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| ZMH > SEC Filings for ZMH > Form 10-Q on 4-Nov-2009 | All Recent SEC Filings |
4-Nov-2009
Quarterly Report
Overview
We are a global leader in the design, development, manufacture and marketing of orthopaedic reconstructive implants, dental implants, spinal implants, trauma products and related surgical products (sometimes referred to in this report as "OSP"). We also provide other healthcare related services. Reconstructive orthopaedic implants restore joint function lost due to disease or trauma in joints such as knees, hips, shoulders and elbows. Dental implants restore function and aesthetics in patients who have lost teeth due to trauma or disease. Spinal implants are utilized by orthopaedic surgeons and neurosurgeons in the treatment of degenerative diseases, deformities and trauma in all regions of the spine. Trauma products are devices used primarily to reattach or stabilize damaged bone and tissue to support the body's natural healing process. OSP includes supplies and instruments designed to aid in predominantly orthopaedic surgical procedures and post-operation rehabilitation. We have operations in more than 25 countries and market products in more than 100 countries. We manage operations through three reportable geographic segments - the Americas, Europe and Asia Pacific.
Certain percentages presented in Management's Discussion and Analysis are calculated from the underlying whole-dollar amounts and therefore may not recalculate from the rounded numbers used for disclosure purposes. In addition, certain amounts in the 2008 consolidated financial statements have been reclassified to conform to the 2009 presentation. Beginning in 2009, we no longer include our Dental product category sales within our Reconstructive products category. Prior year amounts related to Dental product category sales have been reclassified to conform to the current year presentation.
We believe the following developments or trends are important in understanding our financial condition, results of operations and cash flows for the three and nine month periods ended September 30, 2009 and our expected results for the remainder of 2009.
Demand (Volume and Mix) Trends
Volume and mix of products increased 4 percent during the three month period ended September 30, 2009, compared to a 3 percent increase in the same 2008 period. The sales growth rate increase demonstrates the broad acceptance of patient specific solutions.
We believe the market for orthopaedic procedure volume temporarily decelerated from mid single digit growth rates to low single digit growth rates on a global basis due to the weakened global economy. We believe long-term market growth rates will be driven by an aging global population, obesity, proven clinical benefits, new material technologies, advances in surgical techniques and more active lifestyles, among other factors. In addition, the ongoing shift in demand to premium products, such as Longevity® and Prolong® Highly Crosslinked Polyethylenes, Trabecular MetalTM Technology products, hip stems with Kinectiv Technology, high-flex knees, knee revision products, porous hip stems and the introduction of patient specific devices continues to positively affect sales growth.
Pricing Trends
Global selling prices decreased 1 percent during the three month period ended September 30, 2009 compared to flat pricing in the same 2008 period. Selling prices in both the Americas and Europe decreased 1 percent during the three month period ended September 30, 2009, compared to flat pricing in the same 2008 period. Asia Pacific selling prices were flat for the three month period ended September 30, 2009, compared to a 4 percent decrease in the same 2008 period, as we anniversaried out of scheduled reductions in reimbursement prices in Japan. With the effect of governmental healthcare cost containment efforts and continuing pressure from local hospitals and health systems, we expect selling prices will be down approximately 1 percent on a global basis for 2009.
Foreign Currency Exchange Rates
For the three month period ended September 30, 2009, foreign currency exchange rates resulted in a 1 percent decline in sales. We estimate that an overall stronger U.S. Dollar versus foreign currency exchange rates will have a negative effect of approximately 2 percent on sales for the year ending December 31, 2009. We address currency
risk through regular operating and financing activities, and under appropriate circumstances and subject to proper authorization, through the use of forward contracts and foreign currency options solely for managing foreign currency volatility and risk. Changes to foreign currency exchange rates affect sales growth, but due to offsetting gains/losses on hedge contracts, which are recorded in cost of products sold, the effect on net earnings in the near term is expected to be minimal.
