera without
boring you with all the details.
And when I look at day rate gross I get rid of price and mix and
foreign exchange and I just get the U.S. day rate growth. I'll be
honest with you, we're not seeing. I don't know about the market
now. I can only go by the public numbers but all I get as well.
We at Zimmer are not seeing units of surgical procedure in the
reconstructive area declines on a day rate basis. We're simply
not seeing that.
(Mark Landy): Mine may be above in the cash. Could you tell us what the
procedure volume is in Europe?
Man: No.
(Mark Landy): I can only try and it'll ask you Sam, you know that you are in a
cash positive position can you maybe share with us kind of your
thoughts on interest
income, maybe your assumptions for '04 or enough for the second
half of '03 and then for '04?
Man: Well first of all as you know absent to the acquisitions we'll
simply continue to accumulate cash. We do have some modest
interest expense to incur because we keep the Japan data
outstanding. We do a little bit of factoring in in Italy so I
have some expenses there. But on the whole as you know it's a
matter of what we invest in and this interest rate environment
there's not going to be a heck of a lot of interest income
either. So I would suggest that you're expectations seem
quite modest.
(Mark Landy): Well, you know, the point being absent the acquisition. Should we
look at your being, you know, on an interest expense mode or on
some kind of form of interest income mode on that line item?
Man: Yes. I think I've answered your question. I think the
expectation, as going forward should be rather modest on that
line net, net.
(Mark Landy): Thanks guys. Good quarter.
Man: Okay. Thanks.
Operator: Your next question comes from (Lynn Hyper) with Thomas Weisel
Partners.
(Lynn Pieper): Hi. It's (Lynn) now. Good quarter.
Man: All right. Thanks (Lynn).
(Lynn Pieper): Just to follow back on some questions on the MIS area and I saw
though you didn't have interest in any of these. But what is your
goal of your mix going into 2004 as MIS procedures?
Man: Don't have a goal yet because we have not done 2004 plan (Lynn).
I think what we're going to try and do is give some guidance in
the fourth quarter when we do periods as we look at our plans.
Try and give some guidance to people of what they can anticipate
from us in (Nix). The other thing we're looking at is with knee
coming into play at the end of this year in the Quad-Sparing,
other words the fully, not the sort of mini-knees that are out
there now competitively but a full-blown Quad-Sparing knee.
That's going to, we think we're going to get that release this
year, which means it will start to impact in '04. We have not
forecasted that at all at this point. So I'm going to back off at
this point and say we'll promise you some guidance later in the
year.
(Lynn Pieper): Okay. And then I guess sort of following on that, can you talk a
little bit about either ASP different to gross margin, different
on your minimally invasive instrument set versus your standard
premium set?
Man: At this point there is no real difference. It depends upon what
hospital and surgeon it is and what pricing relationship we have
with them. We've viewed at this point and I'm going to give you a
quick second answer to all that.
But at this point we've viewed MIS products as being the same
margin, the same sale, the same ASP. The difference here (Lynn)
is two-fold. Number one in the case of hips, they are virtually
in fact they are all porous. So you're automatically getting a
big up-tick in GP dollars, the very fact that you're putting
these youths in and that's part of what's helping us out in a
general movement to porous as I commented.
Back and looking down the road we're not convinced orthopedics
will always stay in the same model. You give somebody some
instruments. You sell them an implant. They put that in. You pick
up your instruments and you leave or perhaps surround
(unintelligible) up there.
So one of the ultimate models down the road in hospital or in
outpatient surgical units on same-day basis is whether you have a
transaction fee for the entire procedure. You come in with
everything, you leave with everything and it's a unit of
transaction.
So we're looking at several models based upon our economic
value-added analysis that these ten hospitals are doing. We're
looking at other models that may change frankly how the game is
played a little bit.
(Lynn Pieper): Okay. And then I've got just one more. Sounds like your
training's going really well. Of the surgeons you've trained so
far we're seeing a trend that most of them already have
navigation equipment installed or is that currently an inhibitor?
