Zimmer Holdings, Inc. Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2013; unaudited. The filing is by Zimmer Holdings, Inc., the predecessor name to Zimmer Biomet Holdings, Inc. International subsidiaries generally reported periods ending June 25, 2013. The company designs, manufactures and markets orthopedic reconstructive, dental, spine, trauma, biologic and related surgical products.
Financial Performance and Position
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $1,169.5 million | $1,125.0 million | $2,308.4 million | $2,265.7 million |
| Gross profit | $845.9 million | $843.1 million | $1,691.9 million | $1,695.1 million |
| Gross margin | 72.3% | 74.9% | 73.3% | 74.8% |
| Operating profit | $210.4 million | $301.9 million | $508.6 million | $597.5 million |
| Operating margin | 18.0% | 26.8% | 22.0% | 26.4% |
| Net earnings attributable to Zimmer | $152.1 million | $214.5 million | $370.7 million | $424.1 million |
| Diluted EPS | $0.89 | $1.22 | $2.17 | $2.39 |
| Operating cash flow | Not separately provided | Not separately provided | $370.2 million | $438.9 million |
- Second-quarter sales increased 4%; six-month sales increased 2%. Volume and mix contributed 7 percentage points to second-quarter growth, offset by 1 percentage point of pricing pressure and 2 percentage points of foreign-exchange headwinds.
- Net earnings declined 29% in the quarter and 13% year to date. Diluted EPS declined 27% and 9%, respectively, despite share repurchases reducing the diluted share count.
- Reported gross margin declined primarily because of product and geographic mix, lower selling prices, product rationalization and quality-related inventory and manufacturing charges.
- Adjusted net earnings, excluding specified unusual items and related tax effects, were $243.4 million, or $1.43 adjusted diluted EPS, in Q2 2013, compared with $235.6 million and $1.34 in Q2 2012. For six months, adjusted net earnings were $484.2 million versus $466.9 million.
Liquidity, Debt and Capital Allocation
- Cash and cash equivalents were $709.9 million at June 30, 2013, compared with $884.3 million at December 31, 2012. Short-term investments were $525.9 million; total short- and long-term investments had a fair value of $800.1 million.
- Operating cash flow was $370.2 million, investing cash flow was negative $121.6 million and financing cash flow was negative $405.4 million for the first six months.
- Financing uses included $460.8 million of share repurchases and $64.5 million of dividends. The company repurchased 6.2 million shares during the first half and had $553.9 million remaining under its $1.5 billion authorization, expiring December 31, 2014.
- Total debt was approximately $1.688 billion of long-term debt, with no short-term debt at June 30, 2013. The company had no borrowings under its $1.35 billion revolving credit facility and was in compliance with its covenants.
- Management stated that operating cash flow and available revolver capacity were sufficient for working capital, capital expenditures, debt service, dividends and repurchases.
- Inventory was $1,052.9 million, up from $995.3 million at year-end 2012. The company reported 293 days of inventory on hand and 69 days sales outstanding at June 30, 2013.
Material Changes Versus Prior Comparable Period
- Americas sales increased 7% in Q2 and 4% for the first half; Europe increased 1% in both periods; Asia Pacific declined 2% in Q2 and 3% for the first half, principally because of currency effects.
- Q2 product trends included growth in knees of 4%, extremities of 14% and surgical and other products of 24%. Hips were flat, while dental and trauma were flat; spine increased 3%.
- “Certain claims” expense increased by $47.0 million, primarily for Durom Cup-related claims. Special items increased to $75.6 million in Q2 from $30.7 million and to $109.1 million for six months from $64.2 million.
- Research and development expense declined, while SG&A increased in dollars but declined as a percentage of sales, reflecting operational-excellence savings.
- Cash flow from operations declined $68.7 million year over year, mainly because of higher inventory, including inventory supporting new product launches and the medical device excise tax.
Guidance, Outlook, Risks and Unusual Items
- Management projected 2013 sales growth of 2% to 3%, assuming stable knee and hip procedure markets. Pricing was expected to reduce growth by approximately 2% and foreign exchange by approximately 2% at June 30 rates.
- Expected 2013 gross margin was approximately 73.5%, including inventory step-up and other manufacturing charges. R&D was expected at approximately 4.5% of sales and SG&A at approximately 39.5% of sales.
- Management expected approximately $250 million of 2013 expense related to inventory step-up, manufacturing charges, certain claims and special items. The medical device excise tax was expected to affect cost of products sold by approximately $10 million to $15 million per quarter in the second half.
- Remaining estimated Durom Cup liability was $400.8 million, including $50.0 million current and $350.8 million long term. The company recorded a $218.0 million insurance receivable, but insurers reserved their rights and coverage could be denied in whole or in part.
- The IRS issued a Notice of Proposed Adjustment concerning intercompany pricing for tax years 2008 and 2009. The company stated that resolution of tax disputes for 2005 through 2009 could materially affect future tax expense, earnings and cash flows.
- A jury found infringement of certain Stryker patents and awarded $70.0 million; final judgment had not been entered, and the company had not accrued a loss. NexGen product-liability cases remained pending without an accrued estimate.
- An FDA warning letter concerning manufacturing and validation processes at the Ponce, Puerto Rico facility remained outstanding. Potential consequences include additional regulatory action, seizure, injunctions, civil penalties and delays in certain product approvals or export certifications.
- Key ongoing risks include pricing and reimbursement pressure, foreign currency fluctuations, healthcare cost containment, product liability, regulatory compliance, intellectual property claims, tax audits, European receivables exposure, supplier dependence, product launches and operational-excellence execution.
Facts Investors Should Verify
- Whether Durom Cup claim counts, settlement costs, insurance recoveries and the $400.8 million remaining liability develop as estimated.
- The status and ultimate financial impact of the IRS intercompany-pricing disputes and the 2008–2009 Notice of Proposed Adjustment.
- The outcome of the Stryker patent litigation and the potential $70.0 million charge, as well as other product-liability proceedings.
- Whether the Ponce FDA warning letter and other Form 483 observations are remediated without material disruption or additional penalties.
- Progress toward the 2013 sales, gross-margin, expense and special-item outlook, including the impact of pricing, foreign exchange and the medical device excise tax.
- Inventory normalization, operating cash conversion and the sustainability of share repurchases and dividends relative to available liquidity.