Business Context and Reporting Period
Zimmer Holdings, Inc. (now Zimmer Biomet) filed this Form 10-K for the year ended December 31, 2012. The filing includes quarterly information for the fourth quarter, but it is an annual report rather than a standalone Q4 filing. Zimmer designs, manufactures and markets orthopedic reconstructive, spine and trauma devices, biologics, dental implants and surgical products in more than 100 countries through the Americas, Europe and Asia Pacific segments.
- 2012 net sales were generated primarily by the Americas: $2,476.3 million, or 56% of total sales; Europe contributed $1,177.4 million, or 26%; and Asia Pacific contributed $818.0 million, or 18%.
- Direct channel accounts represented approximately 75% of net sales.
Financial Performance and Key Metrics
| Metric | 2012 | 2011 | Change |
|---|---|---|---|
| Net sales | $4,471.7 million | $4,451.8 million | Flat; approximately 0% reported growth |
| Gross profit | $3,346.5 million | $3,329.8 million | Increase of $16.7 million |
| Gross margin | 74.8% | 74.8% | Flat |
| Operating profit | $1,047.4 million | $1,024.1 million | Increase of $23.3 million |
| Operating margin | 23.4% | 23.0% | Increase of 40 basis points |
| Net earnings attributable to Zimmer Holdings | $755.0 million | $760.8 million | Decrease of 1% |
| Diluted EPS | $4.29 | $4.03 | Increase of 6% |
| Operating cash flow | $1,151.9 million | $1,176.9 million | Decrease of $25.0 million |
The 2012 fourth quarter included a $96.0 million goodwill impairment charge. Fourth-quarter net sales were $1,180.5 million and net earnings attributable to Zimmer Holdings were $152.8 million, compared with $1,167.3 million and $156.6 million, respectively, in the fourth quarter of 2011.
- R&D expense was $225.6 million, or 5.0% of sales, compared with 5.4% in 2011.
- SG&A expense was $1,807.1 million, or 40.4% of sales, compared with 41.2% in 2011.
- Reported effective tax rate was 24.0%, compared with 22.4% in 2011. A $34.3 million tax benefit from restructuring certain international operations favorably affected 2012.
- Non-GAAP adjusted net earnings were $932.5 million and adjusted diluted EPS was $5.30, excluding specified claims, goodwill impairment, special items, inventory charges and related tax effects.
Liquidity, Balance Sheet and Capital Allocation
| Balance sheet metric | December 31, 2012 | December 31, 2011 |
|---|---|---|
| Cash and cash equivalents | $884.3 million | $768.3 million |
| Short-term investments | $671.6 million | $455.5 million |
| Accounts receivable, net | $884.6 million | $838.8 million |
| Inventories | $995.3 million | $929.8 million |
| Total assets | $9,012.4 million | $8,515.3 million |
| Short-term debt | $100.1 million | $143.3 million |
| Long-term debt | $1,720.8 million | $1,576.0 million |
| Stockholders’ equity | $5,866.3 million | $5,514.8 million |
- Cash flows used in investing activities were $592.1 million, including $148.9 million of instrument additions and $114.7 million of property, plant and equipment additions.
- Cash flows used in financing activities were $436.5 million. Zimmer paid $94.4 million in dividends and repurchased $485.6 million of common stock, or 7.7 million shares at an average price of $63.39 per share.
- The company had $1,250.0 million available under its $1,350.0 million revolving credit facility and was compliant with its covenants at year-end.
- Total contractual obligations were $3,233.7 million, including $1,688.6 million of long-term debt principal and $1,045.4 million of interest payments.
Material Changes Versus the Prior Comparable Period
- Reported sales were essentially flat. Volume and mix contributed 4 percentage points of growth, offset by approximately 2 percentage points of pricing pressure and 2 percentage points of foreign-exchange headwinds.
- Americas sales increased 1%, while Europe declined 3% and Asia Pacific increased 3%. Management characterized Europe and Asia Pacific as above-market performers and identified underperformance in portions of the Americas.
- By product category, trauma increased 8% and surgical and other increased 11%; reconstructive sales were flat, dental declined 4%, and spine declined 7%.
- Operating margin improved despite $155.4 million of special items and a $96.0 million U.S. Spine goodwill impairment charge. SG&A and R&D ratios improved as operational-excellence initiatives began generating savings.
- Inventory days increased to 301 from 277, primarily because of inventory accumulated for new product launches. Operating cash flow declined as inventory investment and Durom Cup liability payments increased.
- Net earnings declined 1%, but diluted EPS increased 6% because of substantial share repurchases.
Guidance, Outlook, Risks and Unusual Items
- Management projected 2013 sales growth of 2% to 4%, assuming stable to low-single-digit growth in knee and hip procedures.
- Expected 2013 pricing headwind was approximately 2%, with a further 0.5% foreign-exchange headwind based on December 31, 2012 rates.
- Expected 2013 gross margin was 74.5% to 75.5%, and SG&A was expected to be 39.5% to 40.0% of sales. R&D spending was expected to remain approximately 5% of sales.
- Management expected $120 million to $130 million of 2013 operational-excellence expenses and $5 million to $15 million of acquisition and integration costs, largely reported as special items.
- The 2.3% U.S. medical-device excise tax was expected to cost approximately $10 million to $15 million per quarter once reflected in cost of products sold. Management expected cost savings to offset the tax partially or substantially, but not through pricing or volume alone.
- Durom Cup-related claims totaled $403.2 million of cumulative provisions, with an estimated remaining liability of $260.8 million at year-end, partially offset by a $98.0 million insurance receivable. The company expected most payments over the next five years.
- Other material contingencies included pending NexGen knee product-liability litigation, a possible liability of up to approximately $20 million related to the Polett verdict, and a February 2013 jury verdict awarding Stryker $70.0 million in patent damages; Zimmer had not accrued the Stryker loss.
- The FDA issued a September 2012 warning letter concerning manufacturing and validation processes for Trilogy acetabular products produced in Puerto Rico. Potential consequences included additional regulatory action, product seizures, injunctions, penalties and limitations on certain approvals or export certifications.
- Key ongoing risks include reimbursement and healthcare-cost pressures, regulatory compliance, product liability, patent disputes, foreign-exchange movements, European receivable collectability, tax audits, competition, supply-chain concentration and possible further impairment of U.S. Spine goodwill or other intangible assets.
Important Facts for Investors to Verify
- Reconcile GAAP net earnings of $755.0 million with adjusted net earnings of $932.5 million and assess whether excluded items are truly nonrecurring.
- Evaluate the sustainability of sales growth and margins after pricing pressure, foreign-exchange effects, the medical-device excise tax and operational-excellence spending.
- Monitor U.S. Spine performance and the risk of additional goodwill or intangible-asset impairments.
- Review the ultimate cash cost and insurance recovery for Durom Cup claims, including the $260.8 million remaining gross liability.
- Track the Stryker patent litigation, NexGen litigation, Polett appeal and other royalty or intellectual-property disputes.
- Assess FDA remediation progress at the Puerto Rico facility and any effect on product availability, approvals or export certifications.
- Review European government-hospital receivables, particularly the $201.4 million net exposure in Greece, Italy, Portugal and Spain.
- Confirm debt maturities, credit-facility availability, covenant compliance and the company’s capacity to fund dividends, repurchases and planned capital expenditures.