Zimmer Biomet Holdings, Inc. — 2017 Form 10-K Summary
Business context and reporting period
Zimmer Biomet is a global musculoskeletal healthcare company offering orthopaedic reconstruction, sports medicine, biologics, extremities and trauma, spine, craniomaxillofacial and thoracic, dental, office-based and related surgical products. The filing covers the year ended December 31, 2017, with quarterly information including the fourth quarter ended December 31, 2017.
Approximately 40% of 2017 net sales were generated outside the United States. Direct channel accounts represented approximately 75% of net sales. The company appointed Bryan C. Hanson as President and Chief Executive Officer effective December 19, 2017.
Key financial metrics
| Metric | 2017 | 2016 |
|---|---|---|
| Net sales | $7,824.1 million | $7,683.9 million |
| Net earnings attributable to Zimmer Biomet | $1,813.8 million | $305.9 million |
| Diluted EPS | $8.90 | $1.51 |
| Operating profit | $808.2 million | $825.9 million |
| Operating margin | 10.3% | 10.7% |
| Gross margin | 65.0% | 61.6% |
| Cash flow from operations | $1,582.3 million | $1,632.2 million |
| Cash and cash equivalents | $524.4 million | $634.1 million |
| Total debt, approximately | $10.1 billion | Approximately $11.2 billion |
| Goodwill | $10,668.4 million | $10,643.9 million |
| Dividends declared per share | $0.96 | $0.96 |
Reported 2017 net earnings and net margin were materially affected by a provisional $1,272.4 million income tax benefit related to the 2017 Tax Act. The reported net margin was approximately 23.2%, but this is not representative of underlying operating performance. Non-GAAP adjusted net earnings were $1,636.4 million and adjusted diluted EPS was $8.03, compared with $1,610.8 million and $7.96, respectively, in 2016.
Fourth-quarter 2017 net sales were $2,074.3 million and net earnings attributable to Zimmer Biomet were $1,231.4 million. Fourth-quarter results included the $1,272.4 million tax benefit, partially offset by a $272.0 million Spine goodwill impairment charge.
Material changes versus the prior comparable period
- Sales increased 1.8%, driven primarily by the full-year effect of the LDR acquisition and Asia Pacific growth. Volume and mix contributed 4.3 percentage points, while pricing reduced sales growth by 2.5 percentage points.
- Sales by product category were $2,737.1 million for Knees, $1,879.1 million for Hips, $1,709.1 million for S.E.T., $418.6 million for Dental, $759.5 million for Spine and CMF, and $320.7 million for Other.
- Knee sales declined 0.6% and Dental sales declined 2.2%. Spine and CMF sales increased 14.7%, while S.E.T. increased 3.9% and Hips increased 0.6%.
- Production delays and quality remediation at the Warsaw North Campus constrained inventory and reduced the company’s ability to meet demand, particularly for Knee, Hip and S.E.T. products.
- Gross margin improved primarily because Biomet inventory step-up charges declined substantially, discontinued-product inventory charges were lower, and the U.S. medical device excise tax remained subject to a moratorium. These benefits were partly offset by lower pricing and reduced foreign-currency hedge gains.
- Operating profit declined despite higher gross margin because of $304.7 million of goodwill impairment charges, higher quality-remediation spending and other operating pressures.
- Operating cash flow declined $49.9 million, reflecting higher inventory investment, quality-remediation costs and $30.5 million of FCPA-related payments, partly offset by increased accounts-receivable factoring.
- The company repaid approximately $1.25 billion of net principal on senior notes and term loans during 2017. Long-term debt declined to $8,917.5 million from $10,665.8 million, while current debt increased to $1,225.0 million primarily because $1.15 billion of notes mature in April 2018.
Guidance, outlook, commentary and unusual items
Management did not provide a specific numerical 2018 revenue or earnings forecast in the filing. Management expected the new CEO’s business review to conclude during the first quarter of 2018 and anticipated that resulting strategies could affect 2018 performance.
- Priorities include completing Warsaw North Campus quality remediation, restoring supply of key Knee, Hip and S.E.T. brands, improving operational execution and launching new products.
- Management expects lower U.S. corporate tax rates to benefit future results, but plans to reinvest tax savings in the business. The company also expects higher performance-based compensation if 2018 plans are achieved.
- Manufacturing costs associated with 2017 quality remediation are expected to affect 2018 results as related inventory is sold. Special-items expense is expected to decrease as Biomet integration and quality remediation substantially conclude.
- The 2017 Tax Act generated a provisional $1,272.4 million tax benefit, including a $715.0 million benefit related to deemed repatriation and a $557.4 million benefit primarily from remeasurement of deferred taxes. The accounting remains provisional and could change through the fourth quarter of 2018.
- Goodwill impairment charges totaled $304.7 million: $272.0 million for Spine and $32.7 million for Office Based Technologies. The Office Based Technologies goodwill balance was fully impaired; further Spine or other impairments remain possible.
- The company recorded $633.1 million of special-items expense, including $248.0 million of Biomet-related items and $385.1 million of other items.
Liquidity, debt and contingencies
Management stated that operating cash flow and available borrowings under the $1.5 billion multicurrency revolving facility should be sufficient for working capital, capital expenditures, debt service, dividends and share repurchases. No borrowings were outstanding under that facility at December 31, 2017. The company was in compliance with its debt covenants, including a consolidated indebtedness-to-EBITDA covenant of no greater than 4.5 to 1.0 after June 30, 2017.
Contractual obligations totaled $13,795.9 million, including $10,172.3 million of long-term debt, $2,208.4 million of interest payments, $466.0 million of toll-charge tax liability, operating leases, purchase obligations and other long-term liabilities. Expected principal and interest debt service during the next 12 months was $1,522.4 million.
- Remaining Durom Cup product-liability accrual: $199.4 million, including $78.0 million current and $121.4 million long term.
- Remaining Biomet metal-on-metal hip implant claims accrual: $36.0 million.
- Pending FDA warning letters relating to Ponce, Puerto Rico and Montreal, Quebec facilities, as well as Form 483 observations at certain facilities, remain material regulatory matters.
- The company remains subject to a three-year DOJ Deferred Prosecution Agreement related to legacy Biomet FCPA matters and paid approximately $30.5 million in settlement payments in January 2017. Noncompliance could result in prosecution or exclusion from federal healthcare programs.
- An Office of Inspector General subpoena received in June 2017 seeks records concerning healthcare professional consulting arrangements. The company stated that the outcome could not be predicted.
- The company is defending product-liability, intellectual-property, trade-secret and securities litigation, including Durom Cup, NexGen Knee, Biomet metal-on-metal hip and Shah securities class-action matters.
Most important facts for investors to verify
- Whether Warsaw North Campus remediation restores product availability and improves Knee, Hip and S.E.T. revenue growth.
- The final accounting impact of the 2017 Tax Act, including the toll charge, GILTI treatment and deferred-tax remeasurement.
- Refinancing or repayment plans for the $1.15 billion of notes due in April 2018 and other near-term debt maturities.
- Progress under the DOJ Deferred Prosecution Agreement and the status of the OIG investigation.
- Potential additional goodwill impairments, particularly in Spine, and the sustainability of the company’s forecast cash flows and margins.
- Changes in accrued and unaccrued litigation exposure, including Durom Cup, metal-on-metal hip, NexGen Knee, Heraeus and securities claims.
- Whether management’s planned product launches, integration completion and reinvestment of tax savings produce measurable improvement in 2018 operating performance.
- The comparability of GAAP earnings with adjusted earnings, given substantial tax benefits, amortization, goodwill impairment and special items.