Annual Statements Open main menu

ZIMMER BIOMET HOLDINGS, INC. - Quarter Report: 2018 September (Form 10-Q)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2018

Commission File Number 001-16407

 

ZIMMER BIOMET HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

 

Delaware

13-4151777

(State or other jurisdiction of

incorporation or organization)

(IRS Employer

Identification No.)

 

345 East Main Street, Warsaw, IN  46580

(Address of principal executive offices)

Telephone:  (574) 267-6131

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes      No  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).     Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

 

Accelerated filer

 

 

 

 

 

Non-accelerated filer

Smaller reporting company

 

 

 

 

Emerging growth company

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.     

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes      No  

As of October 25, 2018, 203,976,311 shares of the registrant’s $.01 par value common stock were outstanding.

 

 


ZIMMER BIOMET HOLDINGS, INC.

INDEX TO FORM 10-Q

September 30, 2018

 

 

 

 

 

Page

 

 

 

Part I - Financial Information

 

 

 

 

 

 

 

Item 1.

 

Financial Statements (unaudited)

 

3

 

 

Condensed Consolidated Statements of Earnings for the Three and Nine Months Ended September 30, 2018 and 2017

 

3

 

 

Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2018 and 2017

 

4

 

 

Condensed Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017

 

5

 

 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2018 and 2017

 

6

 

 

Notes to Interim Condensed Consolidated Financial Statements

 

7

 

 

 

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

29

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

40

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

40

 

 

 

Part II - Other Information

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

42

 

 

 

 

 

Item 1A.

 

Risk Factors

 

42

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

42

 

 

 

 

 

Item 3.

 

Defaults Upon Senior Securities

 

42

 

 

 

 

 

Item 4.

 

Mine Safety Disclosures

 

43

 

 

 

 

 

Item 5.

 

Other Information

 

43

 

 

 

 

 

Item 6.

 

Exhibits

 

44

 

 

 

Signatures

 

45

 

2


Part I – Financial Information

Item 1.  Financial  Statements

ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(in millions, except per share amounts, unaudited)

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Net Sales

 

$

1,836.7

 

 

$

1,813.1

 

 

$

5,861.9

 

 

$

5,735.0

 

Cost of products sold, excluding intangible asset amortization

 

 

529.0

 

 

 

500.9

 

 

 

1,688.5

 

 

 

1,541.5

 

Intangible asset amortization

 

 

147.6

 

 

 

152.7

 

 

 

447.9

 

 

 

452.4

 

Research and development

 

 

95.7

 

 

 

91.2

 

 

 

290.5

 

 

 

274.9

 

Selling, general and administrative

 

 

787.7

 

 

 

711.7

 

 

 

2,380.7

 

 

 

2,239.6

 

Goodwill and intangible asset impairment

 

 

3.8

 

 

 

32.7

 

 

 

3.8

 

 

 

59.5

 

Acquisition, integration and related

 

 

17.4

 

 

 

61.6

 

 

 

113.9

 

 

 

192.3

 

Quality remediation

 

 

32.2

 

 

 

51.1

 

 

 

112.3

 

 

 

135.4

 

Operating expenses

 

 

1,613.4

 

 

 

1,601.9

 

 

 

5,037.6

 

 

 

4,895.6

 

Operating Profit

 

 

223.3

 

 

 

211.2

 

 

 

824.3

 

 

 

839.4

 

Other expense, net

 

 

(2.2

)

 

 

(2.3

)

 

 

(8.7

)

 

 

(4.5

)

Interest income

 

 

0.8

 

 

 

0.6

 

 

 

2.3

 

 

 

1.4

 

Interest expense

 

 

(68.3

)

 

 

(82.3

)

 

 

(223.1

)

 

 

(247.5

)

Earnings before income taxes

 

 

153.6

 

 

 

127.2

 

 

 

594.8

 

 

 

588.8

 

(Benefit) provision for income taxes

 

 

(8.5

)

 

 

28.4

 

 

 

71.6

 

 

 

6.6

 

Net Earnings

 

 

162.1

 

 

 

98.8

 

 

 

523.2

 

 

 

582.2

 

Less: Net (loss) earnings attributable to noncontrolling interest

 

 

(0.1

)

 

 

-

 

 

 

1.3

 

 

 

(0.2

)

Net Earnings of Zimmer Biomet Holdings, Inc.

 

$

162.2

 

 

$

98.8

 

 

$

521.9

 

 

$

582.4

 

Earnings Per Common Share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.80

 

 

$

0.49

 

 

$

2.57

 

 

$

2.89

 

Diluted

 

$

0.79

 

 

$

0.48

 

 

$

2.55

 

 

$

2.86

 

Weighted Average Common Shares Outstanding

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

203.7

 

 

 

202.3

 

 

 

203.3

 

 

 

201.7

 

Diluted

 

 

205.4

 

 

 

204.0

 

 

 

204.9

 

 

 

203.6

 

Cash Dividends Declared Per Common Share

 

$

0.24

 

 

$

0.24

 

 

$

0.72

 

 

$

0.72

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3


ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in millions, unaudited)

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Net Earnings

 

$

162.1

 

 

$

98.8

 

 

$

523.2

 

 

$

582.2

 

Other Comprehensive Income (Loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency cumulative translation adjustments, net of tax

 

 

(44.0

)

 

 

129.7

 

 

 

(127.0

)

 

 

367.9

 

Unrealized cash flow hedge gains (losses), net of tax

 

 

32.8

 

 

 

(28.3

)

 

 

58.0

 

 

 

(79.4

)

Reclassification adjustments on hedges, net of tax

 

 

4.1

 

 

 

4.1

 

 

 

23.0

 

 

 

(9.4

)

Adjustments to prior service cost and unrecognized actuarial

   assumptions, net of tax

 

 

2.0

 

 

 

(1.0

)

 

 

4.0

 

 

 

(5.0

)

Total Other Comprehensive Income (Loss)

 

 

(5.1

)

 

 

104.5

 

 

 

(42.0

)

 

 

274.1

 

Comprehensive Income

 

 

157.0

 

 

 

203.3

 

 

 

481.2

 

 

 

856.3

 

Comprehensive income (loss) attributable to the noncontrolling interest

 

 

(0.1

)

 

 

(0.2

)

 

 

1.3

 

 

 

(0.6

)

Comprehensive Income Attributable to

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Zimmer Biomet Holdings, Inc.

 

$

157.1

 

 

$

203.5

 

 

$

479.9

 

 

$

856.9

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

4


ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in millions, unaudited)

 

 

 

September 30,

 

 

December 31,

 

 

 

2018

 

 

2017

 

ASSETS

 

 

 

 

 

 

 

 

Current Assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

524.6

 

 

$

524.4

 

Accounts receivable, less allowance for doubtful accounts

 

 

1,262.7

 

 

 

1,544.1

 

Inventories

 

 

2,219.5

 

 

 

2,068.3

 

Prepaid expenses and other current assets

 

 

506.5

 

 

 

428.0

 

Total Current Assets

 

 

4,513.3

 

 

 

4,564.8

 

Property, plant and equipment, net

 

 

2,002.4

 

 

 

2,038.6

 

Goodwill

 

 

10,583.6

 

 

 

10,668.4

 

Intangible assets, net

 

 

7,837.4

 

 

 

8,353.4

 

Other assets

 

 

445.3

 

 

 

388.8

 

Total Assets

 

$

25,382.0

 

 

$

26,014.0

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

345.8

 

 

$

330.2

 

Income taxes payable

 

 

196.2

 

 

 

165.2

 

Other current liabilities

 

 

1,249.2

 

 

 

1,349.3

 

Current portion of long-term debt

 

 

600.0

 

 

 

1,225.0

 

Total Current Liabilities

 

 

2,391.2

 

 

 

3,069.7

 

Deferred income taxes

 

 

1,054.0

 

 

 

1,101.5

 

Long-term income tax payable

 

 

782.0

 

 

 

744.0

 

Other long-term liabilities

 

 

334.4

 

 

 

445.8

 

Long-term debt

 

 

8,597.4

 

 

 

8,917.5

 

Total Liabilities

 

 

13,159.0

 

 

 

14,278.5

 

Commitments and Contingencies (Note 15)

 

 

 

 

 

 

 

 

Stockholders' Equity:

 

 

 

 

 

 

 

 

Zimmer Biomet Holdings, Inc. Stockholders' Equity:

 

 

 

 

 

 

 

 

Common stock, $0.01 par value, one billion shares authorized, 307.8 million

   shares issued in 2018 (306.5 million in 2017)

 

 

3.1

 

 

 

3.1

 

Paid-in capital

 

 

8,662.3

 

 

 

8,514.9

 

Retained earnings

 

 

10,441.2

 

 

 

10,022.8

 

Accumulated other comprehensive loss

 

 

(168.1

)

 

 

(83.2

)

Treasury stock, 103.8 million shares in 2018 (103.9 million shares in 2017)

 

 

(6,721.7

)

 

 

(6,721.8

)

Total Zimmer Biomet Holdings, Inc. stockholders' equity

 

 

12,216.8

 

 

 

11,735.8

 

Noncontrolling interest

 

 

6.2

 

 

 

(0.3

)

Total Stockholders' Equity

 

 

12,223.0

 

 

 

11,735.5

 

Total Liabilities and Stockholders' Equity

 

$

25,382.0

 

 

$

26,014.0

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5


ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions, unaudited)

 

 

 

 

 

 

 

For the Nine Months Ended September 30,

 

 

 

2018

 

 

2017

 

Cash flows provided by (used in) operating activities:

 

 

 

 

 

 

 

 

Net earnings

 

$

523.2

 

 

$

582.2

 

Adjustments to reconcile net earnings to cash provided

   by operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

785.7

 

 

 

798.2

 

Share-based compensation

 

 

45.3

 

 

 

40.1

 

Goodwill and intangible asset impairment

 

 

3.8

 

 

 

59.5

 

Inventory step-up

 

 

-

 

 

 

32.2

 

Changes in operating assets and liabilities, net of effect of acquisitions:

 

 

 

 

 

 

 

 

Income taxes

 

 

(58.3

)

 

 

(245.4

)

Receivables

 

 

237.4

 

 

 

346.7

 

Inventories

 

 

(165.2

)

 

 

(123.9

)

Accounts payable and accrued expenses

 

 

23.6

 

 

 

(170.6

)

Other assets and liabilities

 

 

(27.6

)

 

 

(139.6

)

Net cash provided by operating activities

 

 

1,367.9

 

 

 

1,179.4

 

Cash flows used in investing activities:

 

 

 

 

 

 

 

 

Additions to instruments

 

 

(203.7

)

 

 

(255.7

)

Additions to other property, plant and equipment

 

 

(115.2

)

 

 

(109.8

)

Other business combination investments, net of acquired cash

 

 

-

 

 

 

(4.0

)

Other investing activities

 

 

(15.3

)

 

 

(13.1

)

Net cash used in investing activities

 

 

(334.2

)

 

 

(382.6

)

Cash flows provided by (used in) financing activities:

 

 

 

 

 

 

 

 

Proceeds from senior notes

 

 

749.5

 

 

 

-

 

Proceeds from multicurrency revolving facility

 

 

400.0

 

 

 

400.0

 

Payments on multicurrency revolving facility

 

 

(400.0

)

 

 

(400.0

)

Redemption of senior notes

 

 

(1,150.0

)

 

 

(500.0

)

Proceeds from term loan

 

 

-

 

 

 

192.7

 

Payments on term loan

 

 

(500.0

)

 

 

(640.0

)

Net payments on other debt

 

 

(3.9

)

 

 

(0.9

)

Dividends paid to stockholders

 

 

(146.2

)

 

 

(145.0

)

Proceeds from employee stock compensation plans

 

 

103.4

 

 

 

132.6

 

Net cash flows from unremitted collections from factoring programs

 

 

(54.6

)

 

 

-

 

Business combination contingent consideration payments

 

 

(16.7

)

 

 

(9.1

)

Restricted stock withholdings

 

 

(3.3

)

 

 

(7.6

)

Debt issuance costs

 

 

(4.9

)

 

 

(0.3

)

Net cash used in financing activities

 

 

(1,026.7

)

 

 

(977.6

)

Effect of exchange rates on cash and cash equivalents

 

 

(6.8

)

 

 

27.5

 

Increase (decrease) in cash and cash equivalents

 

 

0.2

 

 

 

(153.3

)

Cash and cash equivalents, beginning of year

 

 

524.4

 

 

 

634.1

 

Cash and cash equivalents, end of period

 

$

524.6

 

 

$

480.8

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

6


ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.  Basis of Presentation

The financial data presented herein is unaudited and should be read in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2017.

