Zimmer Biomet Holdings, Inc. — 2019 Q1 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparative period ended March 31, 2018. The interim financial statements are unaudited. Zimmer Biomet designs, manufactures and markets orthopedic reconstructive, sports medicine, trauma, spine, dental and related surgical products.
Financial performance and condition
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net sales | $1,975.5 million | $2,017.6 million | Down 2.1% |
| Operating profit | $350.2 million | $305.0 million | Up 14.8% |
| Operating margin | 17.7% | 15.1% | Up 2.6 percentage points |
| Net earnings attributable to Zimmer Biomet | $246.1 million | $174.7 million | Up 40.9% |
| Diluted EPS | $1.20 | $0.85 | Up $0.35 |
| Adjusted diluted EPS | $1.87 | $1.91 | Down $0.04 |
| Cash flow from operations | $283.6 million | $490.5 million | Down $206.9 million |
Reported net sales were pressured by a 2.8% foreign-exchange headwind and 2.6% pricing decline, partly offset by 3.3% volume/mix growth. Asia Pacific sales increased 1.4%, while Americas sales declined 1.2% and EMEA sales declined 6.6%. By product category, sales declined across Knees, Hips, S.E.T., Dental and Other; Spine & CMF was approximately flat.
Operating profit benefited from lower acquisition and integration costs, lower quality-remediation expenses, a $23.5 million patent litigation settlement gain, lower litigation costs, favorable hedging effects and lower amortization. Adjusted net earnings declined to $384.2 million from $390.9 million, and adjusted diluted EPS declined to $1.87 from $1.91.
Liquidity and balance sheet: Cash and cash equivalents were $586.8 million at March 31, 2019, compared with $542.8 million at December 31, 2018. Total current assets were $4.5 billion and total current liabilities were $2.3 billion. Debt consisted of $500.0 million current debt and $8.31 billion long-term debt, for approximately $8.81 billion of carrying-value debt. No borrowings were outstanding under the $1.5 billion multicurrency revolving facility. The company reported compliance with its debt covenants.
Investing cash outflows were $105.5 million, including $63.7 million of instrument additions and $37.8 million of property, plant and equipment additions. Financing cash outflows were $135.2 million, including $310.0 million of term-loan repayments, $200.0 million of new term-loan borrowings and $49.0 million of dividends. The company paid approximately $168.0 million related to the Stryker patent judgment during the quarter.
Material changes versus the prior period
- Revenue decreased 2.1%, primarily from foreign exchange and pricing pressure, despite positive volume/mix growth.
- Operating margin improved from 15.1% to 17.7%, while reported diluted EPS increased from $0.85 to $1.20.
- Interest expense declined $20.0 million to $58.0 million because of hedging benefits and lower average debt.
- Acquisition, integration and related expense decreased to $10.7 million from $46.0 million; quality-remediation expense decreased to $19.7 million from $42.6 million.
- Cash flow from operations declined substantially, primarily because of the Stryker judgment payment and less incremental benefit from receivables factoring.
- The company adopted ASC 842 lease accounting on January 1, 2019, recognizing a $274.7 million right-of-use asset and $283.4 million of lease liabilities at adoption.
Guidance, outlook, risks and unusual items
Management expects 2019 sales growth of negative 0.5% to positive 0.5%, including an estimated 1.0% to 1.5% foreign-exchange headwind. New knee-product launches are expected to improve commercial momentum, particularly in the second half of 2019. Management expects net earnings to increase significantly versus 2018, when goodwill and intangible-asset impairments and litigation charges contributed to a net loss. Acquisition, integration and quality-remediation expenses are expected to decline, while research and development and launch-related investments continue.
The company expects to refinance all or part of the $1.5 billion of senior notes due April 1, 2020, or use its revolving facility. It borrowed under the revolving facility in April 2019 to help fund a $192.5 million licensing buyout and expects to repay that borrowing before the end of the second quarter.
- Pending FDA warning letters and Form 483 observations relate to quality-system issues at facilities in Warsaw, Montreal and Ponce. Additional regulatory action could restrict manufacturing, marketing or sales.
- Heraeus trade-secret litigation remains active in Europe and the United States. A France proceeding could materially affect the business if resolved adversely. Heraeus also initiated an ITC investigation in March 2019; the filing states that the outcome cannot currently be predicted.
- Product-liability exposure includes estimated remaining Durom Cup liabilities of $84.4 million and Biomet metal-on-metal hip liabilities of $62.1 million.
- The putative securities class action remains pending, and the company is also responding to an OIG subpoena concerning healthcare-professional consulting arrangements.
- The company remains subject to a DOJ Deferred Prosecution Agreement and independent compliance monitoring through potentially 2020. Noncompliance could lead to prosecution or exclusion from federal healthcare programs.
- Tax audits and disputed IRS proposed adjustments for 2005–2012 could result in significant future cash payments; management estimates the next-twelve-month change in unrecognized tax benefits could range from a $180 million decrease to a $25 million increase.
- Goodwill impairment risk remains elevated for the EMEA reporting unit and the Dental reporting unit, whose estimated fair value exceeded carrying value by less than 5% at the latest annual test.
Investor verification points
- Verify the sustainability of reported earnings growth after excluding the $23.5 million litigation settlement gain, lower remediation and integration costs, tax benefits and other adjustments.
- Monitor organic volume/mix growth against continuing pricing pressure and foreign-exchange effects, particularly in EMEA and the Knees category.
- Assess the company’s ability to refinance the $1.5 billion 2020 maturity while reducing overall leverage.
- Track FDA remediation, the Heraeus ITC and European proceedings, product-liability settlements, and the securities class action for potential cash or operating impacts.
- Reconcile the April 2019 $192.5 million licensing payment and related revolving-facility borrowing in subsequent filings.
- Review adjusted versus GAAP results carefully: adjusted diluted EPS fell to $1.87 despite reported diluted EPS rising to $1.20.