Disruptive Events
We believe that we suffered customer losses as a result of disruptive factors experienced during 2008, including the implementation of our enhanced global compliance initiatives, our temporary suspension of U.S. marketing and distribution of the Durom Cup and our voluntary recall and suspension of production of certain OSP patient care products. We estimated that these customer losses reduced our global knee market share by approximately 1.5 percent and hip market share by approximately 2.0 percent on a cumulative basis through the end of 2008. We believe these share losses have stabilized during 2009 and expect this stabilization to continue as we anniversary out of the majority of the 2008 customer and product-related losses and as we launch new products in sufficient quantities to recover some of the product-related losses. However, we expect our sales growth may continue to be at a rate slower than the market in the near term due to these disruptive factors.
Global Economic Conditions
We believe conditions in the broader economy have resulted in a temporary slowdown in elective hospital procedures. Although many of our products are used in elective procedures, we believe our core knee and hip franchises remain more insulated than many medical product categories from swings in the broader economy because the need for these procedures does not diminish, even if the timing is affected. In particular, our dental revenues have experienced pressure due to the weak economic environment as many of those procedures are not reimbursed by third-party payors.
Third Quarter and Year-to-Date Results of Operations
Net Sales by Operating Segment
The following table presents net sales by operating segment and the components
of the percentage changes (dollars in millions):
Three Months
Ended
September 30, Volume/ Foreign
2009 2008 % Inc (Dec) Mix Price Exchange
Americas $ 584.5 $ 563.3 4 % 5 % (1 )% - %
Europe 242.4 251.0 (3 ) 4 (1 ) (6 )
Asia Pacific 148.7 137.9 8 4 - 4
Total $ 975.6 $ 952.2 2 4 (1 ) (1 )
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Nine Months
Ended
September 30, Volume/ Foreign
2009 2008 % (Dec) Mix Price Exchange
Americas $ 1,768.7 $ 1,764.9 - % 2 % (1 )% (1 )%
Europe 787.9 882.3 (11 ) 1 - (12 )
Asia Pacific 431.5 443.7 (3 ) (1 ) (1 ) (1 )
Total $ 2,988.1 $ 3,090.9 (3 ) 1 (1 ) (3 )
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"Foreign Exchange" as used in the tables in this report represents the effect of changes in foreign exchange rates on sales growth.
Net Sales by Product Category
The following table presents net sales by product category and the components of
the percentage changes (dollars in millions):
Three Months
Ended
September 30, Volume/ Foreign
2009 2008 % Inc (Dec) Mix Price Exchange
Reconstructive
Knees $ 417.4 $ 411.2 2 % 4 % (1 )% (1 )%
Hips 288.2 292.3 (1 ) 1 (1 ) (1 )
Extremities 32.6 27.5 19 21 (1 ) (1 )
Total 738.2 731.0 1 3 (1 ) (1 )
Dental 48.0 51.8 (8 ) (6 ) - (2 )
Trauma 57.6 54.6 6 4 2 -
Spine 61.7 49.7 24 27 (1 ) (2 )
OSP and other 70.1 65.1 8 6 1 1
Total $ 975.6 $ 952.2 2 4 (1 ) (1 )
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Nine Months
Ended
September 30, Volume/ Foreign
2009 2008 % Inc (Dec) Mix Price Exchange
Reconstructive
Knees $ 1,284.6 $ 1,332.0 (4 ) 1 % (1 )% (4 )%
Hips 895.9 965.2 (7 ) (2 ) (1 ) (4 )
Extremities 99.3 90.4 10 14 (1 ) (3 )
Total 2,279.8 2,387.6 (5 ) - (1 ) (4 )
Dental 148.1 170.9 (13 ) (10 ) - (3 )
Trauma 171.2 165.2 4 5 1 (2 )
Spine 190.5 158.0 21 24 - (3 )
OSP and other 198.5 209.2 (5 ) (5 ) 1 (1 )
Total $ 2,988.1 $ 3,090.9 (3 ) 1 (1 ) (3 )
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The following table presents net sales by product category by region (dollars in millions):
Three Months Nine Months
Ended Ended
September 30, September 30,
2009 2008 % Inc (Dec) 2009 2008 % Inc (Dec)
Reconstructive
Knees