In our opinion, the accompanying unaudited condensed consolidated financial statements include all adjustments necessary for a fair statement of the financial position, results of operations and cash flows for the interim periods presented.  The December 31, 2017 condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“GAAP”).  Results for interim periods should not be considered indicative of results for the full year.

We have reclassified expenses that were previously recognized in a financial statement line item labeled “Acquisition, quality remediation and other” (and prior to that, labeled “Special items”) to the financial statement line items of “Research and development,” “Selling, general and administrative,” “Goodwill and intangible asset impairment,” “Acquisition, integration and related,” and “Quality remediation”.  Prior periods have been reclassified to conform to the current year presentation.  Please refer to Note 2 for additional details on the reclassified items.  We made this change to provide additional transparency and better reflect the nature of these expenses.

The words “we,” “us,” “our” and similar words and “Zimmer Biomet” refer to Zimmer Biomet Holdings, Inc. and its subsidiaries.  “Zimmer Biomet Holdings” refers to the parent company only.

2.  Significant Accounting Policies  

We use the financial statement line item “Acquisition, integration and related” to recognize expenses resulting from the consummation of business mergers and acquisitions and the related integration of those businesses.  In 2015, we completed our merger with LVB Acquisition, Inc. (“LVB”), the parent company of Biomet, Inc. (“Biomet”) (which merger is sometimes referred to herein as the “Biomet merger”).  In 2016, we acquired LDR Holding Corporation and other individually immaterial companies.  Acquisition, integration and related expenses are primarily composed of:

 

Consulting and professional fees related to third-party integration consulting performed in a variety of areas, such as tax, compliance, logistics and human resources, and legal fees related to the consummation of mergers and acquisitions.  

 

Employee termination benefits in various areas of our business.  

 

Dedicated project personnel expenses which include the salary, benefits, travel expenses and other costs directly associated with employees who are 100 percent dedicated to our integration of acquired businesses and employees who have been notified of termination.  

 

Contract termination expenses related to terminated contracts, primarily with sales agents and distribution agreements.  

 

Other various expenses to relocate facilities, integrate information technology, losses incurred on assets resulting from the applicable acquisition, and other various expenses.

We use the financial statement line item “Quality remediation” to recognize expenses related to addressing inspectional observations on Form 483 and a warning letter issued by the U.S. Food and Drug Administration (“FDA”) following its inspections of our Warsaw North Campus facility, among other matters.  See Note 15 for additional information about the Form 483 and warning letter.  The majority of these expenses are related to consultants who are helping us to update previous documents and redesign certain processes.

Accounting Pronouncements Recently Adopted

In August 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2017-12 – Targeted Improvements to Accounting for Hedging Activities.  This ASU amends the hedge accounting guidance to simplify the application of hedge accounting, makes more financial and nonfinancial hedging strategies eligible for hedge accounting treatment, changes how companies assess effectiveness and updates presentation and disclosure requirements.  We early adopted this ASU in the first quarter of 2018.  Based upon our hedging portfolio that existed prior to adoption, the adoption of this ASU did not have any impact on our financial position, results of operations or cash flows.  However, after adoption we entered into cross-currency interest rate swaps that we designated as net investment hedges.  Under this ASU, we have made a policy election for changes in the fair value of the cross-currency component of the cross-currency interest rate swaps to be recorded in accumulated other comprehensive income.  Therefore, all changes in the fair value of the cross-currency interest rate swaps are recorded as a component of accumulated other

7


comprehensive loss in the condensed consolidated balance sheet.  The portion of this change related to the excluded component will be amortized into earnings over the life of the derivative while the remainder will be recorded in accumulated other comprehensive loss until the hedged net investment is sold or substantially liquidated.  Under previous guidance, the fair value change related to the cross-currency component was recognized in earnings.  See Note 10 for additional information.    

In February 2018, the FASB issued ASU 2018-02 – Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.  Under GAAP, when there is a change in tax rates, it requires remeasurement of deferred tax assets and liabilities to be recognized as part of income, even if the deferred tax asset or liability had been recorded and recognized in Accumulated Other Comprehensive Income (Loss) (“AOCI”).  As a result, a portion of the amount recognized in AOCI at the previous tax rate would remain stranded in AOCI permanently.  ASU 2018-02 allows the stranded tax effects in AOCI related only to the Tax Cuts and Jobs Act of 2017 (“2017 Tax Act”) to be reclassified from AOCI to retained earnings.  The only stranded tax effects in AOCI we had related to the 2017 Tax Act were due to changes in the U.S. federal corporate income tax rate.  We early adopted this ASU in the first quarter of 2018 and elected to use the beginning of period transition method, which means we recognized the reclassification as of January 1, 2018.  As a result, we reclassified $42.9 million from AOCI to retained earnings.  

In March 2017, the FASB issued ASU 2017-07Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.  This ASU requires us to report the service cost component of pensions in the same location as other compensation costs arising from services rendered by the pertinent employees during the period. We are required to report the other components of net benefit costs in other income (expense) in the statements of earnings.  This ASU was effective for us as of January 1, 2018.  This ASU must be applied retrospectively for the presentation of the service cost component and the other components of net periodic pension cost in the statements of earnings and prospectively, on and after the effective date, for the capitalization of the service cost component of net periodic pension cost in assets.  This ASU provides a practical expedient that allows companies to use the amounts disclosed in prior financial statements as the basis for the retrospective application.  We elected to use this practical expedient.  The impacts of this ASU on our condensed consolidated financial statements for the three and nine month periods ended September 30, 2017 are included in the tables below.  See Note 12 for further information on the components of our net benefit cost.

In May 2014, the FASB issued ASU 2014-09 – Revenue from Contracts with Customers (Topic 606).  This ASU provides a five-step model for revenue recognition that all industries will apply to recognize revenue when a customer obtains control of a good or service.  This ASU was effective for us as of January 1, 2018.  Entities were permitted to apply the standard and related amendments either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the ASU recognized at the date of initial application.  We adopted this new standard using the retrospective method, which resulted in us restating prior reporting periods presented.  This ASU did not result in a change to the timing of our revenue recognition.  However, we were required to reclassify certain immaterial costs from selling, general and administrative (“SG&A”) expense to net sales, which resulted in a reduction of net sales, but had no impact on operating profit or retained earnings.  This ASU also required us to reclassify our estimated refund liability for products expected to be returned from a reduction of accounts receivable to other current liabilities and the related right to receive products from the return from inventories to prepaid expenses and other current assets.  The impacts of this ASU on our condensed consolidated financial statements for the three and nine month periods ended September 30, 2017 and as of December 31, 2017 are included in the tables below.

 

 

 

 

 

 

New

 

 

New

 

 

 

 

 

 

 

 

 

 

As

 

 

Revenue

 

 

Pension

 

 

 

 

 

 

 

 

 

 

Previously

 

 

Standard

 

 

Standard

 

 

 

 

 

 

As

 

(in millions)

Reported

 

 

Adjustment

 

 

Adjustment

 

 

Reclassifications

 

 

Restated

 

Statement of Earnings

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Sales

$

1,818.1

 

 

$

(5.0

)

 

$

-

 

 

$

-

 

 

$

1,813.1

 

Selling, general and administrative

 

694.5

 

 

 

(5.0

)

 

 

2.2

 

 

 

20.0

 

 

 

711.7

 

Goodwill and intangible asset impairment

 

-

 

 

 

-

 

 

 

-

 

 

 

32.7

 

 

 

32.7

 

Acquisition, integration and related

 

-

 

 

 

-

 

 

 

-

 

 

 

61.6

 

 

 

61.6

 

Quality remediation

 

-

 

 

 

-

 

 

 

-

 

 

 

51.1

 

 

 

51.1

 

Special items

 

165.4

 

 

 

-

 

 

 

-

 

 

 

(165.4

)

 

 

-

 

Operating expenses

 

1,604.7

 

 

 

(5.0

)

 

 

2.2

 

 

 

-

 

 

 

1,601.9

 

Operating Profit

 

213.4

 

 

 

-

 

 

 

(2.2

)

 

 

-

 

 

 

211.2

 

Other expense, net

 

(4.5

)

 

 

-

 

 

 

2.2

 

 

 

-

 

 

 

(2.3

)

8


 

 

 

 

 

 

 

New

 

 

New

 

 

 

 

 

 

 

 

 

 

As

 

 

Revenue

 

 

Pension

 

 

 

 

 

 

 

 

 

 

Previously

 

 

Standard

 

 

Standard

 

 

 

 

 

 

As

 

(in millions)

Reported

 

 

Adjustment

 

 

Adjustment

 

 

Reclassifications

 

 

Restated

 

Statement of Earnings

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Sales

$

5,749.8

 

 

$

(14.8

)

 

$

-

 

 

$

-

 

 

$

5,735.0

 

Research and development

 

272.4

 

 

 

-

 

 

 

-

 

 

 

2.5

 

 

 

274.9

 

Selling, general and administrative

 

2,203.3

 

 

 

(14.8

)

 

 

6.7

 

 

 

44.4

 

 

 

2,239.6

 

Goodwill and intangible asset impairment

 

-

 

 

 

-

 

 

 

-

 

 

 

59.5

 

 

 

59.5

 

Acquisition, integration and related

 

-

 

 

 

-

 

 

 

-

 

 

 

192.3

 

 

 

192.3

 

Quality remediation

 

-

 

 

 

-

 

 

 

-

 

 

 

135.4

 

 

 

135.4

 

Special items

 

434.1

 

 

 

-

 

 

 

-

 

 

 

(434.1

)

 

 

-

 

Operating expenses

 

4,903.7

 

 

 

(14.8

)

 

 

6.7

 

 

 

-

 

 

 

4,895.6

 

Operating Profit

 

846.1

 

 

 

-

 

 

 

(6.7

)

 

 

-

 

 

 

839.4

 

Other expense, net

 

(11.2

)

 

 

-

 

 

 

6.7

 

 

 

-

 

 

 

(4.5

)

 

 

 

 

 

 

New

 

 

 

 

 

 

As

 

 

Revenue

 

 

 

 

 

 

Previously

 

 

Standard

 

 

As

 

(in millions)

Reported

 

 

Adjustment

 

 

Restated

 

Balance Sheet

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts receivable, less allowance for doubtful accounts

$

1,494.6

 

 

$

49.5

 

 

$

1,544.1

 

Inventories

 

2,081.8

 

 

 

(13.5

)

 

 

2,068.3

 

Prepaid expenses and other current assets

 

414.5

 

 

 

13.5

 

 

 

428.0

 

Other current liabilities

 

1,299.8

 

 

 

49.5

 

 

 

1,349.3

 

Accounting Pronouncements Not Yet Adopted

In February 2016, the FASB issued ASU 2016-02 – Leases.  This ASU requires lessees to recognize right-of-use assets and lease liabilities on the balance sheet. This ASU will be effective for us beginning January 1, 2019.  We own most of our manufacturing facilities, but lease various office space, vehicles and other less significant assets throughout the world.  We have collected all of our lease agreements from across the organization that were entered into prior to 2018.  We substantially completed our analysis of the key terms of these lease agreements to determine the appropriate accounting treatment.  We are also nearing completion of our methodology to determine discount rates as well as our implementation of software that will be utilized to account for this ASU.  We will continue evaluating our leases, including the collection and analysis of leases entered into during 2018, and the related impact this ASU will have on our consolidated financial statements through the remainder of 2018.

