Orthopedics companies continue to thrive on the fact that most people would rather undergo surgery than live the rest of their lives with a painful degenerative hip or knee condition. As the biggest pure orthopedics company in the world, Zimmer Holdings
Sales in the first quarter climbed 12% to $829 million. Although growth in the hip business wasn't blockbuster, coming in at 6%, strong knee replacement growth (19% worldwide) more than made up for it. Also positive for the quarter that the company at last saw double-digit growth in its spine business (up 14%), though that business is only a tiny portion of the whole.
Bottom-line growth was fueled by the double-digit sales growth as well as significant improvement in margins. Zimmer boosted its gross margin to 77% from 70.4% -- a level that compares favorably even with the notoriously high-margin pharmaceutical industry.
Operating margin also benefited from growth in research and development and SG&A spending that lagged revenue growth. Consequently, operating margin climbed to 31.1% (from 20.7%) for the first quarter of 2005 -- fueling nearly 68% growth in operating earnings and 78% growth in net income.
Despite this strong continued growth, there are a couple of clouds hanging over the business. First, Zimmer was included along with nearly every other orthopedics company in a government probe concerning the relationships between physicians and companies and the possible impact that has had on pricing. While implant prices have soared over the past 15 or so years, I continue to maintain the basic conclusion in my original discussion of the probe -- which is that the probe isn't likely to seriously harm any of the orthopedics companies.
In the longer term, though, greater government scrutiny isn't exactly going to be great for the business. Whether it's investigating doctor-company relationships or encouraging "gain sharing" at hospitals, it is clear that many parties are focused on the slowing price inflation of orthopedic implants.
What's more, for all that the companies want to say about how the higher prices reflect the greater technology and the higher quality of the implants (which is true to a point), a concerted effort from the government and medical communities to keep a lid on pricing will no doubt have some impact.
Nevertheless, Zimmer remains a great company in a great business. Even if howling over implant pricing does affect the market, there is no doubt that the number of patients undergoing these procedures will continue to climb for some time to come. Assuming that the government allows it to stay in business and make a fair profit, Zimmer will likely continue to produce strong organic growth from its artificial hips and knees.
For more medical-device Foolishness:
- Success Is Intuitive
- St. Jude's Healthy Heartbeat
- Diagnosis: JNJ A-Ok
- The DOJ Goes Fishing for Orthopedics
Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).