Zimmer Biomet Holdings, Inc. — 2016 Form 10-K Summary
Business context and reporting period
Zimmer Biomet is a global musculoskeletal healthcare company that develops and sells orthopedic reconstruction, sports medicine, biologics, extremities and trauma, spine, craniomaxillofacial, dental, office-based and related surgical products. The filing covers the year ended December 31, 2016; fourth-quarter information is unaudited.
2016 was the first full year reflecting Biomet’s results following the June 24, 2015 merger. The Company also completed the LDR merger in July 2016 and acquired Cayenne Medical, Compression Therapy Concepts, CD Diagnostics and MedTech.
Financial performance and liquidity
| Metric | 2016 | 2015 | Change/comment |
|---|---|---|---|
| Net sales | $7,683.9 million | $5,997.8 million | Up 28.1%; pro forma sales up 2.2% |
| Gross profit | $4,738.0 million | $3,859.2 million | Gross margin 61.6% versus 64.4% |
| Operating profit | $825.9 million | $467.3 million | Operating margin 10.7% versus 7.8% |
| Net earnings attributable to Zimmer Biomet | $305.9 million | $147.0 million | Diluted EPS $1.51 versus $0.77 |
| Adjusted net earnings | $1,610.8 million | $1,310.5 million | Adjusted diluted EPS $7.96 versus $6.90 |
| Cash flow from operations | $1,632.2 million | $849.8 million | Improved primarily from a full year of Biomet operations |
| Cash and cash equivalents | $634.1 million | $1,459.3 million | Declined after acquisitions, debt repayments and share repurchases |
| Total debt | Approximately $11.2 billion | Not directly comparable | Current portion $575.6 million; long-term debt $10,665.8 million |
Fourth-quarter 2016 net sales were $2,013.1 million, gross profit was $1,250.1 million and net earnings attributable to Zimmer Biomet were $69.6 million, or $0.34 diluted EPS.
- Sales growth was driven by the full-year inclusion of Biomet and acquisitions. On a pro forma basis, volume and mix contributed 4.9 percentage points of growth, while pricing reduced sales by 1.5 points and foreign exchange reduced sales by 0.3 points.
- 2016 sales by product category were: Knees $2,751.9 million, Hips $1,867.9 million, S.E.T. $1,645.4 million, Dental $427.9 million, Spine and CMF $662.0 million, and Other $328.8 million.
- Gross margin declined due primarily to higher intangible amortization, discontinued-product and excess-inventory charges, lower selling prices and lower foreign-exchange hedge gains. These factors were partly offset by lower Biomet inventory step-up charges and the U.S. medical device excise-tax moratorium.
- Special items were $611.8 million, including $487.3 million of Biomet-related costs and $124.5 million of other special items. Intangible asset amortization was $565.9 million, and inventory and manufacturing-related charges were $469.1 million.
- Investing cash outflows were $1,691.5 million, including $1,021.1 million for LDR and $421.9 million for other business combinations. Financing cash outflows were $743.2 million, including approximately $1.01 billion of net debt repayments and $415.5 million of share repurchases.
- The Company declared dividends of $0.96 per share for 2016 and had $1.0 billion remaining under its share-repurchase authorization at year-end.
- Management stated that operating cash flow and available capacity under the $1.5 billion revolving facility were sufficient for working capital, capital expenditures, debt service and shareholder returns. No borrowings were outstanding under that revolving facility at year-end.
Material changes versus prior comparable period
- Reported sales increased substantially because Biomet contributed for the full year in 2016 versus only part of 2015. Pro forma growth was more modest at 2.2%.
- Net earnings and operating profit improved as Biomet contributed for a full year and significant 2015 merger expenses did not recur at the same level.
- Gross margin fell from 64.4% to 61.6%, reflecting acquisition-related amortization, inventory charges, pricing pressure and lower hedge gains.
- Operating cash flow increased from $849.8 million to $1,632.2 million, while cash declined because of acquisitions, debt repayment, capital spending and repurchases.
- Total indebtedness remained elevated after the Biomet and LDR transactions. The Company issued $1.0 billion of Euro-denominated notes in December 2016 and used the proceeds to refinance portions of existing senior notes.
- Dental sales declined 5.9% on a pro forma basis, partly reflecting a prior voluntary field action related to a packaging issue. Pro forma Knees increased 0.6%, Hips increased 1.4%, S.E.T. increased 4.7%, and Spine and CMF increased 13.5%.
Guidance, outlook, risks and unusual items
- Management forecast 2017 sales growth of 2.2% to 3.2% over 2016, assuming approximately 1.5% foreign-exchange headwind, 2% pricing pressure and 1.2% benefit from a full year of LDR sales.
- 2017 operating cash flow was estimated at $1.75 billion to $1.90 billion. Planned 2017 spending included approximately $330 million for instruments and $170 million for property, plant and equipment.
- Management expected 2017 R&D expense of approximately 4.5% of sales, SG&A expense of approximately 37.5% of sales, lower special-item expense than in 2016, lower interest expense from planned debt repayments and approximately $310 million of integration cash outlays.
- Supply-chain and quality-process issues caused shipment delays in Knee, Hip, Upper Extremities, Sports Medicine and Trauma products during the second half of 2016. Management expected substantial remediation and replenishment of safety stocks during the first half of 2017, but acknowledged possible temporary distribution delays.
- As of December 31, 2016, the Company reported a material weakness in internal control over financial reporting related to income-tax accounting resources and controls. Disclosure controls were also deemed ineffective. Management initiated a remediation plan, but did not provide assurance that remediation would be successful.
- Three FDA warning letters remained pending concerning facilities in Ponce, Puerto Rico; Zhejiang, China; and Montreal, Canada. FDA Form 483 observations also affected certain facilities. Additional regulatory action could restrict manufacturing, marketing or product approvals.
- The Company entered into a three-year Deferred Prosecution Agreement with the Department of Justice in January 2017 concerning legacy Biomet FCPA matters. It paid approximately $30.5 million in settlement and criminal payments and is subject to an independent compliance monitor.
- Recorded liabilities included $293.6 million for Durom Cup claims and $57.4 million for Biomet metal-on-metal hip claims. The Company also disclosed unresolved NexGen, Heraeus, Stryker and securities litigation, with potential losses that may exceed recorded amounts.
- The IRS has proposed adjustments reallocating profits between U.S. and foreign subsidiaries for tax years 2005 through 2009. Management disputed the adjustments and stated that future payments could be significant, although timing and ultimate resolution remain uncertain.
- Goodwill was $10.6 billion and total identifiable intangible assets were $8.8 billion. The EMEA reporting unit had only an 8% estimated fair-value cushion over carrying value, creating sensitivity to weaker cash flows, currency movements or operating performance.
Most important facts for an investor to verify
- Whether supply-chain, quality-system and FDA remediation efforts restore product availability and eliminate shipment delays.
- Whether reported pro forma volume growth can offset continuing pricing pressure and foreign-exchange headwinds.
- The pace of debt repayment, refinancing requirements and compliance with the consolidated indebtedness-to-EBITDA covenant.
- The success of Biomet and LDR integration efforts, including achievement of the targeted $350 million of annual pretax synergies by mid-2018.
- The remediation and independent-audit status of the material weakness in income-tax controls.
- Potential cash exposure from Durom Cup, metal-on-metal hip, Stryker, Heraeus, securities and other litigation.
- The outcome of IRS tax disputes and the effect of repatriating foreign earnings, including the recorded deferred tax liability.
- Goodwill and intangible-asset impairment sensitivity, particularly for the EMEA reporting unit.