Man: No. It's not an inhibitor. The vast majority has access to,
easy access to philosophy. The usual problem you get into as
you get into the more advanced image guidance is not their
ability to learn it or use it but in fact the competition for
it within the hospital between neuro, spinal, and perhaps now
more orthopedic. So it's more of an inter-hospital management
of time issue then it tends to be a technical issue.
(Lynn Hyper): Okay. All right. Great. Thanks a lot.
Man: You're welcome.
Operator: Your next question comes from (Bob Hopkins) with Lehman Brothers.
(Bob Hopkins): Oh. Thanks very much. Just a couple of quick questions; first on
porous code and I think you said you estimated 66% of hip sales
in the U.S. are now porous coded. Could you just give us your
opinion on where you think that can go ultimately and then, you
know, where you think Zimmer's mix can ultimately go in hips?
Man: Well I think the answer to the second question is probably the
same as the first one because at some point we'll catch up to the
market. Zimmer is a company that if you go back to knife did not
have as you know (Bob) a big porous mix and we've caught that up
now, particularly with (Apollo) project being finished.
In theory it ought to be able to go to about 78 to 80% because
that's where it was at some point in the late 80s before we got
into managed care and potential, you know, Hilary Clinton health
care legislation, all those kinds of things. So in theory it
ought to go back to that to the degree that it's been there
before.
Whether hospitals will be able to withstand pricing differentials
of it going to that level with no other offsetting cost benefits,
you know, I think is a tougher question to answer. So I'm going
to guess 75% and I'm going to guess that Zimmer will continue to
gap or have a gap to our fellow competitors of five or six
percent but at some point we're going to catch up because
obviously we're filling in the product line gap that we've had.
(Bob Hopkins): Okay. And then just a quick question on spine, if you're
successful in completing the (Center Pulse) transaction do you
feel that you're going to
need to further augment that spine franchise to be competitive or
is their platform enough to be competitive.
Man: It's enough to be competitive but it is a platform. I think
the conversations we've had with the spine tech folks and our own
analysis here probably says that we're going to want to do some,
you know, small all bi or it being standard small bolt on type
acquisitions or licensing agreements over the next couple of
years we would probably want to expand their sales force. We're
fundamental, believe there's good biologics, you know, as
demonstrated by (Medtronic) with infuse is going to be an
important part of spine.
So I think the answer is it's a good platform. We like what we've
seen but I honestly believe we'll augment it with additional
product efforts.
(Bob Hopkins): Okay. And then just last question a very basic orthopedic
question. You guys have been obviously consistently taking
unit share despite what we all know as the sort of the close
relationships between sales people and particular companies.
Could you just give us sort of an update on is that share gain
mostly coming from converting doctors that have been practicing
for a while with your product pipeline or is that just more a
function of just, you know, being more aggressive with the
younger residents coming up. I mean how, just give us an update
on that dynamic and how you're able to continue to grow at this
rate.
Man: Yes. It's going to sound like I'm agreeing with you on both
points but it's basically the truth. If you look at, it's
all, not all but it's largely driven by new product. It's a
commitment we made when we started the turnaround. Those
numbers I quoted are quite accurate. Somewhere used to be
about $50 million
a year in new products. We've done $500 million in new product
sales in the last two years. So it's clearly a new product driven
phenomenon.
We are attracting to answer your question directly, we are
attracting surgeons of all ages, but experienced surgeons I think
because of our pipeline offerings, strength of our sales force in
many cases where we're not the number one person we encourage our
sales people to make sure you're number two. If you're number
four you have no chance. You have to be in the spot next, ready
to go.
So I think it's new product, the position and training of our
sales people, the years of experience they've had in the account.
They average now 12 years of selling experience with Zimmer. So I
think that's a big part of it.
