Zimmer Biomet Holdings, Inc. — Q2 2020 Form 10-Q Summary
Business context and reporting period
Zimmer Biomet designs, manufactures and markets orthopedic reconstructive products, sports medicine, biologics, extremities and trauma products, spine, craniomaxillofacial and thoracic products, office-based technologies, dental implants and related surgical products. This unaudited Form 10-Q covers the three and six months ended June 30, 2020, compared with the corresponding 2019 periods.
Results were materially affected by the COVID-19 pandemic, which caused hospitals and patients to defer elective surgical and dental procedures. The company reorganized its operating segments into Americas and Global Businesses, EMEA and Asia Pacific beginning in 2020.
Key financial metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net sales | $1,226.1 million | $1,988.6 million | $3,009.9 million | $3,964.1 million |
| Operating profit (loss) | $(171.7) million | $204.7 million | $(627.7) million | $554.9 million |
| Net earnings (loss) attributable to Zimmer Biomet | $(206.6) million | $133.7 million | $(715.1) million | $379.8 million |
| Diluted EPS | $(1.00) | $0.65 | $(3.46) | $1.84 |
| Operating margin | (14.0)% | 10.3% | (20.9)% | 14.0% |
| Operating cash flow | $(52.8) million | Not separately provided | $398.1 million | $584.6 million |
- Q2 sales declined 38.3%; six-month sales declined 24.1%. Volume and mix reduced sales by 36.2% and 21.4%, respectively, while pricing reduced sales by 1.8% and 2.1%.
- All major product categories declined in Q2. Knees fell 46.8%, hips 31.1%, S.E.T. 29.2%, Dental, Spine and CMFT 37.6%, and Other 44.5%.
- Six-month operating cash flow declined $186.5 million year over year, primarily because lower sales reduced cash inflows while fixed costs continued.
- Cash and cash equivalents were $713.4 million at June 30, 2020, compared with $617.9 million at December 31, 2019.
- Total debt was approximately $8.2 billion, comprising $450.0 million of current debt and $7,759.3 million of long-term debt. There were no borrowings under either revolving facility at June 30, 2020.
- Current assets were $4,706.8 million versus current liabilities of $2,161.2 million. Inventories increased to $2,496.5 million from $2,385.0 million at year-end 2019.
Material changes versus the prior comparable period
- COVID-19 drove substantial procedure deferrals and reduced sales across every geography. Q2 sales decreased 39.6% in the Americas, 50.1% in EMEA and 18.6% in Asia Pacific.
- The company recorded $645.0 million of goodwill and intangible asset impairment charges in the first six months, including $470.0 million for EMEA and $142.0 million for Dental, primarily reflecting COVID-19-related lower forecast cash flows and higher discount rates. Q2 included $33.0 million of in-process research and development impairments.
- Production was temporarily suspended or limited at certain facilities, resulting in $67.6 million of immediately expensed fixed overhead and hourly labor costs.
- Restructuring and other cost-reduction charges increased to $28.0 million in Q2 and $73.0 million year to date, compared with $6.9 million and $11.6 million, respectively, in 2019.
- Six-month litigation expense was $81.1 million, compared with a $23.5 million litigation settlement gain in 2019.
- The company issued $1.5 billion of senior notes in March 2020 and used the proceeds, together with cash, to repay $1.5 billion of notes due April 1, 2020.
- Cost of products sold increased to 34.6% of sales in Q2 from 29.2%, and SG&A increased to 54.2% from 42.2%, reflecting operating deleverage and pandemic-related impacts.
Guidance, outlook, commentary and risks
- Management reported sequential improvement in elective procedures from April through May and June and expects further improvement in the third and fourth quarters, although potentially at a slower pace. No quantitative full-year revenue or earnings guidance was provided.
- Management expects foreign exchange rates, if sustained at recent levels, to reduce full-year 2020 sales by less than 1%.
- The 2019 Restructuring Plan is expected to generate total pre-tax charges of approximately $350 million to $400 million, with approximately $145 million expected by the end of 2020, and gross annual pre-tax operating expense reductions of approximately $200 million to $300 million by the end of 2023.
- Management believes operating cash flow, cash on hand and available revolving capacity will satisfy ongoing liquidity needs for at least the next twelve months, but warns that a slower or prolonged COVID-19 recovery could change funding needs.
- The company had $1.0 billion available under a revolving facility maturing December 31, 2020 and $1.5 billion available under a multicurrency facility maturing November 1, 2024. The company was in compliance with applicable debt covenants at June 30, 2020.
- The IRS issued a draft notice of proposed adjustments for 2013–2015 involving transfer pricing and profit allocation. The proposed adjustment could result in approximately $600 million of additional 2013 tax expense, before interest and penalties. The company disputes the position and recorded no additional reserve.
- Material contingencies include FDA warning letters and remediation at the Warsaw North Campus and Ponce facilities, Heraeus trade-secret and bone-cement litigation, product liability claims, shareholder litigation, and other regulatory matters.
- Remaining estimated liabilities included $55.4 million for Durom Cup claims, $66.8 million for Metal Reaction claims and $69.5 million for Biomet metal-on-metal hip implant claims. Actual losses may differ materially from estimates.
- The FDA matters could lead to operating restrictions, product seizures, penalties, injunctions or other actions. The ITC was reviewing an Initial Determination favorable to Zimmer Biomet regarding Heraeus bone-cement allegations, with a final determination expected in September 2020.
- The company expects its independent compliance monitorship under the FCPA-related Deferred Prosecution Agreement to conclude no later than August 7, 2020, subject to continued compliance.
Most important facts for investors to verify
- Whether elective procedure volumes continue recovering and whether a resurgence of COVID-19 causes renewed deferrals.
- Liquidity, operating cash flow and refinancing capacity as the $450.0 million floating-rate notes mature in March 2021 and the $1.0 billion revolving facility matures in December 2020.
- Compliance with leverage covenants and the company’s ability to maintain access to its revolving facilities.
- Potential additional goodwill or intangible impairments, particularly for EMEA, Dental and Americas CMFT, whose estimated fair values remain sensitive to forecasts and discount rates.
- The final outcome and financial exposure from the IRS transfer-pricing matter, including the draft approximately $600 million tax adjustment.
- Developments in FDA remediation, the Heraeus ITC and litigation proceedings, product liability claims and related reserves.
- Whether restructuring charges and expected annual cost savings are achieved, and whether quarterly dividends remain sustainable given reduced cash flow.