There are no other recently issued accounting pronouncements that we have not yet adopted that are expected to have a material effect on our financial position, results of operations or cash flows.

3.  Revenue Recognition

We recognize revenue when our performance obligations under the terms of a contract with our customer are satisfied.  This happens when we transfer control of our products to the customer, which generally occurs upon implantation or when title passes upon shipment.  Revenue is measured as the amount of consideration we expect to receive in exchange for transferring our product.  Taxes collected from customers and remitted to governmental authorities are excluded from revenues.

We sell product through three principal channels: 1) direct to healthcare institutions, referred to as direct channel accounts; 2) through stocking distributors and healthcare dealers; and 3) directly to dental practices and dental laboratories.  The direct channel

9


accounts represented approximately 80 percent of our net sales in 2017.  Through this channel, inventory is generally consigned to sales agents or customers so that products are available when needed for surgical procedures.  No revenue is recognized upon the placement of inventory into consignment, as we retain the ability to control the inventory.  Upon implantation, we issue an invoice and revenue is recognized.  Pricing for products is generally predetermined by contracts with customers, agents acting on behalf of customer groups or by government regulatory bodies, depending on the market.  Price discounts under group purchasing contracts are generally linked to volume of implant purchases by customer healthcare institutions within a specified group.  At negotiated thresholds within a contract buying period, price discounts may increase.  Payment terms vary by customer, but are typically less than 90 days.  

Sales to stocking distributors, healthcare dealers, dental practices and dental laboratories accounted for approximately 20 percent of our net sales in 2017.  With these types of sales, revenue is recognized when control of our product passes to the customer, either upon shipment of the product or in some cases upon implantation of the product.  It is our accounting policy to account for shipping and handling activities as a fulfillment cost rather than as an additional promised service.  We have contracts with these customers or orders may be placed from available price lists.  Payment terms vary by customer, but are typically less than 90 days.  

We offer standard warranties to our customers that our products are not defective.  These standard warranties are not considered separate performance obligations.  In limited circumstances, we offer extended warranties that are separate performance obligations.  We have very few contracts that have multiple performance obligations.  Since we do not have significant multiple element arrangements and essentially all of our sales are recognized upon implantation of a product or when title passes, very little judgment is required to allocate the transaction price of a contract or determine when control has passed to a customer.  Our costs to obtain contracts consist primarily of sales commissions to employees or third party agents that are earned when control of our product passes to the customer.  Therefore, sales commissions are expensed as part of selling, general and administrative expenses at the same time revenue is recognized.  Accordingly, we do not have significant contract assets, liabilities or future performance obligations.  

We offer variable consideration through volume-based discounts, rebates, prompt pay discounts, right of return and other various incentives.  If sales incentives may be earned by a customer for purchasing a specified amount of our product, we estimate whether such incentives will be achieved and recognize these incentives as a reduction in revenue in the same period the underlying revenue transaction is recognized.  We primarily use the expected value method to estimate incentives.  Under the expected value method, we consider the historical experience of similar programs as well as review sales trends on a customer-by-customer basis to estimate what levels of incentives will be earned.  Occasionally, products are returned and, accordingly, we maintain an estimated refund liability based upon the expected value method that is recorded as a reduction in revenue.  

We analyze sales by three geographies, the Americas, Europe, Middle East and Africa (“EMEA”) and Asia Pacific, and by the following product categories: Knees; Hips; Surgical, Sports Medicine, Foot and Ankle, Extremities and Trauma (“S.E.T.”); Dental; Spine & Craniomaxillofacial and Thoracic products (“CMF”) and Other.  As discussed in Note 14, we have seven operating segments that are based upon geography and product categories.  The geographic segments include sales of all product categories exclusive of the specific product category operating segments.  The geographic operating segments are the Americas, EMEA and Asia Pacific.  These three operating segments are our reporting segments.  The product category operating segments are Spine, less Asia Pacific; Office Based Technologies; CMF and Dental.  The product operating segments do not constitute a reporting segment because they are, individually and on a combined basis, insignificant to our consolidated results.  

 

Our sales analysis differs from our reporting operating segments because the underlying market trends in any particular geography tend to be similar across product categories, we primarily sell the same products in all geographies and the product category operating segments are not individually significant to our consolidated results.

Net sales by geography are as follows (in millions):

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Americas

 

$

1,153.6

 

 

$

1,137.0

 

 

$

3,578.0

 

 

$

3,570.8

 

EMEA

 

 

372.1

 

 

 

381.1

 

 

 

1,326.3

 

 

 

1,272.5

 

Asia Pacific

 

 

311.0

 

 

 

295.0

 

 

 

957.6

 

 

 

891.7

 

Total

 

$

1,836.7

 

 

$

1,813.1

 

 

$

5,861.9

 

 

$

5,735.0

 

Net sales by product category are as follows (in millions):

10


 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Knees

 

$

627.9

 

 

$

622.9

 

 

$

2,044.2

 

 

$

2,003.7

 

Hips

 

 

444.8

 

 

 

432.8

 

 

 

1,423.7

 

 

 

1,374.6

 

S.E.T.

 

 

414.6

 

 

 

404.8

 

 

 

1,290.7

 

 

 

1,249.4

 

Dental

 

 

92.3

 

 

 

92.9

 

 

 

306.8

 

 

 

311.1

 

Spine & CMF

 

 

184.9

 

 

 

184.5

 

 

 

566.2

 

 

 

564.1

 

Other

 

 

72.2

 

 

 

75.2

 

 

 

230.3

 

 

 

232.1

 

Total

 

$

1,836.7

 

 

$

1,813.1

 

 

$

5,861.9

 

 

$

5,735.0

 

 

  

4.  Inventories

 

 

 

September 30,

 

 

December 31,

 

 

 

2018

 

 

2017

 

 

 

(in millions)

 

Finished goods

 

$

1,784.7

 

 

$

1,618.7

 

Work in progress

 

 

231.7

 

 

 

200.0

 

Raw materials

 

 

203.1

 

 

 

249.6

 

Inventories

 

$

2,219.5

 

 

$

2,068.3

 

 

5.  Property, Plant and Equipment

 

 

 

September 30,

 

 

December 31,

 

 

 

2018

 

 

2017

 

 

 

(in millions)

 

Land

 

$

28.6

 

 

$

29.0

 

Buildings and equipment

 

 

1,906.4

 

 

 

1,838.5

 

Capitalized software costs

 

 

422.7

 

 

 

421.6

 

Instruments

 

 

2,892.8

 

 

 

2,683.9

 

Construction in progress

 

 

126.6

 

 

 

110.7

 

 

 

 

5,377.1

 

 

 

5,083.7

 

Accumulated depreciation

 

 

(3,374.7

)

 

 

(3,045.1

)

Property, plant and equipment, net

 

$

2,002.4

 

 

$

2,038.6

 

 

 

6.  Transfers of Financial Assets

In the fourth quarter of 2016, we executed receivables purchase arrangements with unrelated third parties to liquidate portions of our trade accounts receivable balance.  The receivables relate to products sold to customers and are short-term in nature.  The factorings were treated as sales of our accounts receivable.  Proceeds from the transfers reflect either the face value of the accounts receivable or the face value less factoring fees.  

In the U.S. and Japan, our programs are executed on a revolving basis with a maximum funding limit as of September 30, 2018 of $400 million combined.  We act as the collection agent on behalf of the third party, but have no significant retained interests or servicing liabilities related to the accounts receivable sold.  In order to mitigate credit risk, we purchased credit insurance for the factored accounts receivable.  As a result, our risk of loss is limited to the factored accounts receivable not covered by the insurance.  Additionally, we have provided guarantees for the factored accounts receivable.  The maximum exposures to loss associated with these arrangements were $31.0 million and $22.9 million as of September 30, 2018 and December 31, 2017, respectively.

In Europe, we sell to a third party and have no continuing involvement or significant risk with the factored accounts receivable.

11


Funds received from the transfers are recorded as an increase to cash and a reduction to accounts receivable outstanding in the condensed consolidated balance sheets.  We report the cash flows attributable to the sale of receivables to third parties in cash flows from operating activities in our condensed consolidated statements of cash flows.  Net expenses resulting from the sales of receivables are recognized in selling, general and administrative expense.  Net expenses include any resulting gains or losses from the sales of receivables, credit insurance and factoring fees.

In the nine month periods ended September 30, 2018 and 2017, we sold receivables having an aggregate face value of $1,942.8 million and $1,050.5 million to third parties in exchange for cash proceeds of $1,942.1 million and $1,049.8 million, respectively.  Expenses recognized on these sales during the nine month periods ended September 30, 2018 and 2017 were not significant.  In the nine month periods ended September 30, 2018 and 2017, under the U.S. and Japan programs, we collected $1,613.1 million and $682.2 million, respectively, from our customers and remitted that amount to the third party, and we effectively repurchased $166.7 million and $58.9 million, respectively, of previously sold accounts receivable from the third party, due to the programs’ revolving nature.  As of September 30, 2018 and December 31, 2017, we had collected $48.9 million and $103.5 million, respectively, of funds that were unremitted to the third party, which are reflected in our condensed consolidated balance sheets under other current liabilities.  The initial collection of cash from customers and its remittance to the third party is reflected in net cash provided by/(used in) financing activities in our condensed consolidated statements of cash flows.  We estimate the incremental operating cash inflows related to all of our receivables purchase programs were approximately $25 million in the nine month period ended September 30, 2018.

At September 30, 2018 and December 31, 2017, the outstanding principal amount of receivables that has been derecognized under the U.S. and Japan revolving arrangements amounted to $341.8 million and $261.2 million, respectively.

7.  Debt

Our debt consisted of the following (in millions):

 

 

 

September 30,

 

 

December 31,

 

 

 

2018

 

 

2017

 

Current portion of long-term debt

 

 

 

 

 

 

 

 

2.000% Senior Notes due 2018

 

$

-

 

 

$

1,150.0

 

U.S. Term Loan B

 

 

600.0

 

 

 

75.0

 

Total current portion of long-term debt

 

$

600.0

 

 

$

1,225.0

 

Long-term debt

 

 

 

 

 

 

 

 

4.625% Senior Notes due 2019

 

$

500.0

 

 

$

500.0

 

2.700% Senior Notes due 2020

 

 

1,500.0

 

 

 

1,500.0

 

Floating Rate Notes due 2021

 

 

450.0

 

 

-

 

3.375% Senior Notes due 2021

 

 

300.0

 

 

 

300.0

 

3.150% Senior Notes due 2022

 

 

750.0

 

 

 

750.0

 

3.700% Senior Notes due 2023

 

 

300.0

 

 

-

 

3.550% Senior Notes due 2025

 

 

2,000.0

 

 

 

2,000.0

 

4.250% Senior Notes due 2035

 

 

253.4

 

 

 

253.4

 

5.750% Senior Notes due 2039

 

 

317.8

 

 

 

317.8

 

4.450% Senior Notes due 2045

 

 

395.4

 

 

 

395.4

 

1.414% Euro Notes due 2022

 

 

580.8

 

 

 

600.4

 

2.425% Euro Notes due 2026

 

 

580.8

 

 

 

600.4

 

U.S. Term Loan A

 

 

410.0

 

 

 

835.0

 

U.S. Term Loan B

 

 

-

 

 

 

600.0

 

Japan Term Loan A

 

 

103.5

 

 

 

103.2

 

Japan Term Loan B

 

 

188.4

 

 

 

187.9

 

Other long-term debt

 

 

-

 

 

 

4.1

 

Debt discount and issuance costs

 

 

(49.4

)

 

 

(53.2

)

Adjustment related to interest rate swaps

 

 

16.7

 

 

 

23.1

 

Total long-term debt

 

$

8,597.4

 

 

$

8,917.5

 

 

At September 30, 2018, our total debt balance consisted of $7.9 billion aggregate principal amount of our senior notes, which included $1.2 billion of Euro-denominated senior notes (“Euro Notes”), $410.0 million outstanding under a U.S. term loan (“U.S. Term Loan A”) that will mature on June 24, 2020, $600.0 million outstanding under a U.S. term loan (“U.S. Term Loan B”) that will

12


mature on September 30, 2019, an 11.7 billion Japanese Yen term loan agreement (“Japan Term Loan A”) and a 21.3 billion Japanese Yen term loan agreement (“Japan Term Loan B”) that will each mature on September 27, 2022, and fair value adjustments totaling $16.7 million, partially offset by debt discount and issuance costs of $49.4 million.

