Zimmer Holdings, Inc. — Fiscal 2010 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2010; filed February 24, 2011. The filing is for Zimmer Holdings, Inc., the predecessor company to Zimmer Biomet, not a quarterly filing.
Business Context
Zimmer was a global medical-device company focused on orthopaedic reconstructive, spine and trauma devices, dental implants, surgical products and related healthcare services. It operated in more than 25 countries, marketed products in more than 100 countries, and reported through the Americas, Europe and Asia Pacific segments. Approximately 80% of sales were generated through direct channel accounts.
The Americas represented 58% of 2010 sales, Europe 26%, and Asia Pacific 16%. The company acquired Beijing Montagne Medical Device Co., Ltd. and Sodem Diffusion S.A. in December 2010.
Financial Performance and Position
| Metric | 2010 | 2009 | Change |
|---|---|---|---|
| Net sales | $4,220.2 million | $4,095.4 million | Up 3% |
| Gross profit | $3,207.8 million | $3,104.7 million | Up 3% |
| Gross margin | 76.0% | 75.8% | Up 20 basis points |
| Operating profit | $916.7 million | $1,018.8 million | Down 10% |
| Operating margin | 21.7% | 24.9% | Down 320 basis points |
| Net earnings attributable to Zimmer | $596.9 million | $717.4 million | Down 17% |
| Diluted EPS | $2.97 | $3.32 | Down 11% |
| Operating cash flow | $1,193.5 million | $1,117.5 million | Up 7% |
Research and development expense was $220.0 million, or 5.2% of sales, compared with $205.7 million, or 5.0%, in 2009. Selling, general and administrative expense was $1,757.4 million, or 41.6% of sales, compared with 42.2% in 2009. The effective tax rate increased to 30.6% from 28.1%, partly because goodwill impairment charges generated no tax benefit.
At December 31, 2010, cash and cash equivalents were $668.9 million, short-term investments were $265.1 million, and total short- and long-term debt investments had a fair value of $410.6 million. Total assets were $7,999.9 million and stockholders’ equity was $5,771.3 million.
Long-term debt was $1,142.1 million, consisting primarily of $1.0 billion of senior notes due 2019 and 2039 and $141.8 million drawn under the revolving credit facility. The company had $1,208.2 million of availability under its $1.35 billion senior credit facility and was in compliance with its covenants.
Cash flows used in investing activities were $726.9 million, including $192.5 million for instruments, $79.2 million for other property and equipment, $413.3 million for investments and $82.6 million for other business combinations. Financing activities used $489.6 million, principally reflecting $505.6 million of share repurchases. Approximately $1.2 billion remained authorized under the $1.5 billion repurchase program.
Material Changes Versus the Prior Comparable Period
- Sales increased 3%, driven by 3% volume and mix growth and a 1% favorable foreign-exchange effect, partly offset by 1% pricing pressure.
- Asia Pacific sales increased 14%, Americas sales increased 2%, and Europe sales declined 2%.
- Reconstructive sales increased 3%; dental increased 7%; trauma increased 5%; surgical and other increased 13%; spine declined 8%.
- Net earnings declined primarily because of a $204.0 million goodwill impairment charge related to the U.S. Spine reporting unit, compared with $73.0 million in 2009; $75.0 million of additional Durom Cup claims provisions; higher interest expense; and other special items.
- Durom Cup-related provisions totaled $179.0 million through 2010, with estimated remaining liability of $132.8 million at year-end.
- Non-GAAP adjusted net earnings increased to $871.6 million from $849.9 million, and adjusted diluted EPS increased to $4.33 from $3.94, excluding specified special and unusual items.
- U.S. Spine performance remained weak because of integration difficulties, reimbursement pressure, declining Dynesys sales, increased competition and regulatory uncertainty.
Guidance, Outlook, Risks and Unusual Items
Management projected 2011 sales growth of 3% to 5%, assuming low-single-digit knee and hip procedure growth, modest global economic improvement and stable employment. Pricing was expected to reduce sales growth by 1% to 2%, while foreign exchange was expected to contribute approximately 1% based on year-end 2010 rates.
Management expected 2011 gross margin of approximately 75%, research and development expense of 5% to 6% of sales, and SG&A expense of 40% to 41% of sales. It forecast $75 million to $80 million of restructuring and transformation costs and $15 million to $20 million of acquisition and integration costs. Interest and other expense was expected to be approximately $50 million.
- Durom Cup claims: The company suspended U.S. marketing and distribution in 2008. Remaining liabilities were estimated at $132.8 million, but actual claims and average settlement costs could differ materially.
- Litigation: A jury awarded $27.6 million in a product-liability case; post-trial relief and appeal proceedings were pending, and no liability was recorded because management did not believe a loss was probable or reasonably estimable.
- Regulatory and compliance matters: The company remained subject to a Corporate Integrity Agreement through 2012 and continued cooperating with SEC and DOJ investigations concerning potential Foreign Corrupt Practices Act violations.
- Tax contingency: In January 2011, the IRS issued a Notice of Proposed Adjustment relating to intercompany pricing for 2006 and 2007. The company stated that the ultimate resolution could materially affect tax expense and net earnings.
- Healthcare reform: A 2.3% U.S. medical-device excise tax was scheduled to begin in 2013, with potential effects on earnings and cash flow.
- Goodwill and intangible assets: Further impairment charges could result if U.S. Spine or other reporting units experience lower revenue, margins or cash flows, or if valuation assumptions deteriorate.
- Market risks: The company was exposed to foreign currency, interest-rate, commodity-price and counterparty risks. It had substantial foreign operations and approximately $2.25 billion of net foreign-currency-denominated asset exposure, including goodwill.
Most Important Facts to Verify
- Reconcile GAAP earnings and EPS with adjusted earnings of $871.6 million and adjusted diluted EPS of $4.33, focusing on the $204.0 million goodwill impairment and $75.0 million Durom Cup provision.
- Monitor the remaining $132.8 million Durom Cup liability, settlement payments and any change in claims assumptions.
- Assess whether U.S. Spine revenue, reimbursement trends and Dynesys regulatory prospects support the carrying value of remaining goodwill.
- Compare 2011 actual sales, gross margin, SG&A and restructuring costs with management’s stated outlook.
- Review the IRS intercompany-pricing dispute and any subsequent tax assessment or settlement.
- Evaluate leverage, the 2012 maturity of the revolving credit facility, senior-note interest obligations and the effect of continued share repurchases on liquidity.
- Track the SEC/DOJ FCPA investigation, Corporate Integrity Agreement compliance and material litigation developments.