Zimmer Biomet Holdings, Inc. — Q2 2019 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 filing covers the three and six months ended June 30, 2019, compared with the corresponding 2018 periods.
Financial results and key metrics
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $1,988.6 million | $2,007.6 million | $3,964.1 million | $4,025.2 million |
| Operating profit | $204.7 million | $296.0 million | $554.9 million | $601.0 million |
| Operating margin | 10.3% | 14.7% | 14.0% | 14.9% |
| Net earnings attributable to Zimmer Biomet | $133.7 million | $185.0 million | $379.8 million | $359.7 million |
| Diluted EPS | $0.65 | $0.90 | $1.84 | $1.76 |
| Adjusted diluted EPS | $1.93 | $1.92 | $3.80 | $3.83 |
| Operating cash flow | Not separately provided | Not separately provided | $584.6 million | $883.8 million |
Q2 sales declined 0.9%, reflecting volume/mix growth of 3.9%, pricing pressure of 2.7% and unfavorable currency effects of 2.1%. Six-month sales declined 1.5%, with volume/mix growth of 3.6%, pricing pressure of 2.6% and unfavorable currency effects of 2.5%.
- Q2 product-category sales were $703.5 million for Knees, $479.4 million for Hips, $444.4 million for S.E.T., $185.9 million for Spine & CMF, $106.5 million for Dental and $68.9 million for Other.
- Q2 regional sales were $1,214.3 million in the Americas, $438.0 million in EMEA and $336.3 million in Asia Pacific.
- Cash and cash equivalents were $403.1 million at June 30, 2019, compared with $542.8 million at December 31, 2018.
- Inventories increased to $2,344.5 million from $2,256.5 million at year-end 2018.
- Total debt was approximately $8.7 billion, including $2.0 billion classified as current and $6.7 billion classified as long-term.
- Interest expense declined to $59.7 million in Q2 from $75.3 million in the prior-year quarter and to $117.7 million for six months from $153.3 million.
- The effective tax rate was 6.0% in Q2 and 12.5% for six months, compared with 15.1% and 18.2%, respectively, in 2018. The reductions primarily reflected favorable audit resolutions and releases of uncertain tax positions.
- The company declared quarterly dividends of $0.24 per share in February and May 2019.
Material changes versus the prior comparable period
- Q2 operating profit fell by $91.3 million, primarily because of a $70.1 million impairment of in-process research and development assets, a $20.8 million raw-material supply agreement termination charge, higher SG&A and litigation-related costs, and other charges.
- Quality remediation expense declined to $22.7 million in Q2 from $37.5 million; acquisition, integration and related expense declined to $10.5 million from $50.5 million.
- Six-month net earnings increased despite lower sales and operating profit, principally because of lower remediation, acquisition and interest costs, favorable tax items and a $23.5 million first-quarter litigation settlement gain.
- Operating cash flow declined $299.2 million year over year, driven partly by approximately $168 million of patent litigation payments and other product-liability payments, as well as lower incremental benefits from receivables factoring.
- Investing cash outflows increased to $427.7 million from $195.3 million, including $197.6 million for intellectual-property licensing arrangements and higher instrument and capital expenditures.
- The company adopted the lease standard in January 2019, recognizing a $274.7 million right-of-use asset and approximately $283.4 million of lease liabilities at adoption.
Guidance, outlook, commentary and unusual items
- Management expects 2019 sales to be flat to up 0.5% versus 2018, including an estimated 1.25% to 1.75% negative currency effect.
- Management expects stronger commercial momentum in the second half of 2019 from recent Knee product launches, including Persona, Oxford Partial Knee and ROSA Knee System products.
- Management expects 2019 net earnings to increase significantly from the 2018 net loss, assuming no similarly significant goodwill, intangible-asset or litigation charges recur.
- Management expects acquisition and integration costs and quality-remediation expenses to decline, while continuing investments in research and development, salesforce specialization and product launches.
- A $192.5 million licensing buyout replaced variable royalties otherwise payable through 2029; the payment was capitalized and will be amortized through 2029.
- The company recorded a $70.1 million impairment after terminating certain IPR&D projects. Management stated that the projects were not priorities and their termination was not expected to have a significant effect on future cash flows.
- Debt maturities include $500.0 million of notes due November 2019 and $1.5 billion of notes due April 2020. The company had no borrowings under its $1.5 billion revolving facility and stated that it expects to meet obligations through operating cash flow, refinancing or available revolver capacity.
- Material contingencies include FDA warning letters and Form 483 observations, the Heraeus trade-secret litigation and ITC investigation, the OIG subpoena, product-liability claims, tax disputes and compliance obligations under the FCPA Deferred Prosecution Agreement.
Most important facts for investors to verify
- Whether the targeted 2019 sales range and anticipated second-half Knee momentum materialize amid continuing pricing pressure and currency headwinds.
- The company’s ability to refinance or repay the $2.0 billion of notes maturing by April 2020 while maintaining investment, dividends and liquidity.
- Progress and costs associated with FDA remediation, quality-system compliance and EU Medical Device Regulation requirements.
- Potential financial and operational effects of Heraeus proceedings, including the ITC investigation and European litigation.
- Whether further goodwill or intangible impairments arise, particularly for the EMEA reporting unit and the Dental reporting unit, whose valuation headroom was limited.
- The ultimate exposure from product-liability claims, tax examinations and the OIG investigation, for which outcomes remain uncertain.
- The sustainability of reported earnings given substantial adjustments for amortization, impairment, litigation, remediation, restructuring, integration and other unusual items.