Americas $ 270.5 $ 264.0 2 % $ 818.3 $ 824.0 (1 )%
Europe 89.6 94.5 (5 ) 302.6 339.7 (11 )
Asia Pacific 57.3 52.7 9 163.7 168.3 (3 )
Hips
Americas 138.1 137.8 - 423.0 435.5 (3 )
Europe 99.4 106.8 (7 ) 318.8 372.7 (14 )
Asia Pacific 50.7 47.7 6 154.1 157.0 (2 )
Extremities
Americas 25.3 20.3 25 76.7 65.3 17
Europe 5.3 5.7 (5 ) 17.0 19.8 (14 )
Asia Pacific 2.0 1.5 33 5.6 5.3 6
Total 738.2 731.0 1 2,279.8 2,387.6 (5 )
Dental
Americas 25.4 28.3 (10 ) 77.5 87.5 (11 )
Europe 16.2 15.3 6 53.3 58.7 (9 )
Asia Pacific 6.4 8.2 (23 ) 17.3 24.7 (30 )
Trauma
Americas 31.2 31.1 - 94.8 95.4 (1 )
Europe 13.2 12.3 7 36.5 35.5 3
Asia Pacific 13.2 11.2 19 39.9 34.3 16
Spine
Americas 48.0 38.9 24 148.0 123.5 20
Europe 9.8 8.3 18 32.3 27.6 17
Asia Pacific 3.9 2.5 55 10.2 6.9 48
OSP and other
Americas 46.0 42.9 7 130.4 133.7 (2 )
Europe 8.9 8.1 9 27.4 28.3 (3 )
Asia Pacific 15.2 14.1 7 40.7 47.2 (14 )
Total $ 975.6 $ 952.2 2 $ 2,988.1 $ 3,090.9 (3 )
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Knees
The NexGen® Complete Knee Solution product line, including Gender Solutions Knee Femoral Implants, the NexGen LPS-Flex Knee, the NexGen CR-Flex Knee and the NexGen LCCK Revision Knee, led knee sales. In addition, the Gender Solutions Natural-Knee Flex System made a strong contribution. In Europe, changes in foreign exchange rates negatively affected knee sales in the three and nine month periods ending September 30, 2009 by 6 percent and 12 percent, respectively. In Asia Pacific, changes in foreign exchange rates positively affected knee sales in the three month period ending September 30, 2009 by 2 percent and negatively affected knee sales by 4 percent on a year-to-date basis.
Hips
The continued conversion to porous stems, including the Zimmer® M/L Taper Stem, the Zimmer M/L Taper Stem with Kinectiv Technology, the CLS® Spotorno® Stem from the CLS Hip System, and the Alloclassic® Zweymüller® Hip Stem, led hip stem sales, but was partially offset by weaker sales of cemented stems. Trabecular Metal Acetabular Cups and Longevity and Durasul Highly Crosslinked Polyethylene Liners also made strong contributions. With the lack of a hip resurfacing product within our U.S. hip portfolio, we face a continuing challenge in hip sales growth with the adoption of hip resurfacing in the U.S. market. In Europe, changes in foreign exchange rates negatively affected hip sales in the three and nine month periods ending September 30, 2009 by 6 percent and 10 percent, respectively. In Asia Pacific, changes in foreign exchange rates positively affected hip sales in the three and nine month periods ending September 30, 2009 by 5 percent and 1 percent, respectively.
Extremities
The Bigliani/Flatow® Complete Shoulder Solution and the Zimmer Trabecular Metal Reverse Shoulder System led extremities sales.
Dental
Negative sales growth for our dental business reflects overall weakness in the global economy. While dental sales in the Americas and Asia Pacific reflect this weakness, dental sales in Europe in the three month period increased 6 percent, led by the Tapered Screw-Vent® Implant System.
Trauma
Zimmer Periarticular Locking Plates and the I.T.S.T.TM Intertrochanteric/Subtrochanteric Fixation System led trauma sales but were partially offset by declining sales of compression hip screws. Femoral and tibial nails within the new Zimmer Natural NailTM system also made a contribution during the three month period.
Spine
In the fourth quarter of 2008, we acquired Abbott Spine. As a result of the acquisition, spine sales have increased but the increase is offset in part by sales dis-synergies associated with the integration of the business. Solid sales of acquired fusion devices as well as legacy vertebral body replacement devices and bone graft substitutes partly offset a decline in sales of the Dynesys® Dynamic Stabilization System in the three month period.