The other part is the fact that when we started the turnaround we
noticed that our position in academic institutions and our
position as a percent of sales of academic institutions to total
sales that dropped dramatically from Zimmer's long history of
really being an educator and participator in those accounts. And
we set targets by account and by percentage of growth to continue
to grow them. We continue to monitor it now.
So we've been driving the academic institutions and residents
while marketing a dramatic growth in new products to surgeons I
guess with more experience level.
(Bob Hopkins): Okay. Great. Thanks for your time.
Operator: Your next question comes from (Ben Andrew) with William Blair.
(Ben Andrew): Hi. Good morning.
Man: Hey (Ben).
Man: Good morning (Ben).
(Ben Andrew): Great. Just a couple of quick questions, most of it has been
covered. But on the, you mentioned earlier on the man hours and
time you spent on this and how that's, you know, you've still
avoided getting distracted and having problems in the quarter. Do
you get concerned about that as this process drags on and what do
you think is, is anything being shortchanged within your
organization?
Man: To be honest with you I don't. People have taken a very
disciplined approach around here and we have a lot of depth in
this company. So when we move somebody out however important
they are we're really built this organization to have a lot of
back-up and a lot of depth and a lot of people capable of
being promoted and moving outside of them. I don't have any
real concerns about that.
I think the risk with any kind of prolonged drag out process, the
risk is not so much to us, it tends to be more to the target so
in this case (Center Pulse) because they would have a tendency to
face more people issues on certainly all the things that you
don't like to see, you know, as part of the process. So no. I
have absolutely no - I couldn't be more happy with the way people
have handled the process around here and that's why I
complimented them genuine at the beginning of my comments. But I
would have concerns over time for (Center Pulse). Yes.
(Ben Andrew): Have you observed anything like that then so far?
Man: Not that I'm particularly aware of. I mean clearly we're not
close enough to it on the day-to-day basis. But nothing in
particular.
Man: But (Ben) another perspective I have is this is really a very
energizing activity for this company and the people are just
really psyched for and so they're quite willing to step up and
work a lot harder and not miss anything because of it and
delighted to be a part of such an incredibly strategic
acquisition.
(Ben Andrew): Okay. And you mentioned just a few times here in the call that
you need to step up in MIS spending in the second half. Can
you quantify that for us a little more? You've talked about
some numbers in the past that you would spend this year. But
it sounds like you're going to step it up pretty significantly.
Man: And we've been ramping, you know, we had dollars we spent last
year, we've been ramping up our quarterly expenditures every
quarter for the last ten quarters and that will continue. We
don't quantify it publicly but imagine any new program being
ramped up and it's not a temporary but a permanent ramp up and
will continue to happen throughout next year as well.
(Ben Andrew): Finally just on the spine side there's been a couple of
good questions on that. But what are you doing internally to
prepare in the event that something does not go, you know, with
(Center Pulse)? Do you have the ability to at least a partial
pipeline, or you know, product line out there or is that even in
the plan?
Man: It is of sorts. We're doing a couple of things, two or three
things internally with some MIS spine work and what we call some
transformational technology that's not dissimilar from what we're
looking at on hip fractures. We also shouldn't forget that with
(Implex) and with our potential with them.
(Implex) has a very interesting line of (unintelligible) and
cervicals and so on and so on that are Trabecular metal
oriented. So obviously our relationship with them is also
important. We have a line up of people in some cases that we
haven't completely eliminated our conversations with because
as you know and as we've said many times we will put together
a spinal business through multiple acquisitions if we're not
successful with (Center Pulse).
Lastly we're doubling and in the course of doubling the size
of our Puerto Rican operations that would be very capable of
producing a license line. In other words if we license the
drawings, the brand, the technology and we drop it into our
Puerto Rican operation they would be very capable of
producing the fundamental pipeline, not cages or that sort of
thing but basic spinal props.
So all of those things are multiple directions that are
underway with, you know, the primary focus at this point
obviously on (Center Pulse).