On March 19, 2018, we completed the offering of $450.0 million aggregate principal amount of our floating rate senior notes due March 19, 2021 and $300.0 million aggregate principal amount of our 3.700% senior notes due March 19, 2023.  Interest on the floating rate senior notes is equal to three-month LIBOR plus 0.750% and is payable quarterly, commencing on June 19, 2018, until maturity.  Interest is payable on the 3.700% senior notes semi-annually, commencing on September 19, 2018, until maturity.  We received net proceeds of $749.5 million from this offering.  On April 2, 2018, these proceeds, together with borrowings under the Multicurrency Revolving Facility (as defined below) and cash on hand, were used to repay the 2.000% Senior Notes due 2018.

On September 22, 2017, we entered into a term loan agreement for the Japan Term Loan B, and an amended and restated term loan agreement, which amended and restated the Japan Term Loan A loan agreement dated as of May 24, 2012, as amended as of October 31, 2014. As described above, the term loans under both of these agreements will mature on September 27, 2022. Each of these term loans bears interest at a fixed rate of 0.635% per annum.

We have a revolving credit and term loan agreement (the “2016 Credit Agreement”) and a first amendment to our credit agreement executed in 2014 (the “2014 Credit Agreement”).  The 2016 Credit Agreement contains the U.S. Term Loan B and a five-year unsecured multicurrency revolving facility of $1.5 billion (the “Multicurrency Revolving Facility”).  The Multicurrency Revolving Facility replaced the previous multicurrency revolving facility under the 2014 Credit Agreement and will mature on September 30, 2021, with two available one-year extensions at our discretion.  The 2014 Credit Agreement also provided for the U.S. Term Loan A, which remains in effect.

Borrowings under the 2014 and 2016 Credit Agreements generally bear interest at floating rates. We pay a facility fee on the aggregate amount of the Multicurrency Revolving Facility. If our credit rating falls below investment grade, additional restrictions would result, including restrictions on investments and payment of dividends.  We were in compliance with all financial covenants under the 2014 and 2016 Credit Agreements as of September 30, 2018. As of September 30, 2018, we had no borrowings outstanding under the Multicurrency Revolving Facility.   

Under the terms of U.S. Term Loan A, we have the ability to prepay principal without penalty. We have paid $2.59 billion in principal under U.S. Term Loan A, resulting in $410.0 million in outstanding borrowings as of September 30, 2018.  The outstanding balance is due June 24, 2020.

Under the terms of U.S. Term Loan B, the remaining balance of $600.0 million is due on the maturity date of September 30, 2019.      

The estimated fair value of our senior notes as of September 30, 2018, based on quoted prices for the specific securities from transactions in over-the-counter markets (Level 2), was $7,850.1 million.  The estimated fair value of Japan Term Loan A and Japan Term Loan B, in the aggregate, as of September 30, 2018, based upon publicly available market yield curves and the terms of the debt (Level 2), was $290.9 million.  The carrying values of U.S. Term Loan A and U.S. Term Loan B approximate their fair values as they bear interest at short-term variable market rates.

8.  Accumulated Other Comprehensive Income

AOCI refers to certain gains and losses that under GAAP are included in comprehensive income but are excluded from net earnings as these amounts are initially recorded as an adjustment to stockholders’ equity.  Amounts in AOCI may be reclassified to net earnings upon the occurrence of certain events.  

Our AOCI is comprised of foreign currency translation adjustments, unrealized gains and losses on cash flow hedges and amortization of prior service costs and unrecognized gains and losses in actuarial assumptions on our defined benefit plans.  Foreign currency translation adjustments are reclassified to net earnings upon sale or upon a complete or substantially complete liquidation of an investment in a foreign entity.  Unrealized gains and losses on cash flow hedges are reclassified to net earnings when the hedged item affects net earnings.  Amounts related to defined benefit plans that are in AOCI are reclassified over the service periods of employees in the plan.      

13


The following table shows the changes in the components of AOCI, net of tax (in millions):

 

 

 

Foreign

 

 

Cash

 

 

Defined

 

 

 

 

 

 

 

Currency

 

 

Flow

 

 

Benefit

 

 

Total

 

 

 

Translation

 

 

Hedges

 

 

Plan Items

 

 

AOCI

 

Balance at December 31, 2017

 

$

121.5

 

 

$

(66.5

)

 

$

(138.2

)

 

$

(83.2

)

AOCI before reclassifications

 

 

(127.0

)

 

 

58.0

 

 

 

(5.1

)

 

 

(74.1

)

Reclassifications to retained earnings (Note 2)

 

 

(17.4

)

 

 

(4.4

)

 

 

(21.1

)

 

 

(42.9

)

Reclassifications to statement of earnings

 

 

-

 

 

 

23.0

 

 

 

9.1

 

 

 

32.1

 

Balance at September 30, 2018

 

$

(22.9

)

 

$

10.1

 

 

$

(155.3

)

 

$

(168.1

)

 

The following table shows the reclassification adjustments from AOCI (in millions):

 

 

 

Amount of Gain (Loss)

 

 

 

 

 

Reclassified from AOCI

 

 

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

 

 

September 30,

 

 

September 30,

 

 

Location on

Component of AOCI

 

2018

 

 

2017

 

 

2018

 

 

2017

 

 

Statements of Earnings

Cash flow hedges

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange forward contracts

 

$

(4.9

)

 

$

(5.1

)

 

$

(26.5

)

 

$

12.0

 

 

Cost of products sold

Forward starting interest rate swaps

 

 

(0.1

)

 

 

(0.1

)

 

 

(0.4

)

 

 

(0.4

)

 

Interest expense

 

 

 

(5.0

)

 

 

(5.2

)

 

 

(26.9

)

 

 

11.6

 

 

Total before tax

 

 

 

(0.9

)

 

 

(1.1

)

 

 

(3.9

)

 

 

2.2

 

 

Provision for income taxes

 

 

$

(4.1

)

 

$

(4.1

)

 

$

(23.0

)

 

$

9.4

 

 

Net of tax

Defined benefit plans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Prior service cost

 

$

2.4

 

 

$

2.6

 

 

$

7.4

 

 

$

7.7

 

 

Other expense, net

Unrecognized actuarial (loss)

 

 

(6.7

)

 

 

(5.4

)

 

 

(19.5

)

 

 

(16.2

)

 

Other expense, net

 

 

 

(4.3

)

 

 

(2.8

)

 

 

(12.1

)

 

 

(8.5

)

 

Total before tax

 

 

 

(1.0

)

 

 

(1.1

)

 

 

(3.0

)

 

 

(3.4

)

 

Benefit for income taxes

 

 

$

(3.3

)

 

$

(1.7

)

 

$

(9.1

)

 

$

(5.1

)

 

Net of tax

Total reclassifications

 

$

(7.4

)

 

$

(5.8

)

 

$

(32.1

)

 

$

4.3

 

 

Net of tax

 

The following table shows the tax effects on each component of AOCI recognized in our condensed consolidated statements of comprehensive income (in millions):

 

 

 

Three Months Ended September 30, 2018

 

 

Nine Months Ended September 30, 2018

 

 

 

Before Tax

 

 

Tax

 

 

Net of Tax

 

 

Before Tax

 

 

Tax

 

 

Net of Tax

 

Foreign currency cumulative translation adjustments

 

$

(45.4

)

 

$

(1.4

)

 

$

(44.0

)

 

$

(136.0

)

 

$

(9.0

)

 

$

(127.0

)

Unrealized cash flow hedge gains

 

 

38.1

 

 

 

5.3

 

 

 

32.8

 

 

 

67.7

 

 

 

9.7

 

 

 

58.0

 

Reclassification adjustments on cash flow hedges

 

 

5.0

 

 

 

0.9

 

 

 

4.1

 

 

 

26.9

 

 

 

3.9

 

 

 

23.0

 

Adjustments to prior service cost and unrecognized

   actuarial assumptions

 

 

1.0

 

 

 

(1.0

)

 

 

2.0

 

 

 

1.0

 

 

 

(3.0

)

 

 

4.0

 

Total Other Comprehensive Loss

 

$

(1.3

)

 

$

3.8

 

 

$

(5.1

)

 

$

(40.4

)

 

$

1.6

 

 

$

(42.0

)

 

 

 

Three Months Ended September 30, 2017

 

 

Nine Months Ended September 30, 2017

 

 

 

Before Tax

 

 

Tax

 

 

Net of Tax

 

 

Before Tax

 

 

Tax

 

 

Net of Tax

 

Foreign currency cumulative translation adjustments

 

$

145.0

 

 

$

15.3

 

 

$

129.7

 

 

$

414.6

 

 

$

46.7

 

 

$

367.9

 

Unrealized cash flow hedge (losses)

 

 

(35.9

)

 

 

(7.6

)

 

 

(28.3

)

 

 

(99.0

)

 

 

(19.6

)

 

 

(79.4

)

Reclassification adjustments on cash flow hedges

 

 

5.2

 

 

 

1.1

 

 

 

4.1

 

 

 

(11.6

)

 

 

(2.2

)

 

 

(9.4

)

Adjustments to prior service cost and unrecognized

   actuarial assumptions

 

 

0.5

 

 

 

1.5

 

 

 

(1.0

)

 

 

(2.9

)

 

 

2.1

 

 

 

(5.0

)

Total Other Comprehensive Income

 

$

114.8

 

 

$

10.3

 

 

$

104.5

 

 

$

301.1

 

 

$

27.0

 

 

$

274.1

 

 

14


9.  Fair Value Measurement of Assets and Liabilities

The following financial assets and liabilities are recorded at fair value on a recurring basis (in millions):

 

 

 

As of September 30, 2018

 

 

 

 

 

 

 

Fair Value Measurements at Reporting Date Using:

 

Description

 

Recorded

Balance

 

 

Quoted Prices

in Active

Markets for

Identical

Assets

(Level 1)

 

 

Significant

Other

Observable

Inputs

(Level 2)

 

 

Significant

Unobservable

Inputs

(Level 3)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives, current and long-term

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

38.1

 

 

$

-

 

 

$

38.1

 

 

$

-

 

Interest rate swaps

 

 

35.3

 

 

 

-

 

 

 

35.3

 

 

 

-

 

Total Assets

 

$

73.4

 

 

$

-

 

 

$

73.4

 

 

$

-

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives, current and long-term

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Foreign currency forward contracts

 

$

1.3

 

 

$

-

 

 

$

1.3

 

 

$

-

 

        Interest rate swaps

 

 

4.0

 

 

 

-

 

 

 

4.0

 

 

 

-

 

Contingent payments related to acquisitions

 

 

21.2

 

 

 

-

 

 

 

 

 

 

 

21.2

 

Total Liabilities

 

$

26.5

 

 

$

-

 

 

$

5.3

 

 

$

21.2

 

 

 

 

As of December 31, 2017

 

 

 

 

 

 

 

Fair Value Measurements at Reporting Date Using:

 

Description

 

Recorded

Balance

 

 

Quoted Prices

in Active

Markets for

Identical

Assets

(Level 1)

 

 

Significant

Other

Observable

Inputs

(Level 2)

 

 

Significant

Unobservable

Inputs

(Level 3)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives, current and long-term

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

$

1.6

 

 

$

-

 

 

$

1.6

 

 

$

-

 

Interest rate swaps

 

 

4.5

 

 

 

-

 

 

 

4.5

 

 

 

-

 

Total Assets

 

$

6.1

 

 

$

-

 

 

$

6.1

 

 

$

-

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives, current and long-term

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Foreign currency forward contracts

 

$

50.9

 

 

$

-

 

 

$

50.9

 

 

$

-

 

Contingent payments related to acquisitions

 

 

41.0

 

 

 

-

 

 

 

-

 

 

 

41.0

 

Total Liabilities

 

$

91.9

 

 

$

-

 

 

$

50.9

 

 

$

41.0

 

 

We value our foreign currency forward contracts using a market approach based on foreign currency exchange rates obtained from active markets, and we perform ongoing assessments of counterparty credit risk.  

