Zimmer Holdings, Inc. Form 10-Q Summary
Business Context and Reporting Period
Unaudited quarterly report for the three months ended March 31, 2013, filed May 8, 2013. The filing identifies the registrant as Zimmer Holdings, Inc. and describes a global medical-device company focused on orthopaedic reconstructive implants, biologics, dental and spinal implants, trauma products, surgical products and related services. Results are reported across the Americas, Europe and Asia Pacific.
Financial Performance and Position
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Net sales | $1,138.9 million | $1,140.7 million | Flat; down $1.8 million |
| Gross profit | $846.0 million | $852.0 million | Down $6.0 million |
| Gross margin | 74.2% | 74.7% | Down 0.5 percentage point |
| Operating profit | $298.2 million | $295.6 million | Up $2.6 million |
| Operating margin | 26.2% | 25.9% | Up 0.3 percentage point |
| Net earnings attributable to Zimmer | $218.6 million | $209.6 million | Up 4% |
| Diluted EPS | $1.28 | $1.17 | Up 9% |
| Operating cash flow | $180.5 million | $207.4 million | Down $26.9 million |
Net margin was approximately 19.2% versus 18.4% in the prior-year quarter. The effective tax rate declined to 23.1% from 25.7%, primarily because of retroactive U.S. R&D tax-credit and other tax benefits. Adjusted net earnings, excluding inventory charges, special items and related taxes, were $240.8 million, or $1.41 adjusted diluted EPS, compared with $231.3 million and $1.30, respectively.
At March 31, 2013, cash and cash equivalents were $657.0 million, short-term investments were $544.2 million and total short- and long-term investments at fair value were $775.8 million. Total debt was approximately $1.70 billion, consisting of $1.70 billion of long-term debt and no short-term debt. The company had no borrowings under its $1.35 billion revolving credit facility and was in compliance with its covenants. Total current assets were $3.46 billion versus $763.3 million of current liabilities.
Cash used in financing activities was $452.5 million, including $392.0 million of share repurchases and $30.9 million of dividends. The company repurchased 5.4 million shares at an average price of $73.18 and had $622.7 million remaining under its $1.5 billion authorization. Inventory increased to $1.04 billion, or 319 days on hand, partly because of the medical-device excise tax and support for new product launches.
Material Changes Versus the Prior Comparable Period
- Sales were essentially unchanged because 3% volume and mix growth was offset by 2% pricing pressure and 1% unfavorable foreign exchange; most key markets had two fewer billing days.
- Operating profit improved despite lower gross profit, supported by lower research and development expenses, lower legal expenses and operational-excellence savings.
- Research and development expense declined to $53.5 million from $59.6 million as major projects, including Persona, reached commercialization.
- Net earnings and EPS benefited from the lower tax rate and share repurchases; weighted-average diluted shares declined to 170.7 million from 178.5 million.
- Operating cash flow declined because of higher inventories, receivables and other working-capital uses.
- Product trends were mixed: trauma increased 9%, surgical and other increased 14%, extremities increased 7%, while hips declined 4%, spine declined 10%, knees declined 1% and dental declined 1%.
Guidance, Outlook, Risks and Unusual Items
Management expected 2013 net sales growth of 1% to 3%, assuming stable knee and hip procedure markets with low-single-digit growth. Pricing was expected to reduce sales growth by approximately 2% and foreign exchange by approximately 1.5%. Expected 2013 gross margin was 74.8% to 75.3%, including acquisition and operational-excellence inventory charges. Research and development was expected to be approximately 5% of sales, SG&A was expected to be 39.5% to 40.0% of sales, and net interest income and expense was expected to be approximately $60 million.
Management expected $120 million to $130 million of 2013 operational-excellence expenses and $5 million to $15 million of acquisition and integration costs. The 2.3% U.S. medical-device excise tax was not material in first-quarter cost of products sold because it was capitalized in inventory; management estimated its eventual cost impact at $10 million to $15 million per quarter.
Special items were $33.5 million, including consulting and professional fees, dedicated project personnel, facility relocation, litigation-related items and accelerated software amortization. The company had accrued $403.2 million for Durom Cup-related claims, with no additional first-quarter expense. A Pennsylvania court vacated a $27.6 million Polett case judgment and remanded the matter for a new trial, subject to plaintiffs’ pending re-argument motion. A jury awarded Stryker $70.0 million in a patent case involving Pulsavac Plus products; Zimmer had not accrued the loss and planned post-trial motions and an appeal.
Other significant risks included product-liability and intellectual-property claims, FDA concerns regarding manufacturing and validation processes at the Ponce, Puerto Rico facility, potential regulatory sanctions, tax audits and disputed profit allocations, foreign-exchange volatility, pricing and reimbursement pressure, Eurozone public-hospital receivables, and possible goodwill impairment at the U.S. Spine reporting unit.
Most Important Facts for Investors to Verify
- Whether reported 2013 sales growth and gross-margin guidance were achieved, including the effects of pricing, foreign exchange and the medical-device excise tax.
- The development and ultimate cost of Durom Cup, NexGen knee and other product-liability matters.
- The final outcome and potential exposure from the Stryker patent verdict and Polett litigation.
- Progress in remediating the FDA warning letter concerning the Ponce facility.
- Inventory normalization, operating cash-flow conversion and the impact of new product launches.
- Use of cash for share repurchases and dividends relative to debt maturities and liquidity.
- Tax-audit outcomes and changes in unrecognized tax benefits or the effective tax rate.
- The performance and impairment risk of the U.S. Spine reporting unit.