Zimmer Biomet Holdings, Inc. — 2015 Form 10-K Summary
Business context and reporting period
Zimmer Biomet is a global medical-device company focused on orthopaedic reconstruction, sports medicine, biologics, extremities and trauma, spine, bone healing, craniomaxillofacial and thoracic products, dental implants and related surgical products. The filing covers the year ended December 31, 2015. The company completed its acquisition of Biomet on June 24, 2015; Biomet’s operating results are included from that date, while its balance sheet is included at year-end.
Because Biomet was consolidated for only part of 2015, reported year-over-year comparisons are not fully comparable. Unaudited pro forma 2015 and 2014 sales are provided as if the merger occurred on January 1, 2014.
Key financial metrics
| Metric | 2015 | 2014 |
|---|---|---|
| Net sales | $5,997.8 million | $4,673.3 million |
| Operating profit | $467.3 million | $1,037.3 million |
| Operating margin | 7.8% | 22.2% |
| Net earnings attributable to Zimmer Biomet | $147.0 million | $720.3 million |
| Diluted EPS | $0.77 | $4.20 |
| Operating cash flow | $816.7 million | $1,052.8 million |
| Cash and cash equivalents | $1,459.3 million | $1,083.3 million |
| Total assets | $27,219.5 million | $9,658.0 million |
| Long-term debt | $11,556.3 million | $1,425.5 million |
Sales increased 28.3%, primarily from the Biomet merger. Reported sales were affected negatively by 2.0 percentage points from pricing and 6.4 percentage points from foreign-exchange movements; volume and mix contributed 36.7 percentage points. Pro forma sales declined 5.6% to $7,517.8 million from $7,965.3 million, reflecting foreign exchange, pricing pressure, divestitures and merger-related sales-force disruption.
Gross margin declined to 64.4% from 71.4%. Major factors included $317.8 million of inventory step-up expense, $337.4 million of intangible-asset amortization and higher excess and obsolete inventory charges. R&D was 4.5% of sales, SG&A was 38.1% of sales and special items were 13.9% of sales.
GAAP results included substantial unusual and acquisition-related costs. Adjusted net earnings, a non-GAAP measure, were $1,310.5 million, or $6.90 adjusted diluted EPS, compared with $1,098.0 million and $6.40 in 2014. The filing cautions that these measures exclude significant items and should not replace GAAP results.
Material changes versus the prior comparable period
- The Biomet transaction increased the scale of the company substantially. Biomet contributed $1,602.0 million of 2015 sales and a $295.8 million operating loss, driven by merger compensation, retention costs, inventory step-up, severance and amortization.
- Total assets increased from $9.7 billion to $27.2 billion, including goodwill of $9.9 billion and intangible assets of $8.7 billion at year-end.
- Total indebtedness rose to approximately $11.6 billion from $1.4 billion. The company issued $7.65 billion of senior notes and borrowed $3.0 billion under a term loan to fund the merger and related costs.
- Cash flow from operations fell by $236.1 million, while investing cash use increased to $7.6 billion, primarily because of the $7.76 billion net cash outflow for the Biomet acquisition.
- 2015 earnings included $831.8 million of special items, compared with $341.1 million in 2014, including $619.1 million of Biomet merger-related special items.
- The company discovered prior-period accounting errors involving accounts-payable accruals and the accounting for divested Biomet assets. The 2014 and 2013 financial statements were revised, although management concluded the errors were not material to previously issued statements.
- A material weakness in internal control over financial reporting was identified during 2015 in accounting for non-routine, complex transactions. Management reported that it was remediated as of December 31, 2015, although Biomet was excluded from the year-end control assessment and will be incorporated in the 2016 assessment.
Liquidity, debt and capital allocation
Management stated that operating cash flow and available revolving credit capacity were sufficient for working capital, capital expenditures, debt service, dividends and share repurchases. The company held $1,459.3 million of cash and $273.1 million of short- and long-term debt investments at December 31, 2015. No borrowings were outstanding under the $1.35 billion multicurrency revolving facility.
Debt service obligations for the next 12 months were estimated at $339.8 million of principal and interest, excluding capital leases and equipment notes. The credit agreement includes a maximum consolidated indebtedness-to-EBITDA ratio of 5.0 to 1.0 through June 24, 2016 and 4.5 to 1.0 thereafter. The company was in compliance with its covenants at year-end.
The company declared quarterly dividends of $0.22 per share in 2015 and repurchased $150.0 million of common stock. Approximately $449.5 million remained available under the $1.0 billion repurchase authorization at year-end.
Guidance, outlook, risks and unusual items
- For 2016, management expected pro forma sales to be approximately flat, assuming roughly 4% volume/mix growth, a 2% foreign-exchange headwind and a 2% pricing headwind. Reported first-half sales were expected to exceed the prior-year period because Biomet was consolidated midway through 2015.
- Management expected 2016 R&D expense of 4.5% to 5.0% of sales and SG&A of approximately 37% of sales. Special items were expected to remain significant but lower than in 2015.
- 2016 operating cash flow was estimated at $1.65 billion to $1.75 billion, including approximately $290 million of integration-related cash outflows. Instrument investments were expected at $300 million to $325 million, and property, plant and equipment spending at approximately $250 million.
- Management targeted $350 million of annual pretax operating synergies by the end of the third year after closing, but integration costs and timing remained uncertain.
- Durom Cup product-liability liabilities totaled $314.6 million at year-end, including $50.0 million current and $264.6 million long term. The company had recognized $479.4 million of related expense since 2008 and held a $95.3 million receivable for estimated insurance recoveries.
- Biomet metal-on-metal hip implant liabilities totaled $33.4 million. Other product-liability, patent, commercial and trade-secret matters remained unresolved, and some potential losses could not be reasonably estimated.
- Biomet-related DOJ and SEC investigations continued under an extended Deferred Prosecution Agreement and compliance-monitoring arrangement concerning possible Foreign Corrupt Practices Act violations. FDA warning letters concerning facilities in Ponce, Puerto Rico and Zhejiang, China remained pending.
- Important ongoing risks include integration execution, high leverage and refinancing, pricing and reimbursement pressure, foreign currency volatility, regulatory compliance, product liability, litigation, supply-chain interruptions, goodwill impairment and the effectiveness of internal controls.
Investor verification checklist
- Verify the final purchase-price allocation for Biomet, including goodwill, intangible assets, deferred taxes and any measurement-period adjustments.
- Assess whether reported adjusted earnings appropriately exclude recurring or cash costs, particularly integration, inventory step-up, amortization and special items.
- Monitor leverage, debt maturities, interest expense, covenant compliance and the pace of debt reduction.
- Track realization of the targeted $350 million synergies against the projected $290 million of 2016 integration cash outlays.
- Review developments in Durom Cup, metal-on-metal hip, NexGen, Heraeus and other litigation, including insurance recoveries and potential unaccrued losses.
- Follow the Biomet DOJ and SEC investigations, DPA obligations, FDA warning letters and any related fines, restrictions, recalls or remediation costs.
- Confirm remediation and subsequent testing of internal controls, including the planned inclusion of Biomet in the 2016 assessment.
- Compare pro forma sales trends with reported sales to distinguish acquisition effects from underlying volume, pricing and foreign-exchange performance.