We value our interest rate swaps using a market approach based on publicly available market yield curves and the terms of our swaps, and we perform ongoing assessments of counterparty credit risk.

Contingent payments related to acquisitions consist of commercial milestone, cost savings and sales-based payments, and are valued using discounted cash flow techniques.  The fair value of commercial milestone payments reflects management’s expectations of probability of payment, and increases as the probability of payment increases or expectation of timing of payments is accelerated.  The fair value of cost savings and sales-based payments is based upon probability-weighted future cost savings and revenue estimates, and increases as cost savings and revenue estimates increase, probability weighting of higher cost savings and revenue scenarios increase or expectation of timing of payment is accelerated.  

The following table provides a reconciliation of the beginning and ending balances of items measured at fair value on a recurring basis in the tables above that used significant unobservable inputs (Level 3) (in millions):

15


 

 

Level 3 - Liabilities

 

Contingent payments related to acquisitions

 

 

 

 

Beginning balance December 31, 2017

 

$

41.0

 

Change in estimate

 

 

(2.0

)

Settlements

 

 

(17.8

)

Ending balance September 30, 2018

 

$

21.2

 

 

Changes in estimates are recognized in Acquisition, integration and related on our condensed consolidated statements of earnings.

10.  Derivative Instruments and Hedging Activities

We are exposed to certain market risks relating to our ongoing business operations, including foreign currency exchange rate risk, commodity price risk, interest rate risk and credit risk.  We manage our exposure to these and other market risks through regular operating and financing activities.  Currently, the only risks that we manage through the use of derivative instruments are interest rate risk and foreign currency exchange rate risk.

Interest Rate Risk

Derivatives Designated as Fair Value Hedges

 

In prior years, we entered into various fixed-to-variable interest rate swap agreements that were accounted for as fair value hedges of a portion of our 4.625% Senior Notes due 2019 and all of our 3.375% Senior Notes due 2021.  In August 2016, we received cash for these interest rate swap assets by terminating the hedging instruments with the counterparties.  The remaining unamortized balance as of September 30, 2018 related to these discontinued hedges was $16.7 million, which will be recognized using the effective interest rate method over the remaining maturity period of the hedged notes.  As of September 30, 2018 and December 31, 2017, the following amounts were recorded on our condensed consolidated balance sheets related to cumulative basis adjustments for fair value hedges (in millions):

 

 

 

 

Carrying Amount of the Hedged Liabilities

 

 

 

Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Liabilities

 

Balance Sheet Line Item

 

September 30, 2018

 

 

December 31, 2017

 

 

 

September 30, 2018

 

 

December 31, 2017

 

Long-term debt

 

$

566.5

 

 

$

572.8

 

 

 

$

16.7

 

 

$

23.1

 

 

Derivatives Designated as Cash Flow Hedges

In 2014, we entered into forward starting interest rate swaps that were designated as cash flow hedges of our thirty-year tranche of senior notes (the 4.450% Senior Notes due 2045) we expected to issue in 2015. The forward starting interest rate swaps mitigated the risk of changes in interest rates prior to the completion of the offering of senior notes in connection with the Biomet merger.  The interest rate swaps were settled, and the remaining loss to be recognized at September 30, 2018 was $27.2 million, which will be recognized using the effective interest rate method over the remaining maturity period of the hedged notes.

In September 2016, we entered into various variable-to-fixed interest rate swap agreements with a notional amount of $375.0 million that were accounted for as cash flow hedges of U.S. Term Loan B.  The interest rate swaps minimize the exposure to changes in the LIBOR interest rates while the variable-rate debt is outstanding.  The weighted average fixed interest rate for all of the swaps executed is approximately 0.82 percent through September 30, 2019.    

Foreign Currency Exchange Rate Risk

We operate on a global basis and are exposed to the risk that our financial condition, results of operations and cash flows could be adversely affected by changes in foreign currency exchange rates. To reduce the potential effects of foreign currency exchange rate movements on net earnings, we enter into derivative financial instruments in the form of foreign currency exchange forward contracts with major financial institutions. We also designated our Euro Notes as net investment hedges of investments in foreign subsidiaries. We are primarily exposed to foreign currency exchange rate risk with respect to transactions and net assets denominated in Euros,

16


Swiss Francs, Japanese Yen, British Pounds, Canadian Dollars, Australian Dollars, Korean Won, Swedish Krona, Czech Koruna, Thai Baht, Taiwan Dollars, South African Rand, Russian Rubles, Indian Rupees, Turkish Lira, Polish Zloty, Danish Krone, and Norwegian Krone. We do not use derivative financial instruments for trading or speculative purposes.

Derivatives Designated as Net Investment Hedges

We are exposed to the impact of foreign exchange rate fluctuations in the investments in our wholly-owned foreign subsidiaries that are denominated in currencies other than the U.S. Dollar. In order to mitigate the volatility in foreign exchange rates, we issued Euro Notes in December 2016 and designated 100 percent of the Euro Notes to hedge our net investment in certain wholly-owned foreign subsidiaries that have a functional currency of the Euro. All changes in the fair value of a hedging instrument designated as a net investment hedge are recorded as a component of AOCI in the condensed consolidated balance sheets.  

In the first quarter of 2018, we initiated receive-fixed-rate, pay-fixed-rate cross-currency interest rate swaps with a notional amount of €500.0 million.  In the second quarter of 2018, we initiated additional receive-fixed-rate, pay-fixed-rate cross-currency interest rate swaps with a notional amount of €500.0 million.  In the third quarter of 2018, we initiated additional receive-fixed-rate, pay-fixed-rate cross-currency interest rate swaps with a notional amount of €250.0 million. These transactions further hedged our net investment in certain wholly-owned foreign subsidiaries that have a functional currency of Euro. All changes in the fair value of a derivative instrument designated as a net investment hedge are recorded as a component of AOCI in the condensed consolidated balance sheets. The portion of this change related to the excluded component will be amortized into earnings over the life of the derivative while the remainder will be recorded in AOCI until the hedged net investment is sold or substantially liquidated.  The gains related to the excluded component were not significant for the period.

In the three and nine month periods ended September 30, 2018, we recognized foreign exchange gains of $2.1 million and $66.7 million, respectively, in AOCI in foreign currency translation adjustments on our net investment hedges.  In the three and nine month periods ended September 30, 2017, we recognized foreign exchange losses of $41.7 million and $127.5 million, respectively, in AOCI in foreign currency translation adjustments on our net investment hedges.  We did not reclassify any amount from AOCI to earnings in the three and nine month periods ended September 30, 2018 and 2017.  

Derivatives Designated as Cash Flow Hedges

Our revenues are generated in various currencies throughout the world.  However, a significant amount of our inventory is produced in U.S. Dollars.  Therefore, movements in foreign currency exchange rates may have different proportional effects on our revenues compared to our cost of products sold.  To minimize the effects of foreign currency exchange rate movements on cash flows, we hedge intercompany sales of inventory expected to occur within the next 30 months with foreign currency exchange forward contracts.  We designate these derivative instruments as cash flow hedges.  

We perform quarterly assessments of hedge effectiveness by verifying and documenting the critical terms of the hedge instrument and confirming that forecasted transactions have not changed significantly.  We also assess on a quarterly basis whether there have been adverse developments regarding the risk of a counterparty default.  For derivatives which qualify as hedges of future cash flows, the gains and losses are temporarily recorded in AOCI and then recognized in cost of products sold when the hedged item affects net earnings.  On our condensed consolidated statements of cash flows, the settlements of these cash flow hedges are recognized in operating cash flows.

For foreign currency exchange forward contracts and options outstanding at September 30, 2018, we had obligations to purchase U.S. Dollars and sell Euros, Japanese Yen, British Pounds, Canadian Dollars, Australian Dollars, Korean Won, Swedish Krona, Czech Koruna, Thai Baht, Taiwan Dollars, South African Rand, Russian Rubles, Indian Rupees, Turkish Lira, Polish Zloty, Danish Krone, and Norwegian Krone and obligations to purchase Swiss Francs and sell U.S. Dollars. These derivatives mature at dates ranging from October 2018 through March 2020. As of September 30, 2018, the notional amounts of outstanding forward contracts and options entered into with third parties to purchase U.S. Dollars were $1,620.7 million. As of September 30, 2018, the notional amounts of outstanding forward contracts and options entered into with third parties to purchase Swiss Francs were $270.9 million.

Derivatives Not Designated as Hedging Instruments

We enter into foreign currency forward exchange contracts with terms of one month to manage currency exposures for monetary assets and liabilities denominated in a currency other than an entity’s functional currency.  As a result, any foreign currency re-measurement gains/losses recognized in earnings are generally offset with gains/losses on the foreign currency forward exchange contracts in the same reporting period.  The net amount of these offsetting gains/losses is recorded in Other expense.  These contracts are settled on the last day of each reporting period.  Therefore, there is no outstanding balance related to these contracts recorded on

17


the balance sheet as of the end of the reporting period.  The notional amounts of these contracts are typically in a range of $1.5 billion to $2.0 billion per quarter.

Income Statement Presentation

Derivatives Designated as Cash Flow Hedges

Derivative instruments designated as cash flow hedges had the following effects, before taxes, on AOCI and Net earnings on our condensed consolidated statements of earnings, condensed consolidated statements of comprehensive income and condensed consolidated balance sheets (in millions):

 

 

 

Amount of Gain (Loss)

 

 

 

 

Amount of Gain (Loss)

 

 

 

Recognized in AOCI

 

 

 

 

Reclassified from AOCI

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

 

Location on

 

September 30,

 

 

September 30,

 

Derivative Instrument

 

2018

 

 

2017

 

 

2018

 

 

2017

 

 

Statements of Earnings

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Foreign exchange

   forward contracts

 

$

38.8

 

 

$

(35.6

)

 

$

68.3

 

 

$

(98.7

)

 

Cost of products sold

 

$

(4.9

)

 

$

(5.1

)

 

$

(26.5

)

 

$

12.0

 

Interest rate swaps

 

 

(0.7

)

 

 

(0.3

)

 

 

(0.6

)

 

 

(0.3

)

 

Interest expense

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

Forward starting

   interest rate swaps

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

Interest expense

 

 

(0.1

)

 

 

(0.1

)

 

 

(0.4

)

 

 

(0.4

)

 

 

$

38.1

 

 

$

(35.9

)

 

$

67.7

 

 

$

(99.0

)

 

 

 

$

(5.0

)

 

$

(5.2

)

 

$

(26.9

)

 

$

11.6

 

 

The net amounts recognized in earnings during the three and nine month periods ended September 30, 2018 and 2017 due to ineffectiveness and amounts excluded from the assessment of hedge effectiveness were not significant.  

