Zimmer Holdings, Inc. — Form 10-Q Summary
Business Context and Reporting Period
Zimmer Holdings, Inc. designed, manufactured and marketed orthopedic reconstructive, dental, spinal, trauma and related surgical products in more than 100 countries through the Americas, Europe and Asia Pacific segments. The filing covers the unaudited three and nine months ended September 30, 2009, filed November 4, 2009. The filing predates the company’s later Zimmer Biomet name.
Key Financial Metrics
| Metric | Three Months 2009 | Three Months 2008 | Nine Months 2009 | Nine Months 2008 |
|---|---|---|---|---|
| Net sales | $975.6 million | $952.2 million | $2,988.1 million | $3,090.9 million |
| Gross profit | $726.3 million | $715.0 million | $2,271.7 million | $2,336.7 million |
| Gross margin | 74.4% | 75.1% | 76.0% | 75.6% |
| Operating profit | $204.0 million | $210.3 million | $780.3 million | $850.3 million |
| Operating margin | 20.9% | 22.1% | 26.1% | 27.5% |
| Net earnings attributable to Zimmer | $149.9 million | $214.7 million | $562.2 million | $681.1 million |
| Diluted EPS | $0.70 | $0.95 | $2.59 | $2.97 |
- Third-quarter sales increased 2%, driven by 4% volume and mix growth, offset by 1% pricing pressure and a 1% foreign-exchange headwind.
- Nine-month sales declined 3%, reflecting a 3% foreign-exchange headwind, 1% lower pricing and weaker European and Asia Pacific sales.
- Operating profit declined 3% in the quarter and 8% year to date. Net earnings declined 30% in the quarter and 17% year to date.
- Third-quarter effective tax rate was 25.0%, compared with 9.8% in 2008; the prior-year rate benefited from an approximately $30.8 million tax benefit related to a 2007 civil settlement. The nine-month 2009 rate was 26.8%, compared with 23.1%.
- As of September 30, 2009, cash and cash equivalents were $439.7 million, compared with $212.6 million at December 31, 2008. Total assets were $7.65 billion and total liabilities were $1.67 billion.
- Long-term debt was $600.2 million, up from $460.1 million at December 31, 2008. The company had $749.8 million of available capacity under its $1.35 billion senior revolving credit facility and was in compliance with all covenants.
- Operating cash flow was $732.0 million for the first nine months, compared with $831.2 million in 2008. Investing cash flow used $247.9 million and financing cash flow used $264.3 million.
- The company repurchased 10.8 million shares for $404.4 million during the first nine months. Approximately $730.2 million remained authorized under the repurchase program, which was extended through December 31, 2010.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales growth improved from the prior-year period, but reported profitability weakened because of higher operating expenses, lower production volumes and foreign-exchange effects.
- Spine sales increased 24% in the quarter and 21% year to date, primarily reflecting the October 2008 Abbott Spine acquisition, partially offset by integration-related sales dis-synergies.
- Dental sales declined 8% in the quarter and 13% year to date because of economic weakness. Reconstructive sales rose 1% in the quarter but declined 5% year to date, while trauma and spine grew.
- Research and development expense increased to $52.1 million in the quarter and $153.8 million year to date. Management expected full-year 2009 R&D spending to exceed 5% of sales.
- Acquisition, integration, realignment and other expense increased to $22.2 million in the quarter and $65.7 million year to date, including workforce realignment and approximately $18.4 million of severance and termination-related costs.
- The company recorded a $32.1 million net curtailment and settlement gain year to date from amendments to U.S. and Puerto Rico postretirement plans. It also acquired its remaining noncontrolling interest for approximately $8.6 million.
- Currency hedge gains improved year-to-date gross margin compared with hedge losses in the 2008 period, although quarterly gross margin declined because of higher manufacturing costs per unit.
Guidance, Outlook, Commentary and Risks
- Management expected global selling prices to decline approximately 1% for full-year 2009 and estimated that a stronger U.S. dollar would reduce full-year sales by approximately 2%.
- Management characterized global orthopedic procedure growth as temporarily reduced from mid-single-digit to low-single-digit rates because of the weak economy. Elective procedure timing and dental demand remained under pressure.
- Management believed market-share losses associated with 2008 compliance initiatives, the Durom Cup suspension and product recalls had stabilized, but expected near-term sales growth to remain below market growth.
- The company increased its Durom Cup-related reserve by $35.0 million in the third quarter. The filing states that the reserve was $77.5 million at September 30, 2009, while the cumulative provision recorded was $104.0 million; investors should reconcile these different disclosures.
- Pending matters included product liability claims, a securities class action, an ERISA action, government inquiries and an SEC and DOJ investigation concerning potential Foreign Corrupt Practices Act matters. The company could not predict the outcome of the FCPA investigation.
- The Corporate Integrity Agreement with the Department of Health and Human Services ran through 2012; a material breach could result in exclusion from federal healthcare programs.
- Principal risks included pricing and reimbursement pressure, healthcare reform, competition, product liability, regulatory compliance, litigation, foreign currency movements, acquisitions and integration, intellectual property disputes, supplier dependence and economic conditions.
- Management stated that operating cash flow and available credit were sufficient for working capital, capital expenditures and debt service needs.
Investor Verification Checklist
- Reconcile the $77.5 million Durom Cup reserve balance with the $104.0 million cumulative provision disclosure.
- Assess the sustainability of reported earnings after excluding the postretirement gain, Durom Cup provision, acquisition and realignment costs, litigation items and prior-year tax and investment gains.
- Review the decline in European and year-to-date reconstructive sales, including the effects of currency, pricing, market share and product disruptions.
- Monitor debt utilization, credit-facility covenants, interest expense and the impact of further share repurchases on liquidity.
- Track outcomes of the SEC/DOJ FCPA investigation, Corporate Integrity Agreement compliance, product liability claims and securities-related litigation.
- Evaluate inventory levels, which were $972.1 million at September 30, 2009, and management’s progress in reducing field consignments and improving inventory turns.