OSP and other
OSP sales were led by PALACOS®1 Bone Cement. OSP products had positive sales growth of 8 percent for the three month period ended September 30, 2009 and a negative growth rate of 5 percent on a year-to-date basis. This improvement in the third quarter 2009 was driven by the effect of anniversarying out of the voluntary suspension and recall of certain products during 2008 and by the reintroduction of wound debridement products in 2009.
1 Trademark of Heraeus Kulzer GmbH
Expenses as a Percent of Net Sales
Three Months Ended Nine Months Ended
September 30, September 30,
2009 2008 Inc (Dec) 2009 2008 Inc (Dec)
Cost of products sold 25.6 % 24.9 % 0.7 24.0 % 24.4 % (0.4 )
Research and development 5.3 5.0 0.3 5.1 4.7 0.4
Selling, general and administrative 42.3 42.4 (0.1 ) 42.5 41.1 1.4
Certain claims 3.6 5.0 (1.4 ) 1.2 1.5 (0.3 )
Acquisition, integration, realignment and other 2.3 0.6 1.7 2.2 0.8 1.4
Net curtailment and settlement - - - (1.1 ) - 1.1
Operating expenses 53.5 53.0 0.5 49.9 48.1 1.8
Operating profit 20.9 22.1 (1.2 ) 26.1 27.5 (1.4 )
Interest and other income (expense),net (0.4 ) 3.0 3.4 (0.4 ) 1.2 1.6
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Cost of Products Sold
The increase in cost of products sold as a percent of net sales for the three month 2009 period compared to the same 2008 period was driven by higher manufacturing costs per unit due to lower production levels during 2009. These costs were partially offset by foreign currency hedge gains recognized in the 2009 period compared to hedge losses recognized in the 2008 period. On a year-to-date basis, the improvement in gross margin is due to foreign currency hedge gains recognized in the 2009 period compared to hedge losses recognized in the 2008 period. These hedge gains were partially offset by higher manufacturing costs per unit as well as increased inventory step-up as a result of the Abbott Spine acquisition.
Under our hedging program, for derivatives which qualify as hedges of future cash flows, the effective portion of changes in fair value is temporarily recorded in other comprehensive income, and then recognized in cost of products sold when the hedged item affects earnings.
Operating Expenses
Research and development expense, or R&D, increased to $52.1 million and $153.8 million for the three and nine month periods ended September 30, 2009, respectively, from $47.9 million and $144.0 million in the same 2008 periods, respectively. This increase reflects additional spending on certain development, clinical and external research activities compared to the delay in activities experienced in 2008 as we implemented our enhanced compliance program. We expect R&D spending in 2009 to be over 5 percent of sales for the full year.
Selling, general and administrative expense, or SG&A, increased to $413.0 million from $403.7 million for the three month period ended September 30, 2009 compared to the same 2008 period. This is a slight improvement in SG&A margin by ten basis points. SG&A expense in the 2008 period included approximately $20 million of non-recurring costs, such as monitor fees and consulting and legal fees associated with the global roll-out of our enhanced compliance program. In this challenging economic environment, we are carefully managing our SG&A spend, reducing expenses in certain areas in order to fund growth and productivity initiatives. Areas of investment include marketing and promotion and medical education and training. Additionally, the acquisition of Abbott Spine increased SG&A costs for items such as selling expenses, increased instrument depreciation and amortization of the acquired intangible assets.
On a year-to-date basis, SG&A expense decreased modestly from the same 2008 period, but SG&A margin has increased by 140 basis points. SG&A expense in the 2008 period included approximately $50 million of non-recurring costs such as monitor fees and consulting and legal fees associated with the global roll-out of our enhanced compliance program. The savings from these non-recurring costs have been partially offset by increased spending in 2009 to fund initiatives and Abbott Spine costs, as discussed above. Additionally, SG&A margin is negatively impacted by the decrease in revenues caused by changes in foreign currency rates. A majority of our SG&A spend is incurred in the U.S., primarily from our corporate headquarters and similar functions at our various
businesses such as Dental, Trauma, Spine and OSP. Therefore, SG&A expense does not respond to changes in foreign currency rates proportionally to our revenue, which has caused SG&A margin to increase.