The fair value of outstanding derivative instruments designated as cash flow hedges and recorded on our condensed consolidated balance sheet at September 30, 2018, together with settled derivatives where the hedged item has not yet affected earnings, was a net unrealized gain of $10.2 million, or $10.1 million after taxes, which is deferred in AOCI.  A gain of $8.7 million, or $6.8 million after taxes, is expected to be reclassified to earnings in cost of products sold and a loss of $0.6 million, or $0.5 million after taxes, is expected to be reclassified to earnings in interest expense over the next twelve months.

 

The following table presents the effect of fair value and cash flow hedge accounting on our condensed consolidated statements of earnings (in millions):

 

 

 

Location and Amount of Gain/(Loss) Recognized in Income on Fair Value and Cash Flow Hedging Relationships for the Period Ended:

 

 

 

Three Months Ended

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

Nine Months Ended

 

 

 

September 30, 2018

 

 

September 30, 2017

 

 

September 30, 2018

 

 

September 30, 2017

 

 

 

Cost of

 

 

 

 

 

 

Cost of

 

 

 

 

 

 

Cost of

 

 

 

 

 

 

Cost of

 

 

 

 

 

 

 

Goods

 

 

Interest

 

 

Goods

 

 

Interest

 

 

Goods

 

 

Interest

 

 

Goods

 

 

Interest

 

 

 

Sold

 

 

Expense

 

 

Sold

 

 

Expense

 

 

Sold

 

 

Expense

 

 

Sold

 

 

Expense

 

Total amounts of income and expense line items presented in the statements of earnings in which the effects of fair value or cash flow hedges are

     recorded

 

$

529.0

 

 

$

(68.3

)

 

$

500.9

 

 

$

(82.3

)

 

$

1,688.5

 

 

$

(223.1

)

 

$

1,541.5

 

 

$

(247.5

)

        The effects of fair value and cash flow hedging:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

             Gain (loss) on fair value hedging

                  relationships

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

                       Discontinued interest rate swaps

 

 

-

 

 

 

2.1

 

 

 

-

 

 

 

2.1

 

 

 

-

 

 

 

6.3

 

 

 

-

 

 

 

6.2

 

             Gain (loss) on cash flow hedging

                  relationships

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

                       Forward starting interest rate swaps

 

 

-

 

 

 

(0.1

)

 

 

-

 

 

 

(0.1

)

 

 

-

 

 

 

(0.4

)

 

 

-

 

 

 

(0.4

)

                       Foreign exchange forward contracts

 

 

(4.9

)

 

 

-

 

 

 

(5.1

)

 

 

-

 

 

 

(26.5

)

 

 

-

 

 

 

12.0

 

 

 

-

 

 

 

18


 

Derivatives Not Designated as Hedging Instruments

The following gains and (losses) from these derivative instruments were recognized on our condensed consolidated statements of earnings (in millions):

 

 

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

Location on

 

September 30,

 

 

September 30,

 

Derivative Instrument

 

Statements of Earnings

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Foreign exchange forward contracts

 

Other expense, net

 

$

5.5

 

 

$

(16.3

)

 

$

23.4

 

 

$

(54.9

)

 

These gains and losses do not reflect offsetting losses of $10.2 million and $39.2 million in the three and nine month periods ended September 30, 2018, respectively, and offsetting gains of $11.1 million and $43.0 million in the three and nine month periods ended September 30, 2017, respectively, recognized in Other expense, net as a result of foreign currency re-measurement of monetary assets and liabilities denominated in a currency other than an entity’s functional currency.

Balance Sheet Presentation

As of September 30, 2018 and December 31, 2017, all derivative instruments designated as fair value hedges and cash flow hedges were recorded at fair value on our condensed consolidated balance sheets.  On our condensed consolidated balance sheets, we recognize individual forward contracts and options with the same counterparty on a net asset/liability basis if we have a master netting agreement with the counterparty.  Under these master netting agreements, we are able to settle derivative instrument assets and liabilities with the same counterparty in a single transaction, instead of settling each derivative instrument separately.  We have master netting agreements with all of our counterparties.  The fair value of derivative instruments on a gross basis is as follows (in millions):  

 

 

 

As of September 30, 2018

 

 

As of December 31, 2017

 

 

 

Balance

 

 

 

 

 

Balance

 

 

 

 

 

 

Sheet

 

Fair

 

 

Sheet

 

Fair

 

 

 

Location

 

Value

 

 

Location

 

Value

 

Asset Derivatives

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange forward contracts

 

Other current assets

 

$

31.3

 

 

Other current assets

 

$

14.5

 

Foreign exchange forward contracts

 

Other assets

 

 

21.1

 

 

Other assets

 

 

4.8

 

Interest rate swaps

 

Other assets

 

 

3.9

 

 

Other assets

 

 

4.5

 

Cross-currency interest rate swaps

 

Other assets

 

 

31.4

 

 

Other assets

 

 

-

 

Total asset derivatives

 

 

 

$

87.7

 

 

 

 

$

23.8

 

Liability Derivatives

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange forward contracts

 

Other current liabilities

 

$

13.0

 

 

Other current liabilities

 

$

45.8

 

Foreign exchange forward contracts

 

Other long-term liabilities

 

 

2.6

 

 

Other long-term liabilities

 

 

22.8

 

Cross-currency interest rate swaps

 

Other long-term liabilities

 

 

4.0

 

 

Other long-term liabilities

 

 

-

 

Total liability derivatives

 

 

 

$

19.6

 

 

 

 

$

68.6

 

 

The table below presents the effects of our master netting agreements on our condensed consolidated balance sheets (in millions):

 

 

 

 

 

As of September 30, 2018

 

 

As of December 31, 2017

 

Description

 

Location

 

Gross

Amount

 

 

Offset

 

 

Net Amount in

Balance Sheet

 

 

Gross

Amount

 

 

Offset

 

 

Net Amount in

Balance Sheet

 

Asset Derivatives

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flow hedges

 

Other current assets

 

$

31.3

 

 

$

11.7

 

 

$

19.6

 

 

$

14.5

 

 

$

13.4

 

 

$

1.1

 

Cash flow hedges

 

Other assets

 

 

21.1

 

 

 

2.6

 

 

 

18.5

 

 

 

4.8

 

 

 

4.3

 

 

 

0.5

 

Liability Derivatives

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flow hedges

 

Other current liabilities

 

 

13.0

 

 

 

11.7

 

 

 

1.3

 

 

 

45.8

 

 

 

13.4

 

 

 

32.4

 

Cash flow hedges

 

Other long-term liabilities

 

 

2.6

 

 

 

2.6

 

 

 

-

 

 

 

22.8

 

 

 

4.3

 

 

 

18.5

 

 

19


The following net investment hedge gains (losses) were recognized on our condensed consolidated statements of comprehensive income (in millions):

 

 

 

Amount of Gain (Loss)

 

 

 

Recognized in AOCI

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

Derivative Instrument

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Euro Notes

 

$

6.1

 

 

$

(41.7

)

 

$

39.3

 

 

$

(127.5

)

Cross-currency interest rate swaps

 

 

(4.0

)

 

 

-

 

 

 

27.4

 

 

 

-

 

 

 

$

2.1

 

 

$

(41.7

)

 

$

66.7

 

 

$

(127.5

)

 

 

 

11.  Income Taxes

We operate on a global basis and are subject to numerous and complex tax laws and regulations.  Additionally, tax laws continue to undergo rapid changes in both application and interpretation by various countries, including state aid interpretations and initiatives led by the Organization for Economic Cooperation and Development.  Our income tax filings are subject to examinations by taxing authorities throughout the world. Income tax audits may require an extended period of time to reach resolution and may result in significant income tax adjustments when interpretation of tax laws or allocation of company profits is disputed.  Although ultimate timing is uncertain, the net amount of tax liability for unrecognized tax benefits may change within the next twelve months due to changes in audit status, expiration of statutes of limitations, settlements of tax assessments and other events. Management’s best estimate of such change is within the range of a $115 million decrease to a $25 million increase.

Our U.S. Federal income tax returns have been audited through 2009 and are currently under audit for years 2010-2015.  The IRS has proposed adjustments for years 2005-2012, reallocating profits between certain of our U.S. and foreign subsidiaries.  We have disputed these adjustments and intend to continue to vigorously defend our positions.  For years 2005-2007, we have filed a petition with the U.S. Tax Court.  For years 2008-2012, we are pursuing resolution through the IRS Administrative Appeals Process.

 

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the "2017 Tax Act").  The 2017 Tax Act made changes to the U.S. tax code, which included (1) reducing the U.S. corporate income tax rate from 35 percent to 21 percent, (2) implementing a base erosion and anti-abuse tax, (3) generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries, (4) adding a new provision designed to tax global intangible low-taxed income ("GILTI") of foreign subsidiaries which allows for the possibility of utilizing foreign tax credits to offset the tax liability (subject to some limitations), (5) implementing a lower effective U.S. income tax rate on certain revenues from sources outside the U.S., and (6) implementing a one-time transition tax on certain undistributed earnings of foreign subsidiaries.  In the year ended December 31, 2017, we recorded a provisional discrete net tax benefit associated with the 2017 Tax Act and related matters.  As of September 30, 2018, the amounts recorded for the 2017 Tax Act remain provisional for the transition tax, the remeasurement of deferred taxes, and our reassessment of permanently reinvested earnings, uncertain tax positions and other related matters.  These estimates may be impacted by further analysis and future clarification and guidance regarding available tax accounting methods and elections, earnings and profits computations, state tax conformity to federal tax changes and the impact of the GILTI provisions.  We have not yet determined our policy election with respect to whether to record deferred taxes for basis differences expected to reverse as a result of the GILTI provisions in future periods or use the period cost method.  We have, however, included an estimate of the current GILTI impact in our tax provision for 2018.

In the three and nine month periods ended September 30, 2018, our effective tax rate (“ETR”) was negative 5.5 percent and positive 12.1 percent, respectively.  In the three and nine month periods ended September 30, 2018, we recognized tax benefits resulting from return to provision adjustments related to changes in estimated tax rates on deferred tax liabilities recorded on acquisition-related intangible assets.  The change in estimates from these adjustments resulted in tax benefits of $16.9 million in the three and nine month periods ended September 30, 2018.  In the prior year periods, we had certain discrete adjustments that significantly impacted our ETR.  In the nine month period ended September 30, 2017, we recognized a tax benefit of $69.7 million resulting from a tax restructuring that lowered the tax rate on certain deferred tax liabilities recorded on intangible assets recognized in acquisition-related accounting.  In the three and nine month periods ended September 30, 2017, we recognized tax benefits of $39.8 million and $128.6 million, respectively, related to resolution of certain tax matters.  In addition, our prior year ETR was affected by the significant expenses associated with the Biomet merger and other acquisitions which have generally been recognized in higher income tax jurisdictions.  Accordingly, this has reduced our ETR as our earnings have been lower in these higher income tax jurisdictions.  

20


12.  Retirement Benefit Plans

We have defined benefit pension plans covering certain U.S. and Puerto Rico employees.  The employees who are not participating in the defined benefit plans receive additional benefits under our defined contribution plans.  Plan benefits are primarily based on years of credited service and the participant’s compensation.  In addition to the U.S. and Puerto Rico defined benefit pension plans, we sponsor various foreign pension arrangements, including retirement and termination benefit plans required by local law or coordinated with government sponsored plans.  

