Zimmer Biomet Holdings, Inc. — FY2019 Form 10-K Summary
Business context and reporting period
Zimmer Biomet is a global musculoskeletal healthcare company focused on orthopedic reconstructive products, sports medicine, biologics, extremities and trauma, spine, craniomaxillofacial and thoracic products, dental implants, office-based technologies and related surgical products. The filing covers the year ended December 31, 2019, with comparison to 2018 and 2017. Approximately 40% of 2019 sales were generated outside the United States, and approximately 80% of net sales were consignment sales.
Key financial metrics
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Net sales | $7,982.2 million | $7,932.9 million | 0.6% increase |
| Operating profit | $1,137.5 million | $33.8 million | Significant increase |
| Operating margin | 14.2% | 0.4% | 13.8 percentage-point increase |
| Net earnings attributable to Zimmer Biomet | $1,131.6 million | $(379.2) million | Returned to profitability |
| Diluted EPS | $5.47 | $(1.86) | Improved materially |
| Adjusted net earnings | $1,626.4 million | $1,565.4 million | 3.9% increase |
| Adjusted diluted EPS | $7.87 | $7.64 | 3.0% increase |
| Gross margin | 64.5% | 63.9% | 0.6 percentage-point increase |
| Operating cash flow | $1,585.8 million | $1,747.4 million | 9.2% decrease |
| Cash and cash equivalents | $617.9 million | $542.8 million | Increase |
| Total debt | Approximately $8.2 billion | Not stated in the same summary format | Debt remained substantial |
Sales growth reflected a 4.9% favorable volume and mix effect, offset by a 2.7% pricing decline and a 1.6% unfavorable foreign-exchange effect. By geography, Americas sales increased 0.8%, EMEA declined 3.1%, and Asia Pacific increased 5.1%. By product category, Knees increased 1.3%, Hips 0.7%, S.E.T. 2.5%, Dental 0.7%, while Spine and CMF declined 2.2% and Other declined 9.9%.
Cash flow from investing activities was $(729.3) million, including $197.6 million for intellectual property rights and approximately $523.0 million of additions to instruments and property, plant and equipment. Financing activities used $(779.9) million, primarily reflecting approximately $710 million of net principal repayments on senior notes and term loans, plus $196.7 million of dividends paid.
At December 31, 2019, current assets were $4,723.9 million and current liabilities were $3,441.5 million. The company had a $1.5 billion unsecured multicurrency revolving facility maturing in 2024, with no borrowings outstanding at year-end. A $1.5 billion senior note maturity was due April 1, 2020; management stated it expected to meet this obligation through operating cash flow, new debt issuance and/or revolver borrowings.
Material changes versus the prior comparable period
- Profitability improved sharply because 2018 included $975.9 million of goodwill impairment and $168.0 million of litigation-related charges. These items were substantially lower in 2019.
- Interest expense declined to $226.9 million from $289.3 million, primarily because of debt repayments and gains on cross-currency interest-rate swaps.
- Gross margin increased to 64.5%, aided by foreign-currency hedge gains, lower royalty expense, a U.S. medical-device excise-tax refund and lower intangible amortization. These benefits were partly offset by pricing pressure and higher manufacturing costs.
- Quality-remediation expense declined, but remained material at $82.4 million, compared with $146.9 million in 2018.
- The company recorded $70.1 million of intangible-asset impairment in 2019, versus $979.7 million of combined goodwill and intangible-asset impairment in 2018.
- Research and development expense increased to $449.3 million from $391.7 million, reflecting increased investment in the knee pipeline, EU Medical Device Regulation compliance and patent licenses.
- The company initiated a new global restructuring program in December 2019 and recorded $50.0 million of related restructuring and cost-reduction expenses.
- Operating cash flow decreased despite the return to profitability, primarily because of the approximately $168 million payment on a patent infringement judgment and lower year-end receivables sales.
Guidance, outlook, commentary, risks and unusual items
Management projected 2020 sales growth of 2.5% to 3.5%, with minimal full-year foreign-exchange impact and expected operating-profit leverage. The company expected further reductions in quality-remediation and project costs, as well as lower interest expense from reduced average debt balances.
The restructuring program is expected to generate total pre-tax charges of approximately $350 million to $400 million through 2023, with slightly more than half expected in 2020, and gross annual pre-tax operating-expense reductions of approximately $200 million to $300 million by the end of 2023.
The 2020 outlook did not include potential effects of the coronavirus outbreak, which management stated could defer elective procedures, disrupt facilities and supply chains, and reduce sales, although the magnitude was not yet predictable.
- Regulatory and quality matters remain significant. FDA warning letters concerning the Warsaw North Campus and Ponce facilities remained pending as of December 31, 2019. New FDA Form 483 observations followed a January 2020 Warsaw inspection.
- The company is subject to continuing obligations under a Deferred Prosecution Agreement related to legacy Biomet Foreign Corrupt Practices Act matters. The independent compliance monitorship could remain in place until August 2020 and could be extended.
- Heraeus trade-secret litigation and a related U.S. International Trade Commission investigation involve bone-cement products. An adverse ITC outcome could materially affect operations, and an initial determination was expected by May 2020.
- Product-liability matters include Durom Cup, M/L Taper and Versys Femoral Head, and Biomet metal-on-metal hip claims. Accrued liabilities at year-end were $59.9 million for Durom Cup claims and $50.1 million for Biomet metal-on-metal hip claims.
- The company had $9.6 billion of goodwill and $7.3 billion of intangible assets. EMEA and Dental goodwill reporting units had estimated fair values less than 5% above carrying values, creating sensitivity to weaker cash flows, higher discount rates or adverse market conditions.
- Unrecognized tax benefits totaled $741.8 million, and the company was disputing IRS proposed adjustments involving profit allocation between U.S. and foreign subsidiaries. Management estimated the net unrecognized-tax-benefit liability could change within the following 12 months by a decrease of up to $290 million or an increase of up to $30 million.
- Pricing pressure, reimbursement reductions, healthcare cost containment, currency movements, cybersecurity incidents, supply-chain concentration, competition, regulatory approvals and substantial indebtedness remain core business risks.
Most important facts for an investor to verify
- Whether the 2020 sales-growth outlook and anticipated operating leverage were achieved, particularly after the coronavirus disruption.
- Progress, cost and timing of the global restructuring program and whether projected annual savings of $200 million to $300 million are being realized.
- Resolution of the April 2020 $1.5 billion debt maturity and the company’s subsequent debt balances, refinancing costs and leverage.
- Status of FDA warning letters, Warsaw remediation, January 2020 Form 483 observations and related restrictions on product approvals or manufacturing.
- Outcomes and potential exposures from the Heraeus proceedings, product-liability claims, securities litigation and other legal matters.
- Performance and impairment sensitivity of the EMEA and Dental reporting units, given their limited fair-value cushion.
- Reconciliation of GAAP results to adjusted earnings, including recurring intangible amortization, quality remediation, litigation, restructuring and tax-reform items.