Zimmer Holdings, Inc. — Form 10-Q Summary
Business context and reporting period
Zimmer Holdings designs, manufactures and markets orthopaedic reconstructive, dental, spine, trauma and related surgical products. The company operates through the Americas, Europe and Asia Pacific segments, with operations in more than 25 countries and sales in more than 100 countries. This unaudited filing covers the three and six months ended June 30, 2010, compared with the corresponding 2009 periods.
Key financial metrics
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Net sales | $1,057.7 million | $1,019.9 million | $2,120.5 million | $2,012.5 million |
| Gross profit | $807.1 million | $783.1 million | $1,601.5 million | $1,545.5 million |
| Gross margin | 76.3% | 76.8% | 75.5% | 76.8% |
| Operating profit | $228.1 million | $296.5 million | $522.2 million | $576.3 million |
| Operating margin | 21.6% | 29.1% | 24.6% | 28.6% |
| Net earnings | $165.5 million | $210.1 million | $370.9 million | $412.3 million |
| Net margin | 15.6% | 20.6% | 17.5% | 20.5% |
| Diluted EPS | $0.82 | $0.98 | $1.82 | $1.88 |
| Operating cash flow | Not separately provided | Not separately provided | $532.2 million | $379.7 million |
At June 30, 2010, cash and cash equivalents were $953.7 million, short-term investments were $33.0 million and total current assets were $2,982.8 million. Long-term debt was $1,130.6 million, consisting of $998.8 million of senior notes and $131.8 million drawn under the senior credit facility; no short-term debt was outstanding. The $1,350 million revolving credit facility had $1,218.2 million of availability, and additional uncommitted facilities totaled $80.4 million.
Six-month investing cash outflows were $91.9 million, including $26.7 million for property, plant and equipment, $83.1 million for instruments and $8.2 million for intellectual property rights. Financing cash outflows were $169.8 million, including $178.9 million for share repurchases. Cash increased by $262.0 million during the first six months.
Material changes versus the prior comparable period
- Q2 net sales increased 4% and six-month sales increased 5%. Volume and mix contributed 4 percentage points of Q2 growth; pricing reduced growth by 1 percentage point and foreign exchange contributed 1 percentage point.
- Asia Pacific was the strongest region, with Q2 sales up 15% and six-month sales up 18%. Americas sales increased 3% in both periods, while Europe declined 1% in Q2 but increased 3% for the six months.
- Reconstructive implant sales increased 4% in Q2 and 5% for the six months. Dental and OSP and other sales grew, while spine sales declined 10% in Q2 and 8% for the six months.
- Operating profit declined 23% in Q2 and 9% for the six months. The primary driver was a $75.0 million Q2 provision for Durom Cup-related claims. The 2009 comparison also benefited from a $32.1 million net curtailment and settlement gain.
- Cost of products sold increased to 23.7% of sales in Q2 from 23.2% and to 24.5% for the six months from 23.2%, primarily because of higher manufacturing costs per unit and lower foreign-currency hedge gains.
- SG&A improved as a percentage of sales by 100 basis points in Q2 and 80 basis points for the six months. Acquisition, integration, realignment and other expenses fell to $11.5 million in Q2 and $14.1 million for the six months.
- Net earnings decreased 21% in Q2 and 10% for the six months. Share repurchases reduced diluted weighted-average shares to 203.0 million in Q2 and 203.6 million for the six months, versus 215.5 million and 218.8 million, respectively, in 2009.
- Operating cash flow increased by $152.5 million year over year, reflecting lower working-capital cash uses, improved inventory management and the absence of certain substantial 2009 payments to healthcare professionals and institutions.
Guidance, outlook, risks and unusual items
- Management expects global selling prices to decline approximately 1% to 2% in 2010, mainly because of healthcare cost-containment efforts and pricing pressure from hospitals and health systems.
- Management estimates that a stronger U.S. dollar will reduce 2010 sales by approximately 0% to 1%. Foreign-currency hedging is expected to make the near-term earnings impact minimal.
- Full-year 2010 research and development spending is expected to be 5% to 6% of sales. Capital spending on equipment and instruments is expected to increase during the remainder of 2010.
- The Durom Cup claims provision totaled $179.0 million after the additional $75.0 million Q2 charge. Remaining estimated liability at June 30, 2010 was $156.8 million, including $42.5 million current and $114.3 million long term; most payments are expected within three years. Actual claims may differ materially from estimates.
- The U.S. Spine reporting unit had no Q2 goodwill impairment charge, but its estimated fair value was only modestly above carrying value at the prior test. Lower revenues, cash flows or operating margins could result in future impairment charges.
- The company remains subject to product liability and intellectual property litigation, SEC and DOJ Foreign Corrupt Practices Act investigations, tax audits and other regulatory matters. It also remains subject through 2012 to a Corporate Integrity Agreement; a material breach could affect participation in federal healthcare programs.
- In July 2010, the board authorized an additional $1.5 billion share repurchase program through December 31, 2013. The company also agreed to acquire Beijing Montagne Medical Device Co., subject to approvals and other conditions, with closing expected in late 2010 or early 2011.
- Management states that operating cash flows and available credit are sufficient for working capital, capital expenditures and debt service needs.
Most important facts for investors to verify
- Whether Durom Cup claim volumes and settlement payments remain consistent with the $156.8 million estimated remaining liability.
- The sustainability of volume-driven sales growth amid expected 1% to 2% pricing declines and foreign-exchange pressure.
- Progress and profitability of the U.S. Spine business, including the risk of future goodwill impairment.
- Whether operating margins recover after the Durom Cup provision and higher manufacturing costs.
- Cash deployment under the new $1.5 billion repurchase authorization and its effect on leverage and liquidity.
- Developments in the FCPA investigation, Corporate Integrity Agreement, product liability matters and other pending litigation.