Zimmer Biomet Holdings, Inc. — Form 10-Q Summary
Business Context and Reporting Period
Unaudited results cover the three and six months ended June 30, 2016. Zimmer Biomet designs, manufactures and markets orthopedic reconstructive, sports medicine, biologics, extremities, trauma, spine, bone healing, craniomaxillofacial, dental and related surgical products. Comparisons are materially affected by the June 24, 2015 Biomet merger; 2015 reported results include Biomet only after the merger closing date.
Key Financial Metrics
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Net sales | $1,934.0 million, up 65.6% | $3,838.0 million, up 66.7% |
| Operating profit | $201.6 million; 10.4% margin | $447.1 million; 11.7% margin |
| Net earnings attributable to Zimmer Biomet | $(31.3) million; $(0.16) diluted EPS | $77.5 million; $0.38 diluted EPS |
| Adjusted net earnings | $407.1 million | $814.3 million |
| Adjusted diluted EPS | $2.02 | $4.03 |
| Cash flow from operations | Not separately provided | $652.4 million |
| Capital expenditures and instrument additions | Not separately provided | $231.0 million |
| Cash and cash equivalents at June 30 | $976.3 million | |
| Total debt at June 30 | $11,033.5 million carrying value, including $500.0 million current debt |
Reported earnings were significantly affected by $156.6 million of inventory step-up and related manufacturing charges, $133.8 million of intangible amortization and $137.9 million of special items in the second quarter. For the six-month period, these amounts were $334.9 million, $260.4 million and $226.6 million, respectively. Interest expense was $88.1 million in the quarter and $176.3 million year to date.
The effective tax rate was unusually high at 128.7% for the quarter and 71.0% for the six-month period, primarily because of non-cash tax-account finalization adjustments related to the Biomet merger. The company declared quarterly dividends of $0.24 per share and repurchased 4.2 million shares for $415.5 million during the first six months.
Material Changes Versus the Prior Comparable Period
- Sales increased primarily because 2016 includes Biomet for the full period. On a pro forma basis, sales increased 2.9% in the quarter and 0.4% for the six months.
- Pro forma sales growth was driven by volume and mix, partly offset by pricing pressure, divestitures and foreign exchange. Second-quarter volume/mix contributed 5.7 percentage points; pricing reduced growth by 1.2 points.
- Reported operating profit improved from a $132.1 million loss to $201.6 million profit in the quarter and increased from $137.8 million to $447.1 million for the six months.
- Reported net loss narrowed from $173.8 million to $31.7 million in the quarter, while six-month net earnings improved from a $2.7 million loss to $77.0 million.
- Operating cash flow increased from $288.7 million to $652.4 million for the six months, while investing cash use declined from $7.72 billion to $170.4 million because the prior-year period included the Biomet acquisition.
- Cost of products sold increased as a percentage of sales to 33.1% from 25.2% in the quarter and to 33.4% from 25.2% year to date, principally due to acquired Biomet inventory step-up charges.
- Special items declined substantially from $469.2 million to $137.9 million in the quarter and from $556.0 million to $226.6 million year to date.
Guidance, Outlook, Risks and Unusual Items
- Management expected 2016 R&D expense of 4.5% to 5.0% of sales and SG&A expense of approximately 38% of sales.
- Management expected lower Biomet inventory step-up expense in the second half of 2016, supporting gross profit, but anticipated lower hedge gains, higher R&D from acquired businesses and continued significant special items.
- Integration plans are expected to continue through 2018. The company estimated total integration costs of $170 million for employee termination benefits and $130 million for contract terminations; approximately $290 million of related cash outlays were expected in 2016. Management targeted $350 million of annual pretax operating synergies by the end of the third year after the merger.
- The company acquired LDR for $1.09 billion on July 13, 2016 and acquired 58.8% of Medtech for $107.0 million on July 18, 2016. LDR was primarily funded with revolver borrowings, with alternative debt financing expected.
- Debt agreements include a maximum consolidated indebtedness-to-EBITDA ratio of 4.5 to 1.0 after June 24, 2016. The company was in compliance with its covenants at June 30, 2016, and had no revolver borrowings at that date.
- Material contingencies include $303.2 million of estimated Durom Cup liabilities, offset in part by a $95.3 million insurance receivable; $69.0 million of Biomet metal-on-metal hip implant liabilities; unresolved Stryker litigation that could require a future charge of up to $140.0 million; and ongoing Biomet DOJ and SEC investigations related to the Foreign Corrupt Practices Act.
- FDA warning letters concerning facilities in Ponce, Puerto Rico; Zhejiang, China; and Montreal, Canada remained pending. Potential consequences include additional regulatory action, product restrictions, injunctions and civil penalties.
- Tax audits and proposed IRS adjustments, foreign exchange movements, healthcare cost containment, pricing pressure, product liability claims, intellectual property disputes and acquisition integration are significant risks.
- The company adopted the employee share-based payment accounting standard early in the second quarter and adopted the debt issuance cost presentation standard retrospectively. The filing states that the revenue recognition standard is not effective until 2018 and its impact cannot yet be estimated.
Most Important Facts for Investors to Verify
- Reconcile reported growth with pro forma growth to isolate organic performance from the Biomet merger.
- Assess the sustainability of adjusted earnings after excluding inventory step-up, amortization, special items and merger-related tax adjustments.
- Monitor leverage, upcoming debt maturities, post-quarter LDR and Medtech financing, and compliance with the 4.5-times debt covenant.
- Track integration cash costs and progress toward the $350 million annual synergy target.
- Review the status and ultimate costs of Durom Cup, Biomet metal-on-metal, Stryker and other product-liability matters, including insurance recoveries.
- Follow the Biomet DOJ and SEC investigations and the potential consequences of an alleged DPA breach.
- Evaluate FDA remediation progress and any effects on manufacturing, product approvals or market access.
- Consider the effect of pricing pressure, currency movements and European public-hospital receivables on future sales and cash collection.