The components of net periodic pension expense for our U.S. and foreign defined benefit pension plans are as follows (in millions):

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Service cost

 

$

6.8

 

 

$

7.1

 

 

$

21.3

 

 

$

21.0

 

Interest cost

 

 

5.6

 

 

 

4.6

 

 

 

16.7

 

 

 

13.9

 

Expected return on plan assets

 

 

(11.6

)

 

 

(10.1

)

 

 

(35.1

)

 

 

(30.3

)

Curtailment loss

 

 

-

 

 

 

0.2

 

 

 

-

 

 

 

0.4

 

Amortization of prior service cost

 

 

(2.4

)

 

 

(2.6

)

 

 

(7.4

)

 

 

(7.7

)

Amortization of unrecognized actuarial loss

 

 

6.7

 

 

 

5.4

 

 

 

19.5

 

 

 

16.2

 

Net periodic pension expense

 

$

5.1

 

 

$

4.6

 

 

$

15.0

 

 

$

13.5

 

 

Service cost is recognized in the operating expense line item in which the related employee is classified.  All other components of net periodic pension expense are recognized in Other expense, net.

 

We expect that we will have minimal legally required funding obligations in 2018 for our U.S. and Puerto Rico defined benefit pension plans, and therefore we have not made, nor do we voluntarily expect to make, any material contributions to these plans during 2018.  We contributed $14.5 million to our foreign-based defined benefit pension plans in the nine month period ended September 30, 2018, and we expect to contribute $4.8 million to these foreign-based plans during the remainder of 2018.

13.  Earnings Per Share

The following is a reconciliation of weighted average shares for the basic and diluted shares computations (in millions):

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Weighted average shares outstanding for basic

   net earnings per share

 

 

203.7

 

 

 

202.3

 

 

 

203.3

 

 

 

201.7

 

Effect of dilutive stock options and other equity awards

 

 

1.7

 

 

 

1.7

 

 

 

1.6

 

 

 

1.9

 

Weighted average shares outstanding for diluted

   net earnings per share

 

 

205.4

 

 

 

204.0

 

 

 

204.9

 

 

 

203.6

 

 

During the three and nine month periods ended September 30, 2018, an average of 0.7 million options and 1.8 million options, respectively, to purchase shares of common stock were not included in the computation of diluted earnings per share because the exercise prices of these options were greater than the average market price of our common stock.  In the three and nine month periods ended September 30, 2017, an average of 0.9 million and 0.8 million options, respectively, were not included for the same reason.  

14.  Segment Information

We design, manufacture and market orthopaedic reconstructive products; sports medicine, biologics, extremities and trauma products; spine and CMF products; office based technologies; dental implants; and related surgical products.  We allocate resources to achieve our operating profit goals through seven operating segments.  Our operating segments are comprised of both geographic and product category business units.  The geographic operating segments are the Americas, which is comprised principally of the U.S. and includes other North, Central and South American markets; EMEA, which is comprised principally of Europe and includes the Middle East and African markets; and Asia Pacific, which is comprised primarily of Japan, China and Australia and includes other Asian and Pacific markets.  The product category operating segments are Spine, less Asia Pacific; Office Based Technologies; CMF and Dental.  The geographic operating segments include results from all of our product categories except those in the product category operating segments.  The Office Based Technologies, CMF and Dental product category operating segments reflect those respective product

21


category results from all regions, whereas the Spine, less Asia Pacific product category operating segment includes all spine product results excluding those from Asia Pacific.  

As it relates to the geographic operating segments, we evaluate performance based upon segment operating profit exclusive of operating expenses pertaining to inventory step-up and certain other inventory and manufacturing related charges, intangible asset amortization, goodwill and intangible asset impairment, acquisition, integration and related, quality remediation, litigation, other charges and global operations and corporate functions.  Global operations and corporate functions include research, development engineering, medical education, brand management, corporate legal, finance and human resource functions, manufacturing operations and logistics and share-based payment expense.  As it relates to each product category operating segment, research, development engineering, medical education, brand management and other various costs that are specific to the product category operating segment’s operations are reflected in its operating profit results.  Due to these additional costs included in the product category operating segments, profitability metrics among the geographic operating segments and product category operating segments are not comparable.  Intercompany transactions have been eliminated from segment operating profit.

We do not review asset information by operating segment.  Instead, we review cash flow and other financial ratios by operating segment.

These seven operating segments are the basis for our reportable segment information provided below.  The four product category operating segments are individually insignificant to our consolidated results and therefore do not constitute a reporting segment either individually or combined.  For presentation purposes, these product category operating segments have been aggregated.  Prior period reportable segment financial information has been restated to reflect the impact of the adoption of ASU 2017-07 and ASU 2014-09, as described in Note 2.

Net sales and operating profit by segment are as follows (in millions):

 

 

 

Net Sales

 

 

Operating Profit

 

 

 

Three Months Ended

 

 

Three Months Ended

 

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Americas

 

$

934.5

 

 

$

916.7

 

 

$

479.8

 

 

$

501.4

 

EMEA

 

 

326.8

 

 

 

335.4

 

 

 

85.5

 

 

 

96.4

 

Asia Pacific

 

 

295.9

 

 

 

281.7

 

 

 

94.8

 

 

 

98.3

 

Product Category Operating Segments

 

 

279.5

 

 

 

279.3

 

 

 

43.3

 

 

 

49.0

 

Global Operations and Corporate Functions

 

 

-

 

 

 

-

 

 

 

(232.4

)

 

 

(205.4

)

Total

 

$

1,836.7

 

 

$

1,813.1

 

 

 

 

 

 

 

 

 

Inventory step-up and other inventory and manufacturing

   related charges

 

 

 

 

 

 

 

 

 

 

(5.0

)

 

 

(11.5

)

Intangible asset amortization

 

 

 

 

 

 

 

 

 

 

(147.6

)

 

 

(152.7

)

Goodwill and intangible asset impairment

 

 

 

 

 

 

 

 

 

 

(3.8

)

 

 

(32.7

)

Acquisition, integration and related

 

 

 

 

 

 

 

 

 

 

(17.4

)

 

 

(61.6

)

Quality remediation

 

 

 

 

 

 

 

 

 

 

(34.2

)

 

 

(50.0

)

Litigation

 

 

 

 

 

 

 

 

 

 

(14.0

)

 

 

(8.0

)

Other charges

 

 

 

 

 

 

 

 

 

 

(25.7

)

 

 

(12.0

)

Operating profit

 

 

 

 

 

 

 

 

 

$

223.3

 

 

$

211.2

 

 

22


 

 

Net Sales

 

 

Operating Profit

 

 

 

Nine Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Americas

 

$

2,904.7

 

 

$

2,886.5

 

 

$

1,515.0

 

 

$

1,566.6

 

EMEA

 

 

1,159.4

 

 

 

1,108.5

 

 

 

344.5

 

 

 

345.0

 

Asia Pacific

 

 

914.1

 

 

 

850.5

 

 

 

309.7

 

 

 

308.7

 

Product Category Operating Segments

 

 

883.7

 

 

 

889.5

 

 

 

136.6

 

 

 

191.4

 

Global Operations and Corporate Functions

 

 

-

 

 

 

-

 

 

 

(701.5

)

 

 

(627.3

)

Total

 

$

5,861.9

 

 

$

5,735.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Inventory step-up and other inventory and manufacturing

   related charges

 

 

 

 

 

 

 

 

 

 

(24.7

)

 

 

(52.7

)

Intangible asset amortization

 

 

 

 

 

 

 

 

 

 

(447.9

)

 

 

(452.4

)

Goodwill and intangible asset impairment

 

 

 

 

 

 

 

 

 

 

(3.8

)

 

 

(59.5

)

Acquisition, integration and related

 

 

 

 

 

 

 

 

 

 

(113.9

)

 

 

(192.3

)

Quality remediation

 

 

 

 

 

 

 

 

 

 

(125.8

)

 

 

(141.2

)

Litigation

 

 

 

 

 

 

 

 

 

 

(15.5

)

 

 

(15.0

)

Other charges

 

 

 

 

 

 

 

 

 

 

(48.4

)

 

 

(31.9

)

Operating profit

 

 

 

 

 

 

 

 

 

$

824.3

 

 

$

839.4

 

 

 

15.  Commitments and Contingencies

On a quarterly and annual basis, we review relevant information with respect to loss contingencies and update our accruals, disclosures and estimates of reasonably possible losses or ranges of loss based on such reviews.  We establish liabilities for loss contingencies when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated.  For matters where a loss is believed to be reasonably possible, but not probable, no accrual has been made.

Litigation

Durom® Cup-related claims:  On July 22, 2008, we temporarily suspended marketing and distribution of the Durom Cup in the U.S.  Subsequently, a number of product liability lawsuits were filed against us in various U.S. and foreign jurisdictions.  The plaintiffs seek damages for personal injury, and they generally allege that the Durom Cup contains defects that result in complications and premature revision of the device.  We have settled the majority of these claims and others are still pending.  The majority of the pending U.S. lawsuits are currently in a federal Multidistrict Litigation (“MDL”) in the District of New Jersey (In Re: Zimmer Durom Hip Cup Products Liability Litigation).  Litigation activity in the MDL is stayed to allow participation in the U.S. Durom Cup Settlement Program, an extrajudicial program created to resolve actions and claims of eligible U.S. plaintiffs and claimants.  Other lawsuits are pending in various domestic and foreign jurisdictions, and additional claims may be asserted in the future.  The majority of claims outside the U.S. are pending in Canada, Germany, Netherlands, Italy and the UK.  A Canadian class settlement was approved in late 2016, and the period for class members to submit a claim for compensation under the settlement closed in September 2017.  The majority of claims in the UK are consolidated in a Group Litigation Order.

In the second quarter of 2018, we lowered our estimate of the number of Durom Cup-related claims we expect to settle.  Therefore, we recognized a $20.0 million gain in selling, general and administrative expense in the nine month periods ended September 30, 2018, with no additional gain or expense recorded in the three month period ended September 30, 2018.  In the three and nine month periods ended September 30, 2017, we did not record any expense for Durom Cup-related claims.  Since 2008, we have recognized net expense of $469.7 million for Durom Cup-related claims.  

We maintain insurance for product liability claims, subject to self-insurance retention requirements.  We have recovered insurance proceeds from certain of our insurance carriers for Durom Cup-related claims.  While we may recover additional insurance proceeds in the future for Durom Cup-related claims, we do not have a receivable recorded on our condensed consolidated balance sheet as of September 30, 2018 for any possible future insurance recoveries for these claims.

Our estimate as of September 30, 2018 of the remaining liability for all Durom Cup-related claims is $112.3 million, of which $48.9 million is classified as short-term in “Other current liabilities” and $63.4 million is classified as long-term in “Other long-term

23


liabilities” on our condensed consolidated balance sheet.  We expect to pay the majority of the Durom Cup-related claims within the next few years.

Our understanding of clinical outcomes with the Durom Cup and other large diameter hip cups continues to evolve.  We rely on significant estimates in determining the provisions for Durom Cup-related claims, including our estimate of the number of claims that we will receive and the average amount we will pay per claim.  The actual number of claims and the actual amount we pay per claim may differ from our estimates.  Among other factors, since our understanding of the clinical outcomes is still evolving, we cannot reasonably estimate the possible loss or range of loss that may result from Durom Cup-related claims in excess of the losses we have accrued.  Although we are vigorously defending these lawsuits, their ultimate resolution is uncertain.