(Ben Andrew): Okay. Great. Thanks.
Man: You're welcome.
Operator: Your next question comes from (Robert Faulkner) with
Prudential.
(Robert Faulkner): Thank you and great quarter as many others have said
already. Two conceptual questions, one is you have this MIS
training thing rolled out where you're really changing the
way many doctors are thinking about and patients thinking
about surgery.
How would you compare the role that that is playing in
helping our share gains and attracting doctors versus the
robust in the product pipeline? And then secondly if you
could comment on what you've learned about the MIS
program in the last six months as you've started to roll it out.
So what has changed for you?
Man: Okay. On the first one I think they're kind of combined.
There's absolutely no question that we are getting entry into
institutions and into individual discussions and opportunities
with surgeons that we have not had the opportunity to do in
the past.
We are getting phone calls from people that frankly are shocking
to me because these are people I would not imagine would have
called up and said could you meet with us and sit down and talk.
So there's no question it has a direct impact.
What happens is when you we get in there they may or may not
agree with everything we're doing in MIS. They may find they
personally are not comfortable or they want a younger associate
to look at or something on those lines. But it gives you the
chance (Bob) to show the pipeline and show all the things we're
doing at Zimmer. Sometimes we have the chance to get them out
here. Show them the plant, show them R&D.
And it gives us the chance and in many cases they're shocked
because what they knew of Zimmer might have been five years ago
or seven years ago. They may not have talked to us much in the
last year.
So it's very important that MIS is a legitimate, tremendous
marketing technology and we think patient benefit and share
gainer, but it also gets us into, you know, to show that
pipeline.
In terms of what we have learned, you know, I think we're
becoming very fascinated with the potential. We've always
believed that we had a chance
here to make systemic change, not just in, you know, as we've
said all the way along, this isn't about a small incision. I mean
that's a roughly a minor part of this.
We're learning that the potential ability we have as the
front-runner to not only a way to take share but to make a change
in how surgery is structured, how people's lives are structured,
the costs of this economically.
I think we're getting really pumped up about the idea that
there's just so much more to this than just the obvious, you
know, sell more implants to make more share. There's an
opportunity here to be in the share because of systemic change.
And I think that's starting to come to the forefront much more
than it has in the past.
(Robert Faulkner):Are you seeing more activity from your competitors at
this point and can you characterize that how you see it from
your perspective?
Man: We are and I think and it certainly varies by competitor but I
think in general our competitors are recognizing that this. If
they don't believe it's for real I'm sure they believe they sort
of have to be there with something and I can't tell you what they
really believe about it because it's obviously it's not a
discussion I had with them.
We are seeing though stuff that we were doing four to five years
ago. You know sort of the many - it's not patient changing, game
changing for the most of it. Most of it is smaller incision, a
few instruments. It's not producing the kind of patient outcome
results that I can see that we're talking about.
So sure they're all there. Are they doing meaningful changes? Are
they where we are? I don't believe I have seen nothing that would
lead me to believe that.
(Robert Faulkner): Great. Great job. Thanks.
Man: Thank you.
Operator: Your next question comes from (Michael Loffman) with (Chase
Equity Partners).
(Michael Lachman): Good morning. I just wanting to see if everything's been
answered. But if I could ask you to maybe try to get a little bit
more color over (unintelligible) you don't break out volume
versus mix. You talk about those together.
But looking back over the last several quarters and then looking
forward over the next few quarters, could you characterize the
mixed piece of that as a growing piece or a declining piece or
relatively stable piece of that volume mix combination.
Man: I'll answer in a market sense (Michael). I think my own
belief is that the market going forward is going to be a
market. Let's fit the U.S. where we have better data and see
that it validates. My own belief if we take recon in the
U.S., which is obviously a huge market. I think we're going
to see eight to nine percent unit perceived, just the market
now not Zimmer, eight to nine percent unit procedures. And
I'm guessing mix is going to continue to be in a market sense
about three. I think that's what it is now for the market. I
think we have people that are higher or lower than that. But
I think it's going to be a nine in three combination for a 12%
base market going forward, U.S. recon.
