June 5, 2008 - Zimmer Holdings, Inc. (ZMH-NYSE) can put the spring back in your step or the zing back in your swing. The company designs and markets orthopedic products, including reconstructive implants used in knee or hip replacement surgery, shoulder implants that restore function in arthritic joints, and dental implant systems and allografts. It also makes spinal implants to fix aching or injured backs and trauma products (such as plates, screws, and pins) that help broken bones to heal. Additionally, Zimmer makes surgical products used in orthopedic surgeries, including tourniquets and devices for wound cleansing. Zimmer operates worldwide, with direct operations in about 25 countries.

It would seem the odds are gathering in favor of a northern route. With demographics strongly on its side, the company's products are giving Baby Boomers just what they need and want. By offering new products and improving the existing ones, Zimmer's sales continue to increase. In 2005, they were $3.3 billion. Last year they hit $3.9 billion. Analysts are looking for $4.3 billion this year, and $4.65 billion next year. In the last 5 years, revenues increased, on average, 17.7% a year.

The earnings did even better than sales. Over the last 5 years, on average, earnings per share (eps) improved by 24.5% a year. In 2005, they were $3.10 a share, then $3.42, followed by $4.11. This year analysts look for $4.20 and next year $4.77. While this year's eps advance is tepid, next year's growth shows strength once again.

This year's numbers will be hurt because of a voluntary recall of some of the orthopaedic surgical products made at the Ohio plant. Management decided these were not up to quality standards, recalled them, halted production, and is now training employees to improve quality. This will "cost" the sales total about $70 million to $80 million this year. Management is taking steps to offset this problem by cutting back on some operations and buying back stock. No other products are being halted or affected by this recall.

One of the manufacturing plants in Ireland is being upgraded. Management is focused on attaining higher quality in its products in every plant. With demographics that will only grow and demand more of what Zimmer offers, it wants to stay in the forefront of the industry with design and quality of the artificial limbs it offers. There are new offerings for this year, including several for knees and hips.

More numbers: Return on Equity is a solid 16%. Debt is only 2% of capital. Market cap is $16.3 billion on 233.185 million shares. Net profit margin is 23%. Current assets are more than 2.5 times current liabilities.

One caution to consider: According to the Financial Times, Zimmer is reviewing its contracts with hundreds of US surgeons in a move that could take the company's bill for clearing up a legal case last year to more than $450 million.

Under procedures intended to make its dealings with surgeons with whom it has consultancy relationships more transparent, Zimmer is considering terminating its royalty contracts with many of these doctors.

As part of the change, Zimmer would buy out the surgeons from their current agreements, handing them a one-time payment to substitute for the chance of gaining regular fees for years ahead.

The company refused to speculate on how much these payments might amount to, but one analyst with close knowledge of the industry said it was "reasonable" to estimate the sum could come to about $250 million.

The new arrangements have irritated some surgeons, who might have to be offered substantial one-time payments to win their support for being bought out of current contracts, analysts believe.

The payments to surgeons being contemplated by Zimmer would come on top of a $169.5 million fine levied on the company last September by the US government.

This followed an inquiry by the Department of Justice into allegations that Zimmer and other implant makers had paid illicit "kickbacks" to surgeons in the US in an effort to persuade them to use their products.

Zimmer has also said the costs of fitting in with new compliance measures - agreed in the wake of the legal case to prevent unethical practices recurring - could amount to up to $54 million over an 18-month period ending next April.

The payments could be classified by the company as a special charge, and are due to be worked out during the next few months.

So there are impending fines and/or payments that will be extraordinary but could meaningfully influence the bottom line over the next few quarters.

This is a company making products that people need, most must have them. It's working on being the best in the industry and offering new products as well as improving existing ones. Profitability has been there in the past and appears to be returning, especially once the extraordinary payments are made. Look deeper if you're trying to find a medical device company with a story worth reading.

- Company Web site: www.zimmer.com

- Ted Allrich