Zimmer Holdings, Inc. Form 10-Q Summary
Business context and reporting period
Zimmer Holdings designs, manufactures and markets orthopaedic reconstructive implants, biologics, dental and spinal implants, trauma products, surgical products and related services. Operations are managed through the Americas, Europe and Asia Pacific segments. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2012; certain international subsidiaries report periods ending September 25.
Financial performance and liquidity
| Metric | Three months ended Sept. 30, 2012 | Three months ended Sept. 30, 2011 | Nine months ended Sept. 30, 2012 | Nine months ended Sept. 30, 2011 |
|---|---|---|---|---|
| Net sales | $1,025.5 million | $1,031.5 million | $3,291.2 million | $3,284.5 million |
| Gross profit | $769.8 million | $779.6 million | $2,464.9 million | $2,465.7 million |
| Gross margin | 75.1% | 75.6% | 74.9% | 75.1% |
| Operating profit | $249.4 million | $266.6 million | $846.9 million | $822.9 million |
| Operating margin | 24.3% | 25.8% | 25.7% | 25.1% |
| Net earnings attributable to Zimmer | $178.1 million | $191.5 million | $602.2 million | $604.2 million |
| Diluted EPS | $1.02 | $1.01 | $3.41 | $3.15 |
| Adjusted diluted EPS | $1.15 | $1.04 | $3.79 | $3.44 |
Nine-month operating cash flow was $783.9 million, essentially unchanged from $783.8 million in the prior-year period. Investing cash flow was a use of $367.5 million, and financing cash flow was a use of $378.4 million. Cash and cash equivalents increased to $801.5 million from $768.3 million at year-end 2011.
At September 30, 2012, short-term investments totaled $687.4 million and total short- and long-term investments had a fair value of $801.7 million. Total debt was approximately $1.734 billion of long-term debt and $0.3 million of short-term debt. The company had no borrowings under its $1.35 billion revolving credit facility and had $79.5 million of additional uncommitted credit facilities.
The company repurchased 5.5 million shares for $345.7 million during the first nine months and paid $63.2 million in dividends. Approximately $1.154 billion remained available under the $1.5 billion repurchase authorization. A quarterly dividend of $0.18 per share was declared.
Material changes versus the prior comparable period
- Third-quarter sales declined 1%, while nine-month sales were flat. Volume and mix contributed 5% growth in the quarter, offset by 2% pricing pressure and a 4% foreign-exchange headwind.
- Quarterly net earnings attributable to Zimmer declined 7%, primarily reflecting lower sales, lower gross margin, higher interest expense and higher special items. Nine-month net earnings declined slightly, while diluted EPS increased 8% because of share repurchases.
- Quarterly special items increased to $36.9 million from $8.0 million; nine-month special items increased to $101.1 million from $47.0 million. Charges primarily related to consulting and professional fees, restructuring, litigation and accelerated software amortization.
- Research and development expense declined to 5.2% of sales from 5.9% in the quarter. SG&A declined to 41.9% of sales from 43.0%.
- Americas quarterly sales were flat, Europe declined 3%, and Asia Pacific was flat. Nine-month sales increased 1% in the Americas and 3% in Asia Pacific but declined 3% in Europe.
- Trauma and surgical-and-other sales grew strongly, while spine sales declined 10% in the quarter and 8% for the nine months. Reconstructive sales declined 2% in the quarter and were flat for the nine months.
Guidance, outlook, commentary and risks
- Management expected 2012 sales to be flat versus 2011, assuming low-single-digit knee and hip procedure growth, approximately 2% pricing pressure and approximately 2% foreign-exchange pressure.
- Management expected 2012 gross margin of approximately 75%, R&D expense of 5% to 6% of sales, SG&A of approximately 40% of sales, approximately $125 million of restructuring and operational-excellence costs, and approximately $10 million of acquisition, integration and other costs.
- Net interest expense was expected to be approximately $60 million in 2012, higher primarily because of the $550 million senior-notes offering completed in November 2011.
- Management cited stable procedure volumes, premium-product adoption, new product introductions and operational-excellence initiatives as potential growth drivers. Pricing pressure, healthcare cost containment, Japanese price reductions and currency movements remained significant offsets.
- A 2.3% U.S. medical-device excise tax was scheduled to begin in 2013. Management did not expect to offset its full earnings impact through pricing or volume, but expected cost savings to mitigate the effect.
- The company had accrued $388.2 million since 2008 for Durom Cup claims; the remaining estimated liability at September 30, 2012 was $229.7 million. Management stated that additional losses could exceed the accrued amount, but could not reasonably estimate the potential range.
- The company received an FDA warning letter concerning manufacturing and validation processes at its Ponce, Puerto Rico facility for Trilogy Acetabular System products. Potential consequences include additional regulatory action, seizures, injunctions, civil penalties and delayed approvals.
- An FCPA investigation by the SEC and DOJ remained unresolved. The company also disclosed product liability, royalty, tax and other litigation matters that could materially affect a future period.
- European receivables remained exposed to government budget constraints. Net receivables in Greece, Italy, Portugal and Spain totaled $196.5 million after allowances; deterioration in government funding could produce additional bad-debt expense.
Investor verification priorities
- Reconcile reported GAAP earnings with adjusted earnings, including the recurring nature and cash impact of special items.
- Monitor the Durom Cup reserve, ongoing litigation and the unaccrued Polett, NexGen and royalty matters.
- Track remediation of the Ponce FDA warning letter and any effect on product approvals, manufacturing or sales.
- Assess European receivable collections, inventory levels and potential bad-debt or obsolescence charges.
- Evaluate the effect of pricing pressure, Japanese reimbursement changes, foreign exchange and the 2013 medical-device excise tax on margins and earnings.
- Confirm debt maturities, interest-rate exposure, share repurchases and dividend sustainability relative to operating cash flow.