And then you can add to that whatever you believe in devising a
foreign exchange. Add to that whatever you believe in price.
If you take our two to three percent, take eight to nine percent
on units and about three on mix, you know, that gives you a
pretty good look at what at least what I think the U.S. refund
market is going to be going forward.
So if you're not growing, you know, pick a number on a reported
basis, I know 14% or whatever number you want to pick that adds
the ranges up with that in U.S. recon you're probably not staying
with the market I think.
(Michael Lachman):And when you talk about the, I think you provided numbers that
are about 13% overall volume mix in the Americas, about four
percent price. And I guess that's an overall Americas number.
Have you looked at the (Recon) piece?
Man: Yes.
(Michael Lachman): Would that still be pretty consistent with
those numbers?
Man: Are you talking about the price portion of it you mean?
(Michael Lachman): The price in let me think - price in (Recon)
is within a few tenths of a point. There's not a lot of
difference there. But that's a good point.
(Michael Lachman): All right. Thank you.
Operator: We have time for one more question. Your final question comes
from (Mike Weinstein) with J.P. Morgan.
(Mike Weinstein): Wow! I can't believe we're still on this call.
Man: Neither can we.
(Mike Weinstein): In the midst of, you know, how many companies
are reporting earnings. Well first off obviously a good quarter.
I just want to go back and make sure I understood a few items
that you talked about on the call.
Man: Sure.
(Mike Weinstein): First Sam just with respect to the quarter and
the margin improvement, you said you might have had some small
benefit from currency but is the implication that it was that it
wasn't much. Is there any way to quantify what it was below the
top line?
Sam Leno: Yes. If it was significant we would quantify it (Michael) but
it's not. So now we have, we have not made that public.
(Mike Weinstein): Okay.
Sam Leno: As you know also in past quarters it's been virtually no
effect at all.
(Mike Weinstein): Right. Right. Pardon my question. As we look at the back
half of the year and see your contracts are off. Some of the
(unintelligible) more of a currency benefit on a bottom line, as
we look at that half of the year.
Sam Leno: Yes. Our contracts roll off. Our contracts roll off like one
quarter at a time and get replaced with new ones. So we have
no end to our contracts.
(Mike Weinstein): Okay. That's helpful. Let's first make the assumption
that there has been a out-buying part of (Center Pulse) part of
price to be too expensive and you move forward and doing what
you're doing now it's obviously been very strong. When you gave
your guidance to the back half of the year, I know you guys like
to speak conservative with these numbers, but you didn't
extrapolate the margins that you showed in the second quarter in
part because of your spending plans around MIS.
If we look out to the second quarter of 2003 and sort of second
quarter of 2004 can you improve upon the margins that you showed
here? I mean if particular a reconstructive company doing better
than 76% gross margins. You have 32.8% operating margins; it's
tough to image that margin starting to get that much better. How
much before MIS becomes meaningful would still be on the table
relative to that type of profile we saw in the second quarter.
Man: You know in theory can they grow? Sure in theory they can
come down a bit. Yes. As you know (Mike) from
(unintelligible) since the beginning from a long time. I'm
less enthusiastic about worrying about tenths of points of
margin. I mean we're in the cash business and I don't get as
excited analytically about that unless it's a pre-cursor, some
kind of indicator of a problem.
So for me to come on a telephone call and say, "Oh my God. Our
margins are down from 76 to 75.8, the world is ending". I don't
live in that world because I don't think it works that way.
The real answer is the things that are in our margin are
obviously standard cost production, automation, all the things we
do in the plant to make it better. We continue to drive that and
drive our folks with these standard cost
reductions, improved productivity, bring automation and we're
doing it every day as we're speaking to you.