Certain claims expense is a provision for estimated Durom Cup patients undergoing revision surgeries within specified times. A provision of $69.0 million was originally recorded during 2008 with an additional $35.0 million recorded during the three month period ended September 30, 2009, bringing the total provision to $104.0 million for these claims. For more information regarding certain claims, see Note 14 to the consolidated financial statements.
Acquisition, integration, realignment and other expenses for the three and nine month periods ended September 30, 2009 were $22.2 million and $65.7 million, respectively, compared to $5.6 million and $25.4 million in the same 2008 periods. The increase in the three month 2009 period compared to the same 2008 period relates primarily to approximately $9.3 million of certain litigation matters recognized during the 2009 period as well as costs incurred related to acquired distributors. During the nine month 2009 period, we initiated a workforce realignment, which included the elimination of positions in some areas and planned increases in others, to balance the requirements necessary to support long-term growth. As a result of this realignment and severance costs from acquisitions, we incurred approximately $18.4 million of severance and termination-related expenses. Other items contributing to the increase on a year-to-date basis include $8.6 million of expenses related to contract termination costs, $14.1 million of certain litigation matters that were recognized during the period and various costs incurred to integrate the Abbott Spine business acquired in the fourth quarter of 2008.
We recognized a net curtailment and settlement gain of $32.1 million during the nine month period ended September 30, 2009 related to amending our U.S. and Puerto Rico postretirement benefit plans. For more information regarding the net curtailment and settlement gain, see Note 11 to the consolidated financial statements.
Operating Profit, Interest and Other Expense, Income Taxes and Net Earnings
Operating profit for the three and nine month periods ended September 30, 2009 was $204.0 million and $780.3 million, respectively, from $210.3 million and $850.3 million in the same 2008 periods. The decrease in operating profit is due to higher operating expenses as a percent of sales and lower reported revenues on a year-to-date basis.
Interest and other expense, net for the three and nine month periods ended September 30, 2009, increased to $4.2 million and $11.9 million, respectively, compared to income of $28.2 million and $36.0 million in the same 2008 periods. Interest and other income in the 2008 periods reflects realized gains of $30.1 million for the three month period and $38.8 million for the nine month period, related to the sale of certain marketable securities. Excluding the effect of these gains in 2008, interest expense increased in the 2009 periods as the result of increased long-term debt used to partially fund the Abbott Spine acquisition and share repurchases.
The effective tax rate on earnings before income taxes increased to 25.0 percent for the three month period ended September 30, 2009, from 9.8 percent in the same 2008 period. The effective tax rate for the 2008 period reflected a tax benefit of approximately $30.8 million related to a 2007 civil settlement. Additionally, the effective tax rate on earnings for the nine month period ended September 30, 2008 was impacted by this tax benefit. The effective tax rate for the nine month period ended September 30, 2009 increased to 26.8 percent from 23.1 percent in the same 2008 period.
Net earnings decreased 30 percent to $149.9 million for the three month period ended September 30, 2009, compared to $214.7 million in the same 2008 period. Net earnings decreased 17 percent to $562.2 million for the nine month period ended September 30, 2009, compared to $681.1 million in the same 2008 period. For the three month 2009 period, basic earnings per share decreased 27 percent to $0.70 from $0.96. Diluted earnings per share for the three month 2009 period decreased 26 percent to $0.70 from $0.95 in the same 2008 period. For the nine month 2009 period, basic earnings per share decreased 13 percent to $2.60 from $2.98 in the same 2008 period and diluted earnings per share also decreased 13 percent to $2.59 from $2.97 in the same 2008 period. The disproportional change in earnings per share as compared with net earnings is attributed to the effect of 2009 and 2008 share repurchases.
Liquidity and Capital Resources
Cash flows provided by operating activities were $732.0 million for the nine month period ended September 30, 2009, compared to $831.2 million in the same 2008 period. The principal source of cash was net earnings of $562.2 million. Non-cash items included in net earnings accounted for another $285.1 million of . . .
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