Zimmer Biomet Holdings, Inc. — Q1 2020 Form 10-Q Summary
Business context and reporting period
Zimmer Biomet designs, manufactures and markets orthopedic reconstructive products, sports medicine, biologics, extremities and trauma products, spine, craniomaxillofacial and thoracic products, office-based technologies, dental implants and related surgical products. The filing covers the unaudited three months ended March 31, 2020, compared with the same period in 2019.
Results were materially affected by the COVID-19 pandemic, particularly the deferral of elective surgical and dental procedures. The company reorganized its operating segments into Americas and Global Businesses, EMEA and Asia Pacific.
Financial performance and key metrics
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net sales | $1,783.8 million | $1,975.5 million | Down 9.7% |
| Operating profit/(loss) | $(456.0) million | $350.2 million | Declined $806.2 million |
| Operating margin | (25.6)% | 17.7% | Down 43.3 percentage points |
| Net earnings/(loss) | $(509.1) million | $246.2 million | Declined $755.3 million |
| Net earnings/(loss) attributable to Zimmer Biomet | $(508.5) million | $246.1 million | Declined $754.6 million |
| Diluted EPS | $(2.46) | $1.20 | Declined $3.66 |
| Adjusted net earnings | $353.9 million | $384.2 million | Down 7.9% |
| Adjusted diluted EPS | $1.70 | $1.87 | Down 9.1% |
| Operating cash flow | $450.9 million | $283.6 million | Up $167.3 million |
Sales declines reflected volume and mix reductions of 6.6%, pricing pressure of 2.3% and unfavorable foreign exchange of 0.8%. Geography sales were $1,101.3 million in the Americas, $398.1 million in EMEA and $284.4 million in Asia Pacific. Product-category sales included knees of $629.8 million, hips of $432.6 million, S.E.T. of $333.6 million, Dental, Spine and CMFT of $251.7 million, and Other of $136.1 million.
The reported loss included a $612.0 million goodwill impairment charge, consisting of $470.0 million for EMEA and $142.0 million for Dental. Other significant Q1 charges included $45.0 million of restructuring and cost-reduction expenses, $79.8 million of litigation expense, $15.9 million of quality remediation expense, $11.0 million of EU Medical Device Regulation expense and $147.6 million of intangible-asset amortization.
Cash flow from operations benefited from a $612.0 million noncash goodwill impairment adjustment, a $289.7 million receivables-related working-capital benefit and proceeds from receivables factoring. Investing cash flow was $(121.2) million, including $85.7 million of instrument additions and $40.2 million of property, plant and equipment additions. Financing cash flow was $1,492.8 million, primarily reflecting $1,497.1 million of senior-note proceeds.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $2,433.6 million at March 31, 2020, compared with $617.9 million at December 31, 2019.
- Total debt was approximately $9.7 billion, including $1,950.0 million classified as current and $7,724.2 million classified as long-term debt.
- The company issued $600.0 million of 3.050% senior notes due 2026 and $900.0 million of 3.550% senior notes due 2030 on March 20, 2020. Together with cash on hand, proceeds were used to repay $1.5 billion of 2.700% notes due April 1, 2020.
- The company had no borrowings under its $1.5 billion revolving facility as of March 31, 2020 and reported compliance with its covenants.
- After quarter-end, on April 23, 2020, the company amended the 2019 credit agreement to provide temporary covenant flexibility and established a new unsecured $1.0 billion revolving facility maturing December 31, 2020.
- Management stated that operating cash flow, cash on hand and available revolving facilities should be sufficient for ongoing liquidity needs for at least the next twelve months, although borrowings may be needed in the near term.
Material changes versus the prior comparable period
- Sales decreased 9.7% as COVID-19 caused hospitals and healthcare systems to defer elective procedures, with the greatest pressure occurring late in the quarter.
- The company moved from profitability to a substantial GAAP operating and net loss, primarily because of goodwill impairment, lower sales, litigation charges and restructuring costs.
- Adjusted diluted EPS declined to $1.70 from $1.87, despite cost savings from restructuring, lower performance-related compensation and reduced discretionary spending.
- Litigation expense changed from a $1.8 million benefit in the segment reconciliation in Q1 2019 to a $79.8 million charge in Q1 2020.
- Operating cash flow increased primarily because Q1 2019 included an approximately $168 million patent-litigation payment; management expects COVID-19-related sales and collection pressure to reduce operating cash flow beginning in Q2.
- Goodwill declined to $8,951.2 million from $9,599.7 million, principally because of the $612.0 million impairment charge.
- Cash dividends of $0.24 per share were declared. The Board will reassess future dividends in light of expected cash-flow pressure.
Guidance, outlook, commentary and risks
The company withdrew its full-year 2020 financial guidance because the scope, duration and financial impact of COVID-19 could not be reasonably estimated. Management expected Q2 2020 to experience the most significant negative impact, followed by sequential improvement in Q3 and Q4, but emphasized that the recovery timing was uncertain.
Management implemented temporary compensation reductions, including the Chief Executive Officer forgoing 100% of salary, reduced discretionary spending, temporary production limitations at certain facilities and use of government wage-assistance and tax-relief programs. The 2019 Restructuring Plan is expected to generate total pre-tax charges of approximately $350 million to $400 million and gross annual pre-tax operating-expense reductions of approximately $200 million to $300 million by the end of 2023.
- COVID-19 may cause prolonged procedure deferrals, lower sales, negative operating cash flow, delayed collections, excess inventory, additional impairment charges and covenant or credit-rating pressure.
- Goodwill and intangible assets remain significant at approximately $9.0 billion and $7.1 billion, respectively. Additional impairment charges are possible if cash-flow estimates, discount rates or operating performance deteriorate.
- FDA warning letters and Form 483 observations concerning the Warsaw North Campus and Ponce facilities remained unresolved at March 31, 2020. Adverse regulatory action could restrict manufacturing, marketing or sales.
- Product-liability and other litigation remain material. Estimated remaining liabilities included $57.2 million for Durom Cup claims, $68.0 million for Metal Reaction claims and $76.9 million for Biomet metal-on-metal hip claims.
- Heraeus trade-secret litigation and related proceedings, including an ITC investigation, remained uncertain. An adverse outcome could materially affect the business, financial condition and results of operations.
- The IRS has proposed adjustments for tax years 2005–2012 involving profit allocation between U.S. and foreign subsidiaries. Management disputed the adjustments; future payments could materially affect operating cash flow.
- The company remains subject to risks involving supply-chain concentration, manufacturing interruptions, cybersecurity, foreign exchange, pricing pressure, healthcare reimbursement and compliance with its FCPA-related Deferred Prosecution Agreement.
Important facts for investors to verify
- Verify the pace of elective-procedure recovery after Q1 2020 and the actual effect on quarterly sales, margins and operating cash flow.
- Track liquidity after the April 1 repayment of the $1.5 billion notes, use of revolving facilities, covenant compliance and refinancing needs.
- Assess whether the EMEA, Dental and Americas CMFT reporting units require additional goodwill or long-lived-asset impairments.
- Monitor restructuring charges, workforce actions and whether the expected $200 million to $300 million annual cost reductions are achieved by 2023.
- Review the status and potential financial exposure of FDA remediation, product-liability claims, Heraeus proceedings and the disputed IRS tax matters.
- Confirm whether quarterly dividends continue at the $0.24-per-share level and whether the company reinstates or revises 2020 guidance.