Our mix is a huge factor in the business, both product mix and
geographic mix. On the product side we sell more knees, you're
going to make more money generally speaking. Spine we don't even
have yet and it's the highest margin of all typically in the
industry we're in.
It was usually the case although I'm hard pressed to support it
this quarter, that if you have a lot more European business
generally speaking your margins go down because as you know the
margins over there are smaller although with our business over
70% this month it's now tougher to support that. But generally
speaking if you grow Europe it goes down.
We have hedge contract expression in there. We have royalties
in there. A lot of those things are forecast able. So it
really comes down do we run the plants really very well and do
we get the mix we want. You know can you grow from where
we're at? Yes. Can you grow if we bring spine in?
Absolutely. As long as you don't get hit by the offsetting
factors too heavily.
So you know if you dramatically grow your Europe business your
margins are going to come down a bit. But, you know, a long
answer to a short question. I don't want to sound
(unintelligible) and say I don't care because I don't mean it
quite that way. But I'll take all the Europe growth you can give
me at 20 or 30% a quarter and I'll justify our decline in margins
based upon the dramatic increase in cash flow and earnings.
(Mike Weinstein): Sure. The 70% gain in European profits this quarter, is
that prior to including the hedge in the contracts?
Man: That's not a gain; although coincidentally they're gain in
operating profit was 78%. What I was quoting, which we generally
don't give people and as I said may not in the future, we had a
70% GP in gross profit in margin in Europe for our business.
That's unheard of in orthopedics in Europe.
(Mike Weinstein): But your profits were up more than 70%.
Man: They were up 78.
(Mike Weinstein): So again my question was when you quoted that 78% growth
number did that come prior to the hedge in the contracts?
Man: That of course incorporates the hedge in the contracts.
(Mike Weinstein): That does incorporate the hedge in the contracts. Wow!
Man: That's the point I was making. I'm glad you - I maybe should
have included that in the presentation so that's a good point
to make (unintelligible).
(Mike Weinstein): Okay. And If I could just switch over to (Center Pulse),
you made the comment that you're still confident that you're
going to end up being victorious that's the appropriate word
here in winning (Center Pulse) at the end of the day.
Man: I don't know what conference call you're on (Mike) but I
certainly nor did Sam say (unintelligible) - the word I used was
close, not victorious or anything like that.
(Mike Weinstein): Well I think it's more victorious.
Man: No. We're not cutting it. This is all dependent upon what
(unintelligible). We're not confident - what I said was in my
presentation is we've developed enough confidence around this
company with the group we have here that we're confident that
we can properly execute a three billion cross-border
transaction. But we're not - it's 50/50 until we understand
what...
Man: And my comments might just be cleared too. I just made the
comment that we were confident, not confident but something
close to that, closed by the end of the third quarter. That
wasn't necessarily for me. I think that's one of the two of
us. They're going to close this thing and it will not drag
out indefinitely.
(Mike Weinstein): Okay. So your confidence was then your ability to close not
necessarily that you'll end up being at the end of that specific
fire. But that was part of your accounting assumptions Sam right
and the faster your capitalizing some of the expenses associated
with the pursuit rather than expense all that through the income
statement.
Sam Leno: Yes. That's clearly true and as I mentioned our guidance does
not include any further expensing of cost fees that are
incurred or about to be incurred through the transactions. If
we lose the deal than all that gets charged off to the P&L in
the third quarter. Normally on the quarter we deem that we're
not going to win.
(Mike Weinstein): Okay. Thank you guys.
Man: Okay. You're welcome.
Operator: Gentlemen do you have any closing remarks.
Man: No. That's great. We appreciate people that are staying on
and so many good questions and have a long call and look
forward to talking to you all of you soon. Thanks (Barbara) I
appreciate it.
Operator: Thank you sir. And thank you for participating in the Zimmer
second quarter 2003 financial results conference call. You
may now disconnect.
END