Zimmer Biomet Holdings, Inc. — Form 10-Q Summary
Business context and reporting period
Zimmer Biomet designs, manufactures and markets orthopedic reconstructive, sports medicine, biologics, extremities and trauma, spine, craniomaxillofacial, dental and related surgical products. This unaudited Form 10-Q covers the three and six months ended June 30, 2018, compared with the corresponding 2017 periods.
Financial performance and key metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $2,007.6 million | $1,949.5 million | $4,025.2 million | $3,921.9 million |
| Operating profit | $296.0 million | $280.1 million | $601.0 million | $628.2 million |
| Operating margin | 14.7% | 14.4% | 14.9% | 16.0% |
| Net earnings attributable to Zimmer Biomet | $185.0 million | $184.2 million | $359.7 million | $483.6 million |
| Diluted EPS | $0.90 | $0.90 | $1.76 | $2.38 |
| Net margin | 9.2% | 9.4% | 8.9% | 12.3% |
- Q2 sales increased 3.0%; six-month sales increased 2.6%. Growth reflected volume and mix, particularly in Knees and Hips, plus favorable foreign exchange, partly offset by pricing pressure.
- Q2 operating profit increased 5.7%, but six-month operating profit declined 4.3%. Q2 benefited from lower acquisition and integration costs and the absence of the prior-year intangible impairment charge.
- Q2 net earnings were essentially flat because higher sales and lower integration costs were offset by hedge losses, higher manufacturing and inventory costs, increased R&D and SG&A, and higher tax expense versus the prior year.
- Cash flow from operations was $883.8 million for the six months, versus $715.9 million in 2017. Investing cash flow was $(195.3) million, and financing cash flow was $(729.0) million. Cash ended at $481.2 million, down from $524.4 million at December 31, 2017.
- At June 30, 2018, total current assets were $4.5 billion and total liabilities were $13.4 billion. Carrying-value debt was approximately $9.5 billion, consisting of $100.0 million current debt and $9.4 billion long-term debt.
- The company had $25.0 million outstanding under its $1.5 billion multicurrency revolving facility and was in compliance with applicable financial covenants.
- Quarterly cash dividends remained $0.24 per share. A $1.0 billion share-repurchase authorization remained entirely available.
Material changes versus the prior comparable period
- Geographic sales growth was strongest in Asia Pacific, up 8.5% in Q2 and 8.4% for the six months; EMEA increased 4.4% and 7.0%, respectively. Americas sales increased 1.0% in Q2 but declined 0.4% for the six months.
- Q2 product-category growth was led by Hips, up 4.0%, Knees, up 3.4%, and S.E.T., up 3.0%. Dental declined 3.2%.
- Global pricing reduced sales by 2.5% in Q2 and 2.6% year to date, while volume/mix increased sales by 3.5% and 2.3%, respectively. Foreign exchange increased sales by 2.0% and 2.9%.
- Cost of products sold increased to 29.1% of sales in Q2 from 27.1%, primarily due to hedge losses, Warsaw North Campus manufacturing costs, excess and obsolete inventory charges and lower selling prices. Six-month cost of products sold increased to 28.8% from 26.5%.
- Acquisition, integration and related expense declined to $50.5 million in Q2 from $72.5 million and to $96.5 million year to date from $130.7 million. Quality remediation expense was $37.5 million in Q2 and $80.1 million year to date.
- The company adopted revenue recognition guidance retrospectively and adopted new hedge-accounting and pension-cost presentation guidance. The revenue standard did not change the timing of revenue recognition but reclassified certain costs and balance-sheet items.
- The company issued $750.0 million of senior notes in March 2018 and used the proceeds, revolver borrowings and cash to repay $1.15 billion of notes due April 2, 2018. It also repaid $225.0 million of U.S. Term Loan A.
Guidance, outlook, commentary and risks
- Management forecast 2018 sales growth of 1.0% to 2.5%, including an estimated 1.0% to 1.5% benefit from foreign exchange. Volume and mix growth was expected to strengthen in the second half as supply constraints improved.
- Management expected higher 2018 product costs because of Warsaw North Campus production costs, with some effects continuing into 2019. R&D and SG&A were expected to rise as tax savings were reinvested, while integration costs were expected to decline.
- Quality remediation expense was expected to remain consistent in the second half. Estimated 2018 interest expense was approximately $300 million.
- Pending FDA warning letters and Form 483 observations at facilities in Ponce, Montreal and Warsaw could lead to operating restrictions, delayed approvals, penalties or other regulatory action. Quality remediation and supply constraints remain material operating risks.
- The company recorded a $20.0 million gain from reducing its estimate of Durom Cup claims. The remaining estimated Durom Cup liability was $119.4 million, including $48.9 million current and $70.5 million long term.
- Estimated remaining liability for Biomet metal-on-metal hip claims was $41.4 million. A Stryker patent matter could require an additional charge of up to $170.0 million, although the ultimate resolution was uncertain.
- Other material contingencies include Heraeus trade-secret litigation, the Polett litigation appeal, NexGen knee claims, a securities class action, FDA matters and an OIG subpoena concerning healthcare-professional consulting arrangements.
- The IRS has proposed profit-allocation adjustments for 2005–2012. Management disputed the adjustments; future tax payments could be significant. The estimated change in unrecognized tax benefits over the following twelve months ranged from a $115.0 million decrease to a $25.0 million increase.
- The 2017 Tax Act amounts remained provisional. The company had not finalized certain transition-tax, deferred-tax, GILTI and uncertain-tax-position matters.
- Management stated that operating cash flow and available revolver capacity were sufficient for working capital, capital expenditures, debt service, dividends and potential share repurchases.
Most important facts for investors to verify
- Whether Warsaw North Campus remediation and supply improvements deliver the expected second-half volume and mix growth without further quality, inventory or manufacturing charges.
- Progress toward the 2018 sales-growth guidance of 1.0% to 2.5% and the expected foreign-exchange contribution.
- Debt maturities, refinancing needs and the effect of floating-rate debt and currency movements on interest expense and cash flow.
- The ultimate cost and timing of Durom Cup, Biomet metal-on-metal, Stryker, Heraeus and other litigation matters.
- Resolution of FDA warning letters, Form 483 observations, the OIG subpoena and compliance obligations under the Deferred Prosecution Agreement.
- Finalization of the provisional 2017 Tax Act accounting and the outcome of IRS examinations and proposed adjustments.
- Whether operating cash flow remains sufficient after factoring activity, remediation spending, dividends, debt repayment and potential litigation payments.