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Zimmer Holdings (ZMH - Analyst Report) reported net earnings of $152.8 million or 88 cents per share in the fourth quarter of 2012 compared with $156.6 million or $87 cents in the year-ago quarter. After taking into account certain one-time items, adjusted earnings came in at $1.51, surpassing the Zacks Consensus Estimate of $1.49 and the previous year’s $1.36.

For the full year, adjusted earnings per share (EPS) were $5.30, 2 cents ahead of the Zacks Consensus Estimate and 10.4% higher than the prior year’s $4.80.The adjusted EPS remained in line with the upper limit of the company-provided guided range of $5.25−$5.30.

Revenues were $1.180 billion, up 1.1% on a reported basis and up 2.1% at constant exchange rates ("CER"), which beat the Zacks Consensus Estimate of $1.175 billion. Revenue generated in the Americas was $644 million (up 4% at CER), in Europe was $326 million (down 1%) and in Asia-Pacific was $211 million (up 2%). Fiscal 2013 revenues remained at $4.47 billion, up by a marginal 0.4% from 2011 and exceeded the Zacks Consensus Estimate of $4.46 billion. However, revenues remained below the company’s guided range of $4.75−$4.80.

Segments

Zimmer’s biggest segment, Reconstructive Implant, recorded revenues of $871.9 million, flat year over year at CER. This was due to a 2% decline in Europe, fully offset by a 2% increase in Asia-Pacific.Revenues from Knees (within Reconstructive) increased 1% to $476 million, while Hips recorded a decline of 1% (at CER) to $349 million. Revenues from Extremities increased 7% year over year to $47 million.

Among the other segments at Zimmer, sales from Spine recorded a decline of 5% (at CER) to $54 million and Dental revenues declined 2% to $61 million. Growth was witnessed in the other two segments – Surgical and Other (19% annually to $110 million) and Trauma (10% to $84 million).

Margins

During the quarter, Zimmer’s gross margin expanded 65 basis points (bps) to 74.7%. Moreover, with selling, general and administrative, and research and development expenses decreasing by a respective, 0.3% to $460.5 million and 14.8% to $55.3 million, operating margin improved 210 bps to 30.9%.

We believe that better operating margin along with a 3.06% year-over-year drop in outstanding share count owing to the continuous share repurchase program led to an improvement in EPS.

Balance Sheet and Cash Flow

Zimmer exited fiscal 2012 with cash and cash equivalents of $884.3 million compared with $768.3 million as of Dec 2011. Long-term debt increased marginally to $1,720 million compared with $1,576 million at the end of 2011.

Operating cash flow for the reported quarter was $368 million. The company repurchased 2.1 million shares for $140 million during the quarter, under the current program (of up to $1.5 billion of shares)that expires on Dec 31, 2014.The company also paid $94 million in dividends to shareholders.

Outlook

Zimmer provided its outlook for 2013. The company expects to report revenue growth of 2.5%−4.5% at CER. Currency movement is expected to lower revenues by 0.5%, which in turn would lead to 2%−4%revenue growth on a reported basis. The Zacks Consensus EPS Estimate of $5.75 remains within the given range. The 2013 guidance for both adjusted EPS and on a reported basis were $5.65−$5.85 and $5.05−$5.25, respectively (the Zacks Consensus revenue Estimate for 2013 is $4.63 billion).

The company expects to continue with its global restructuring and transformation initiatives in 2013, which is expected to generate annualized pre-tax savings of more than $80 million, including $30-$40 million to be realized in 2013.  

Recommendation

Zimmer offers a broad line of reconstructive implant and trauma products as well as orthopedic surgical instruments and supplies. We believe that the company has embarked on its growth trajectory with new product launches, employment of new technologies and expansion into the emerging markets.

However, Zimmer continues to face pricing pressure and lower procedure volumes resulting from economic uncertainty. Moreover, the company faces tough competition from well-capitalized players such as Smith & Nephew (SNN - Snapshot Report) among others.

Zimmer holds a Zacks Rank #3 (Hold).While we prefer to remain on the sidelines on Zimmer, other medical device stocks worth a look are Cyberonics Inc. (CYBX - Analyst Report) and Haemonetics Corporation (HAE - Analyst Report). Both the stocks carry a Zacks Rank #1 (Strong Buy).

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