Zimmer Holdings, Inc. — Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2011. The filing is unaudited and compares results with the corresponding 2010 periods. Zimmer designs, manufactures and markets orthopedic reconstructive, dental, spine, trauma, surgical and related healthcare products across the Americas, Europe and Asia Pacific.
Financial performance and position
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $1,137.4 million | $1,057.7 million | $2,253.0 million | $2,120.5 million |
| Gross profit | $849.5 million | $807.1 million | $1,686.1 million | $1,601.5 million |
| Operating profit | $259.1 million | $228.1 million | $556.3 million | $522.2 million |
| Net earnings | $203.8 million | $165.5 million | $412.7 million | $370.9 million |
| Diluted EPS | $1.06 | $0.82 | $2.14 | $1.82 |
- Q2 sales increased 8%; six-month sales increased 6%. Reported Q2 growth comprised approximately 3 percentage points from volume/mix, negative 1 point from pricing and positive 6 points from foreign exchange.
- Q2 gross margin was approximately 74.7%, compared with 76.3% in 2010; six-month gross margin was approximately 74.8%, compared with 75.5%. Lower margins primarily reflected foreign-currency hedge losses and higher average unit costs.
- Q2 operating margin improved to approximately 22.8% from 21.6%; six-month operating margin was approximately 24.7% versus 24.6%.
- Q2 net earnings rose 23% and six-month net earnings rose 11%. Diluted EPS benefited from share repurchases and increased 29% in Q2 and 18% year to date.
- Product performance was led by hips, dental, trauma and surgical products. Spine sales declined 3% in Q2 and 4% year to date, primarily because of Americas operational, reimbursement and Dynesys-related challenges. Reconstructive sales increased 6% in Q2 and 5% year to date.
- Cash and cash equivalents were $624.1 million at June 30, 2011, compared with $668.9 million at December 31, 2010. Short-term investments were $321.4 million; total available-for-sale investments had a fair value of $425.7 million.
- Six-month operating cash flow was $433.2 million, down from $532.2 million. Investing cash flow used $162.5 million and financing cash flow used $324.3 million, including $357.2 million for repurchases of 6.1 million shares.
- Total assets were $8.25 billion and total liabilities were $2.23 billion at June 30, 2011. Long-term debt was $1.15 billion, with no short-term debt. The $1.35 billion revolving credit facility had $143.0 million drawn and $1.207 billion available.
Material changes versus the prior comparable period
- Sales growth accelerated in Europe and Asia Pacific, while Americas sales were essentially flat in Q2. Foreign exchange contributed materially to reported growth.
- Operating results included $13.5 million of Q2 special items and $39.0 million for the first six months, compared with $11.5 million and $14.1 million, respectively, in 2010. The 2011 charges primarily related to employee severance, organizational restructuring, acquisitions and related integration activities.
- Zimmer recorded an additional $50.0 million Q2 provision for Durom Cup-related claims, compared with $75.0 million in Q2 2010. Cumulative “Certain claims” provisions totaled $229.0 million, with an estimated remaining Durom Cup liability of $159.8 million at June 30, 2011.
- Interest expense declined to $9.8 million in Q2 and $20.8 million year to date, from $14.3 million and $28.9 million, respectively, primarily due to interest-rate swaps and higher investment income.
- Receivables and inventories increased from year-end, while operating cash flow declined because of lower collections, inventory investment, increased pension funding and product liability payments.
- Approximately 500 employees were affected by management-layer reductions and organizational changes during the first six months of 2011.
Guidance, outlook and risks
- Management expected full-year 2011 sales growth of 5.5% to 6.5%, assuming global knee and hip procedure volumes are flat to slightly positive.
- At June 30, 2011 currency rates, management expected approximately 3% positive foreign-exchange impact on sales, approximately 1% negative pricing impact, gross margin of approximately 75%, R&D expense of 5% to 5.5% of sales and SG&A of approximately 41% of sales.
- Expected 2011 restructuring and transformation expenses were $75 million to $80 million, with an additional $15 million to $20 million of acquisition integration costs.
- The IRS completed an examination of 2005–2007 U.S. federal returns and issued assessments reallocating profits between U.S. and foreign subsidiaries. Zimmer is contesting the matter; the ultimate impact could be material and cannot currently be estimated.
- Durom Cup claims remain a significant contingency. Zimmer expects to pay most of the remaining accrued liability within three years, but cannot reasonably estimate losses above the accrued amount.
- A Pennsylvania jury verdict resulted in a $20.3 million judgment against Zimmer and another defendant. Zimmer appealed and recorded no charge, stating that a loss was not considered probable; a future charge could be material.
- The SEC is investigating potential Foreign Corrupt Practices Act matters and issued a subpoena covering substantially all Asia Pacific countries where Zimmer operates. The outcome cannot currently be predicted.
- Other risks include pricing pressure, reimbursement and healthcare cost containment, product liability, regulatory compliance, intellectual property disputes, competition, currency fluctuations, acquisitions, supplier dependence and the federal medical-device excise tax scheduled for 2013.
- Management concluded that disclosure controls were effective as of June 30, 2011, and reported no material changes in internal control over financial reporting.
Most important facts for investors to verify
- Whether full-year sales growth of 5.5% to 6.5% and approximately 75% gross margin were achieved or revised.
- The ultimate cost and payment timing of the $159.8 million accrued Durom Cup liability and any additional product-liability claims.
- The outcome and potential tax impact of the IRS profit-allocation assessment.
- The status and potential exposure from the SEC and DOJ FCPA investigation and Asia Pacific subpoena.
- The outcome of the Pennsylvania appeal and any resulting liability.
- Whether operating cash flow improves from the six-month level and whether receivable days, inventory levels and foreign-exchange hedging materially affect liquidity.
- Progress against the restructuring program, acquisition integration costs and the remaining approximately $0.8 billion share-repurchase authorization.