Zimmer Holdings, Inc. Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2013. The filing predates the Zimmer Biomet name and identifies the registrant as Zimmer Holdings, Inc. Financial statements are unaudited; certain international subsidiaries report through September 25, 2013.
Business Context and Results
Zimmer designs, manufactures and markets orthopedic reconstructive implants, biologics, dental and spinal implants, trauma products, surgical products and related services. Reportable regions are the Americas, Europe and Asia Pacific.
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Net sales | $1,074.3 million | $1,025.5 million | $3,382.7 million | $3,291.2 million |
| Gross profit | $745.5 million | $769.8 million | $2,437.4 million | $2,464.9 million |
| Gross margin | 69.4% | 75.1% | 72.1% | 74.9% |
| Operating profit | $211.7 million | $249.4 million | $720.3 million | $846.9 million |
| Operating margin | 19.7% | 24.3% | 21.3% | 25.7% |
| Net earnings attributable to Zimmer | $154.4 million | $178.1 million | $525.1 million | $602.2 million |
| Diluted EPS | $0.90 | $1.02 | $3.07 | $3.41 |
| Adjusted diluted EPS | $1.25 | $1.15 | $4.09 | $3.79 |
Cash Flow, Liquidity and Capital Structure
- Nine-month operating cash flow was $662.9 million, down from $783.9 million. Higher inventories, the medical-device excise tax and quality and operational initiatives reduced cash generation.
- Investing cash outflow was $272.3 million, including $77.2 million of property, plant and equipment spending and $166.1 million of instrument additions.
- Financing cash outflow was $345.1 million, including $478.3 million of share repurchases and $98.4 million of dividends, partially offset by $325.4 million from employee stock compensation plans.
- Cash and cash equivalents were $917.4 million at September 30, 2013, compared with $884.3 million at December 31, 2012. Short- and long-term investments had fair value of $856.0 million.
- Total debt was approximately $1.686 billion of long-term debt, with no short-term debt outstanding. The $1.35 billion revolving credit facility had no borrowings, and the company was in compliance with its covenants.
- The company had $536.4 million remaining under its $1.5 billion share-repurchase authorization, expiring December 31, 2014.
Material Changes Versus the Prior Comparable Period
- Sales increased 5% in the quarter and 3% year to date, but attributable net earnings declined 13% in both periods.
- Volume and mix contributed 8 percentage points to quarterly sales growth, while pricing reduced growth by 1 point and foreign exchange reduced growth by 2 points.
- Americas sales increased 8% in the quarter and 5% year to date; Europe increased 4% and 2%; Asia Pacific declined 5% and 4%, primarily from foreign exchange.
- Gross margin declined because of excess and obsolete inventory charges, product discontinuations, lower pricing, product and geographic mix, and quality-related inventory and manufacturing charges.
- Q3 cost of products sold included $52.5 million of excess and obsolete inventory charges, including $36.2 million related to discontinued products. An additional $2.9 million was recorded in special items for related instruments.
- Special items increased to $46.4 million in Q3 and $155.5 million year to date, compared with $36.9 million and $101.1 million, respectively, in 2012.
- The company repurchased 6.4 million shares for $478.3 million during the first nine months, contributing to a smaller decline in EPS than in net earnings.
Guidance, Outlook and Management Commentary
- Management expected 2013 sales growth of 2.5% to 3%, based on stable to low-single-digit growth in knee and hip procedures.
- Pricing was expected to reduce sales growth by approximately 2%, and foreign exchange was expected to reduce growth by 1.5% to 2% using September 30, 2013 exchange rates.
- 2013 gross margin was expected to be approximately 72.5%, including inventory step-up and other inventory and manufacturing charges.
- Expected 2013 R&D expense was approximately 4.5% of sales and SG&A was approximately 39.5% of sales.
- Management expected approximately $335 million of 2013 expenses for inventory step-up and manufacturing charges, certain claims and special items. It expected the medical-device excise tax to add approximately $10 million to $15 million of cost of products sold per quarter once reflected for a full quarter.
- Management expected 2013 net interest expense of approximately $56 million, assuming prevailing variable interest rates continued.
Risks, Contingencies and Unusual Items
- Remaining estimated Durom Cup-related liability was $391.6 million, including $50.0 million current and $341.6 million long term. The company recorded a $218.0 million insurance receivable, but insurers reserved their rights and could deny some or all coverage.
- A Stryker patent-infringement case resulted in a trial judgment involving up to $210.0 million of damages, plus interest and attorneys’ fees after trebling. Zimmer appealed and had not accrued the loss because it did not believe liability was probable.
- NexGen knee product litigation, the Polett matter and other product-liability claims remained unresolved. The filing states that potential losses for certain matters could not reasonably be estimated.
- An FDA warning letter concerning manufacturing and validation processes at the Ponce, Puerto Rico facility remained pending. Additional regulatory action, including seizure, injunctions, penalties or delays in approvals, was possible.
- IRS proposed adjustments for 2008 and 2009 intercompany pricing matters remained under dispute. The ultimate tax resolution could materially affect future tax expense, earnings and cash flow.
- Receivables in Greece, Italy, Portugal and Spain totaled $216.7 million net of allowances, or 25% of consolidated trade receivables. Deterioration in government healthcare funding could increase bad-debt expense.
- The company continued operational-excellence initiatives, including restructuring, outsourcing and centralization of finance functions. Approximately 150 positions were eliminated during the first nine months.
Important Facts for Investors to Verify
- Whether the company achieved its 2013 sales, gross-margin and expense guidance, including the impact of the medical-device excise tax.
- Actual cash payments and ultimate insurance recoveries related to Durom Cup claims.
- Progress and potential exposure from the Stryker appeal and other product-liability litigation.
- Resolution of the FDA warning letter and related manufacturing observations at the Ponce facility.
- Outcome of IRS intercompany-pricing examinations and the potential change in unrecognized tax benefits.
- Inventory levels, product-discontinuation charges and whether operational-excellence savings offset pricing, currency and regulatory pressures.
- Future capital allocation among debt repayment, dividends, share repurchases and acquisitions.