Zimmer Biomet Holdings, Inc. — 2018 Form 10-K Summary
Business context and reporting period
Zimmer Biomet is a global musculoskeletal healthcare company serving orthopedic, spine, craniomaxillofacial, thoracic, dental, sports medicine, biologics, trauma and related surgical markets. The filing covers the year ended December 31, 2018, with quarterly information for the fourth quarter of 2018. Approximately 40% of 2018 net sales were generated outside the United States, and approximately 80% of sales were made through consignment arrangements.
Financial performance and liquidity
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Net sales | $7,932.9 million | $7,803.3 million | 1.7% increase |
| Operating profit | $33.8 million | $799.3 million | Substantial decrease |
| Net earnings attributable to Zimmer Biomet | $(379.2) million | $1,813.8 million | Shift to loss |
| Diluted EPS | $(1.86) | $8.90 | Decrease |
| Operating cash flow | $1,747.4 million | $1,582.3 million | Increase |
| Gross margin | 63.9% | 64.9% | 100 basis-point decrease |
| Cash and cash equivalents | $542.8 million | $524.4 million | Increase |
Fourth-quarter 2018 net sales were $2,071.0 million, gross profit was $1,339.6 million, and the company recorded a net loss attributable to Zimmer Biomet of $901.1 million, or $(4.42) per diluted share. The fourth-quarter loss primarily reflected $975.9 million of goodwill impairment charges.
2018 sales growth reflected volume and mix growth of 3.2 percentage points and favorable foreign exchange of 0.9 percentage points, partly offset by pricing declines of 2.4 percentage points. By geography, Americas sales declined 0.2%, EMEA sales increased 3.2%, and Asia Pacific sales increased 6.6%. By product category, Knees increased 1.5%, Hips 2.6%, S.E.T. 2.9%, Spine and CMF 0.8%, while Dental declined 1.8% and Other declined 2.6%.
Major 2018 charges included $979.7 million of goodwill and intangible asset impairment, $186.0 million of litigation charges, $165.4 million of quality remediation expense, $133.7 million of acquisition and integration costs, and $226.1 million of excess and obsolete inventory charges. Non-GAAP adjusted net earnings were $1,565.4 million, or $7.64 adjusted diluted EPS, compared with $1,636.4 million, or $8.03, in 2017.
Total debt was approximately $8.9 billion at December 31, 2018, including $525.0 million classified as current debt and $8,413.7 million of long-term debt. Debt service obligations for the next 12 months were estimated at $776.9 million. The company repaid approximately $1.15 billion of net principal on senior notes and term loans during 2018. It had no borrowings under its $1.5 billion multicurrency revolving facility and was in compliance with debt covenants.
Cash used in investing activities was $416.6 million and cash used in financing activities was $1,302.2 million, principally reflecting debt repayment. The company paid $195.2 million of dividends in 2018 and retained a $1.0 billion share repurchase authorization, none of which remained used as of year-end. Management stated that operating cash flow and available revolver capacity were sufficient for working capital, capital expenditures, debt service, dividends and potential share repurchases.
Material changes versus the prior comparable period
- Sales improved modestly after supply-chain remediation reduced backorders and increased safety-stock levels, particularly in Knees and Hips.
- Operating profit fell from $799.3 million to $33.8 million, primarily because of the impairment, litigation, inventory, quality-remediation and higher SG&A charges.
- Net income benefited from a $1,272.4 million tax benefit related to the 2017 Tax Act; the absence of that benefit, together with 2018 operating charges, drove the year-over-year shift to a net loss.
- Goodwill impairment totaled $975.9 million in 2018, including $567.0 million for EMEA and $401.2 million for Spine. No goodwill remained in the Spine reporting unit after the charge.
- Gross margin declined to 63.9% from 64.9%, reflecting higher excess and obsolete inventory charges, lower selling prices and unfavorable hedge effects.
- Operating cash flow increased by $165.1 million, aided by receivables sales, lower acquisition and integration costs, lower quality-remediation spending and the absence of certain significant 2017 payments.
Guidance, outlook, risks and unusual items
Management described 2018 and 2019 as a two-year turnaround effort. For 2019, it expected sales to range from a 0.5% decline to a 0.5% increase, including an estimated 1.0% to 1.5% adverse foreign-exchange effect. New Knee product launches were expected to support commercial momentum, particularly in the second half of 2019. Assuming no significant goodwill or intangible-asset impairments or litigation charges, management expected net earnings to increase significantly from the 2018 loss. Quality-remediation and acquisition-integration costs were expected to decline, while R&D and launch-related investments would continue.
- FDA warning letters concerning Warsaw North Campus, Montreal and Ponce remained pending as of February 2019. Additional regulatory action could restrict manufacturing, marketing or product approvals.
- The company remains subject to a Deferred Prosecution Agreement related to legacy Biomet FCPA matters, including independent compliance monitoring. Noncompliance could lead to prosecution or exclusion from federal healthcare programs.
- Material litigation exposures include Durom Cup claims, Biomet metal-on-metal hip claims, M/L Taper and Versys claims, NexGen claims, Heraeus trade-secret litigation, the Stryker patent matter and a putative securities class action.
- The company accrued approximately $168 million for the Stryker patent matter and estimated remaining Durom Cup and Biomet metal-on-metal liabilities of $91.6 million and $70.4 million, respectively, at year-end.
- The company faces substantial debt obligations, including $500 million of senior notes due in 2019, $1.5 billion due in 2020 and additional maturities thereafter. It also faces pricing pressure, reimbursement and healthcare cost-containment risks, foreign-exchange exposure, supply-chain concentration and cybersecurity risks.
- Goodwill was $9.6 billion at year-end. The Dental reporting unit’s estimated fair value exceeded carrying value by less than 5%, creating sensitivity to weaker performance or valuation changes.
- The 2.3% U.S. medical-device excise tax was suspended through December 31, 2019 and could be reinstated beginning January 1, 2020.
- The company expected adoption of the new lease standard on January 1, 2019 to add approximately $265 million to $295 million of right-of-use assets and lease liabilities, without a material earnings effect.
Most important facts for investors to verify
- Whether the turnaround produces sustained organic growth after the 2019 product launches and supply-chain improvements.
- Whether additional goodwill impairments occur, particularly in EMEA and Dental.
- The resolution, timing and cash cost of FDA remediation, product-liability matters, the Stryker judgment, Heraeus proceedings and the securities class action.
- Debt maturities, refinancing activity, covenant compliance and the company’s ability to reduce leverage while maintaining dividends and investment spending.
- The reinstatement or further suspension of the medical-device excise tax and the effects of foreign-exchange movements on sales and earnings.
- Progress toward closing the pending FDA warning letters and completing the FCPA Deferred Prosecution Agreement.
- The sustainability of operating cash flow, including the extent to which cash generation depends on receivables sales and working-capital changes.