Zimmer Holdings, Inc. 2014 Form 10-K Summary
Business context and reporting period
Zimmer Holdings, Inc. designs, manufactures and markets orthopaedic reconstructive, trauma and spine devices, biologics, dental implants and related surgical products. It operates in more than 25 countries and sells in more than 100 countries through the Americas, Europe and Asia Pacific segments. The filing covers the year ended December 31, 2014; quarterly data is provided for the fourth quarter but this is an annual Form 10-K.
The company entered into an agreement on April 24, 2014 to acquire Biomet’s parent, LVB Acquisition, Inc., in a cash-and-stock transaction valued at approximately $13.35 billion. The transaction was expected to close in the first quarter of 2015 and is not included in the historical financial results presented.
Key financial metrics
| Metric | 2014 | 2013 | Change |
|---|---|---|---|
| Net sales | $4,673.3 million | $4,623.4 million | Up 1% |
| Gross profit | $3,423.5 million | $3,337.3 million | Up 3% |
| Gross margin | 73.3% | 72.2% | Up 1.1 percentage points |
| Operating profit | $1,034.7 million | $1,035.6 million | Down slightly |
| Operating margin | 22.1% | 22.4% | Down 0.3 percentage points |
| Net earnings attributable to Zimmer | $720.1 million | $761.0 million | Down 5% |
| Diluted EPS | $4.19 | $4.43 | Down 5% |
| Adjusted net earnings | $1,041.0 million | $988.4 million | Up 5% |
| Adjusted diluted EPS | $6.06 | $5.75 | Up 5% |
| Cash flow from operations | $1,052.8 million | $963.1 million | Up 9% |
| Cash flow used in investing | $469.4 million | $282.5 million | Higher use |
| Cash flow used in financing | $562.4 million | $467.3 million | Higher use |
At December 31, 2014, cash and cash equivalents were $1,083.3 million, short- and long-term investments totaled $868.9 million, and total current assets were $4,289.0 million. Long-term debt was $1,425.5 million, compared with $1,672.3 million in 2013. Total assets were $9,634.7 million and stockholders’ equity was $6,522.6 million.
The company had 64 days of sales outstanding and 337 days of inventory on hand at year-end. Inventory increased to $1,169.0 million from $1,074.5 million, driven by product launches, increased consignment inventory and expanded direct sales in certain Eastern European markets.
Cash returned to stockholders included $145.5 million of dividends and $400.5 million of share repurchases. The quarterly dividend was $0.22 per share, or $0.88 annually, a 10% increase from 2013. Share repurchases were suspended after the first quarter because of the pending Biomet transaction.
Material changes versus the prior comparable period
- Sales increased 1%, with 4 percentage points of volume and mix growth offset by 2 percentage points of pricing pressure and a 1 percentage point foreign-exchange headwind.
- Europe sales increased 5% to $1,269.5 million and Asia Pacific sales increased 2% to $809.6 million; Americas sales declined 1% to $2,594.2 million.
- Knee sales increased 3% to $1,965.8 million, supported by the Persona Personalized Knee System. Hip sales were flat, extremities increased 5%, dental increased 1%, spine increased 2%, and trauma was flat.
- Surgical and other sales declined 5% to $410.1 million, primarily because 2013 benefited from unusually strong Transposal capital-equipment sales following a competitor’s commercial disruption.
- Net earnings declined despite higher sales because of increased operational-excellence spending, Biomet integration-planning expenses, a $70.0 million litigation accrual, and $39.6 million of expenses related to financing facilities for the pending merger.
- Special items increased to $356.5 million from $216.7 million, including merger-related professional fees, quality and operational-excellence costs, intangible-asset impairments and litigation costs.
- Gross margin improved primarily because 2013 included larger excess and obsolete inventory charges. The improvement was partly offset by lower selling prices and the U.S. medical-device excise tax.
- Cash from operations improved by $89.7 million, while investing cash use increased because of higher property, plant and equipment spending and investment activity.
Guidance, outlook, risks and unusual items
Management did not provide 2015 guidance for the combined Zimmer-Biomet company. On a standalone basis, management expected stronger U.S. dollar exchange rates to create significant sales headwinds, continued volume and mix growth in a stable joint-replacement market, ongoing pricing pressure, R&D spending of approximately 4% to 4.5% of sales, and continued SG&A efficiencies. Management expected foreign-exchange hedge gains to partially offset the earnings effect of currency movements.
The Biomet transaction was expected to require approximately $10.35 billion of cash consideration, funded with existing cash, a committed $3.0 billion term loan and senior notes of up to $7.66 billion. If senior notes were not issued before closing, the company could draw on a $7.66 billion bridge facility. Debt was expected to increase from approximately $1.43 billion at year-end 2014 to approximately $12.09 billion immediately after closing. Management estimated integration and restructuring costs exceeding $400 million during the first two years after the merger.
- Durom Cup product-liability accruals totaled $471.7 million since 2008, including $21.5 million recorded in 2014. The remaining estimated liability at year-end was $357.2 million, partly offset by a $170.3 million receivable for expected insurance recoveries. Insurance coverage remained subject to carrier reservations, a 20% co-payment and a cap.
- The company accrued a $70.0 million loss related to Stryker patent litigation. The Federal Circuit affirmed the lost-profit award but reversed the willfulness finding and vacated treble damages and attorneys’ fees.
- NexGen Knee System litigation remained unresolved, with bellwether trials expected in the third quarter of 2015; no loss was accrued because management did not believe a loss was probable or reasonably estimable.
- An FDA warning letter issued in 2012 concerning manufacturing and validation processes for Trilogy Acetabular System products at the Ponce, Puerto Rico facility remained pending. Additional regulatory action, product restrictions and penalties were possible.
- The IRS proposed adjustments reallocating profits between U.S. and foreign subsidiaries for 2006 through 2009. The company disputed the adjustments; resolution could materially affect future tax expense, cash flow and results.
- Key ongoing risks include medical-device regulation, product liability, reimbursement and healthcare cost containment, foreign currency movements, pricing pressure, cybersecurity and information systems, supplier concentration, intellectual property disputes, tax audits and the integration and financing of Biomet.
Most important facts for investors to verify
- Whether the Biomet merger closed on the expected timetable and the final purchase price, financing mix, share issuance and resulting leverage.
- Post-closing debt levels, credit ratings, covenant compliance, interest expense and the pace of debt repayment.
- Actual integration, restructuring and synergy costs compared with management’s estimate of more than $400 million over two years.
- Developments in Durom Cup, NexGen Knee and Stryker litigation, including insurance recoveries, settlements and additional accruals.
- Resolution of the FDA warning letter and related Form 483 observations at the Ponce facility.
- Resolution of IRS proposed adjustments and other unrecognized tax benefits; the filing reports $314.0 million of unrecognized tax benefits at December 31, 2014.
- Whether currency headwinds, pricing pressure and healthcare cost-containment measures affect sales and margins as projected.
- The sustainability of high inventory levels, particularly the 337 days of inventory on hand at year-end.
- The reconciliation between GAAP and adjusted results, noting that 2014 adjusted net earnings excluded $356.5 million of special items, $21.5 million of claims, $21.2 million of inventory and manufacturing charges, and $39.6 million of merger-financing expense, before tax effects.