Margo and Daniel Polett v. Zimmer, Inc. et al.:  On August 20, 2008, Margo and Daniel Polett filed an action against us and an unrelated third party, Public Communications, Inc. (“PCI”), in the Court of Common Pleas, Philadelphia, Pennsylvania seeking an unspecified amount of damages for injuries and loss of consortium allegedly suffered by Mrs. Polett and her spouse, respectively.  The complaint alleged that defendants were negligent in connection with Mrs. Polett’s participation in a promotional video featuring one of our knee products.  The case was tried in November 2010 and the jury returned a verdict in favor of plaintiffs.  The jury awarded $27.6 million in compensatory damages and apportioned fault 30 percent to plaintiffs, 34 percent to us and 36 percent to PCI.  Under applicable law, we may be liable for any portion of the damages apportioned to PCI that it does not pay.  On December 2, 2010, we and PCI filed a motion for post-trial relief seeking a judgment notwithstanding the verdict, a new trial or a remittitur.  On June 10, 2011, the trial court entered an order denying our motion for post-trial relief and affirming the jury verdict in full and entered judgment for $20.3 million against us and PCI.  On June 29, 2011, we filed a notice of appeal to the Superior Court of Pennsylvania and posted a bond for the verdict amount plus interest.  Oral argument before the appellate court in Philadelphia, Pennsylvania was held on March 13, 2012.  On March 1, 2013, the Superior Court of Pennsylvania vacated the $27.6 million judgment and remanded the case for a new trial.  On March 15, 2013, plaintiffs filed a motion for re-argument en banc, and on March 28, 2013, we filed our response in opposition.  On May 9, 2013, the Superior Court of Pennsylvania granted plaintiffs’ motion for re-argument en banc.  Oral argument (re-argument en banc) before the Superior Court of Pennsylvania was held on October 16, 2013.  On December 20, 2013, the Court issued its opinion again vacating the trial court judgment and remanding the case for a new trial.  On January 21, 2014, plaintiffs filed a petition for allowance of appeal in the Supreme Court of Pennsylvania, which was granted on May 21, 2014.  Oral argument before the Supreme Court of Pennsylvania took place on October 8, 2014.  On October 27, 2015, the Supreme Court of Pennsylvania reversed the order of the Superior Court of Pennsylvania and remanded the case to that court to consider the question of whether the trial court erred in refusing to remit the jury’s compensatory damages award.  On June 6, 2016, an en banc panel of the Superior Court of Pennsylvania vacated the $27.6 million verdict and remanded the case back to the trial court for reconsideration of whether remittitur was appropriate.  On December 2, 2016, the trial court remitted the verdict to $21.5 million, which, after being molded to reduce for plaintiffs’ comparative negligence, totals approximately $15.8 million between PCI and us.  On December 5, 2016, we filed a notice of appeal to the Superior Court of Pennsylvania.  Oral argument before the Superior Court of Pennsylvania took place on September 20, 2017, and on December 15, 2017, the Superior Court of Pennsylvania issued its decision affirming the $21.5 million remitted award.  We subsequently filed a motion for re-argument en banc on December 29, 2017, which motion was denied without opinion on February 12, 2018.  We filed a petition for allowance of appeal in the Supreme Court of Pennsylvania on March 14, 2018, which was denied on August 28, 2018.  In September 2018, we paid the final $15.8 million remitted and molded verdict, plus post-judgment interest from the date of verdict in 2010.  We had recorded a charge for approximately this amount in the three month period ended December 31, 2017.  This matter is now closed.

NexGen® Knee System claims:  Following a wide-spread advertising campaign conducted by certain law firms beginning in 2010, a number of product liability lawsuits have been filed against us in various jurisdictions.  The plaintiffs seek damages for personal injury, alleging that certain products within the NexGen Knee System, specifically the NexGen Flex Femoral Components and MIS Stemmed Tibial Component, suffer from defects that cause them to loosen prematurely.  The majority of the cases are currently pending in an MDL in the Northern District of Illinois (In Re: Zimmer NexGen Knee Implant Products Liability Litigation).  Other cases are pending in various state courts, and additional lawsuits may be filed.  Thus far, all cases decided by the MDL court or a jury on the merits have involved NexGen Flex Femoral Components, which represent the majority of cases in the MDL.  The initial bellwether trial took place in October 2015 and resulted in a defense verdict.  The next scheduled bellwether trial, which was set to commence in November 2016, was dismissed following the court’s grant of summary judgment in our favor in October 2016.  That decision was appealed by the plaintiff and subsequently affirmed by the Seventh Circuit Court of Appeals in March 2018.  The second bellwether trial took place in January 2017 and resulted in a defense verdict.  The parties attended a court-ordered mediation in January 2018, at which a settlement in principle was reached that would resolve all MDL cases and all state court cases that involved MDL products.  MDL proceedings have been stayed pending administration of the aforementioned settlement.  Although we are vigorously defending these lawsuits, their ultimate resolution is uncertain.

Zimmer M/L Taper, M/L Taper with Kinectiv Technology, and Versys Femoral Head-related claims: We are a defendant in a number of product liability lawsuits relating to our M/L Taper and M/L Taper with Kinectiv Technology hip stems, and Versys Femoral Head implants. The plaintiffs seek damages for personal injury, alleging that defects in the products lead to corrosion at the

24


head/stem junction resulting in, among other things, pain, inflammation and revision surgery.  The majority of the cases were recently consolidated in an MDL in the United States District Court for the Southern District of New York (In Re: Zimmer M/L Taper Hip Prosthesis or M/L Taper Hip Prosthesis with Kinectiv Technology and Versys Femoral Head Products Liability Litigation).  Other related cases are pending in various state courts, with the majority of state court cases pending in Oregon, New Mexico, Indiana and Florida.  Additional lawsuits are likely to be filed.  Although we are vigorously defending these lawsuits, their ultimate resolution is uncertain.  

Biomet metal-on-metal hip implant claims:  Biomet is a defendant in a number of product liability lawsuits relating to metal-on-metal hip implants, most of which involve the M2a-MagnumTM hip system.  The majority of the cases are currently consolidated in an MDL in the U.S. District Court for the Northern District of Indiana (In Re: Biomet M2a Magnum Hip Implant Product Liability Litigation).  Other cases are pending in various state and foreign courts, with the majority of domestic state court cases pending in Indiana and Florida.

On February 3, 2014, Biomet announced the settlement of the MDL.  Lawsuits filed in the MDL by April 15, 2014 were eligible to participate in the settlement.  Those claims that did not settle via the MDL settlement program have re-commenced litigation in the MDL under a new case management plan.  The settlement does not affect certain other claims relating to Biomet’s metal-on-metal hip products that are pending in various state and foreign courts, or other claims that may be filed in the future.  In light of recent litigation developments, our estimate as of September 30, 2018 of the remaining liability for all Biomet metal-on-metal hip implant claims has increased to $62.1 million.

Biomet has exhausted the self-insured retention in its insurance program and has been reimbursed for claims related to its metal-on-metal products up to its policy limits in the program.  Zimmer Biomet is responsible for any amounts by which the ultimate losses exceed the amount of Biomet’s third-party insurance coverage.  As of September 30, 2018, Biomet had received all of the insurance proceeds it expects to recover under the excess policies.  Although we are vigorously defending these lawsuits, their ultimate resolution is uncertain.

Heraeus trade secret misappropriation lawsuits:  In December 2008, Heraeus Kulzer GmbH (together with its affiliates, “Heraeus”) initiated legal proceedings in Germany against Biomet, Inc., Biomet Europe BV, certain other entities and certain employees alleging that the defendants misappropriated Heraeus trade secrets when developing Biomet Europe’s Refobacin and Biomet Bone Cement line of cements (“European Cements”).  The lawsuit sought to preclude the defendants from producing, marketing and offering for sale their current line of European Cements and to compensate Heraeus for any damages incurred.

On June 5, 2014, the German appeals court in Frankfurt (i) enjoined Biomet, Inc., Biomet Europe BV and Biomet Deutschland GmbH from manufacturing, selling or offering the European Cements to the extent they contain certain raw materials in particular specifications; (ii) held the defendants jointly and severally liable to Heraeus for any damages from the sale of European Cements since 2005; and (iii) ruled that no further review may be sought (the “Frankfurt Decision”).  The Heraeus and Biomet parties both sought appeal against the Frankfurt Decision.  In a decision dated June 16, 2016, the German Supreme Court dismissed the parties’ appeals without reaching the merits, rendering that decision final.

In December 2016, Heraeus filed papers to restart proceedings against Biomet Orthopaedics Switzerland GmbH, seeking to require that entity to relinquish its CE certificates for the European Cements.  In January 2017, Heraeus notified Biomet it had filed a claim for damages in the amount of €121.9 million for sales in Germany, which it later increased to 125.9 million.  In September 2017, Heraeus filed an enforcement action in the Darmstadt court against Biomet Europe, requesting that a fine be imposed against Biomet Europe for failure to disclose the amount of the European Cements which Biomet Orthopaedics Switzerland had ordered to be manufactured in Germany (e.g., for the Chinese market).  In June 2018, the Darmstadt court dismissed Heraeus’ request.  Heraeus appealed the decision.  Also in September 2017, Heraeus filed suit against Zimmer Biomet Deutschland in the court of first instance in Freiberg concerning the sale of the European Cements with certain changed raw materials.  Heraeus seeks an injunction on the basis that the continued use of the product names for the European Cements is misleading for customers and thus an act of unfair competition.  On June 29, 2018, the court in Freiberg, Germany dismissed Heraeus’ request for an injunction prohibiting the marketing of the European Cements under their current names on the grounds that the same request had already been decided upon by the Frankfurt Decision which became final and binding.  Heraeus may appeal this decision to the Court of Appeals in Karlsruhe, Germany.

On September 8, 2014, Heraeus filed a complaint against a Biomet supplier, Esschem, Inc. (“Esschem”), in the U.S. District Court for the Eastern District of Pennsylvania.  The lawsuit contained allegations that focused on two copolymer compounds that Esschem sells to Biomet, which Biomet incorporates into certain bone cement products that compete with Heraeus’ bone cement products.  The complaint alleged that Biomet helped Esschem to develop these copolymers, using Heraeus trade secrets that Biomet allegedly misappropriated.  The complaint asserted a claim under the Pennsylvania Uniform Trade Secrets Act, as well as other various common law tort claims, all based upon the same trade secret misappropriation theory.  Heraeus sought to enjoin Esschem from supplying the copolymers to any third party and actual damages.  The complaint also sought punitive damages, costs and attorneys’ fees.  Although Biomet was not a party to this lawsuit, Biomet agreed, at Esschem’s request and subject to certain

25


limitations, to indemnify Esschem for any liability, damages and legal costs related to this matter.  On November 3, 2014, the court entered an order denying Heraeus’ motion for a temporary restraining order.  On June 30, 2016, the court entered an order denying Heraeus’ request to give preclusive effect to the factual findings in the Frankfurt Decision.  On June 6, 2017, the court entered an order denying Heraeus’ motion to add Biomet as a party to the lawsuit.  On January 26, 2018, the court entered an order granting Esschem’s motion for summary judgment and dismissed all of Heraeus’ claims with prejudice.  On February 21, 2018, Heraeus filed a notice of appeal to U.S. Court of Appeals for the Third Circuit, which heard oral argument on the appeal on October 23, 2018.

On December 7, 2017, Heraeus filed a complaint against Zimmer Biomet Holdings, Inc. and Biomet, Inc. in the U.S. District Court for the Eastern District of Pennsylvania alleging a single claim of trade secret misappropriation under the Pennsylvania Uniform Trade Secrets Act based on the same factual allegations as the Esschem litigation.  On March 5, 2018, Heraeus filed an amended complaint adding a second claim of trade secret misappropriation under Pennsylvania common law.  Heraeus seeks to enjoin the Zimmer Biomet parties from future use of the allegedly misappropriated trade secrets and recovery of unspecified damages for alleged past use.  On April 18, 2018, the Zimmer Biomet parties filed a motion to dismiss both claims.

Heraeus continues to pursue other related legal proceedings in Europe seeking various forms of relief, including injunctive relief and damages, against Biomet-related entities relating to the European Cements.  On October 2, 2018, the Belgian Court of Appeal of Mons issued a judgment in favor of Heraeus relating to its request for past damages caused by the alleged misappropriation of its trade secrets, and an injunction preventing future sales of certain European Cements in Belgium.  We intend to appeal this judgment to the Belgian Supreme Court.  

We have accrued an estimated loss relating to the Frankfurt Decision, but have not recognized any losses for Heraeus-related lawsuits in other jurisdictions because we do not believe it is probable that we have incurred a liability, and we cannot reasonably estimate any loss that might eventually be incurred.  Damages relating to the Frankfurt Decision are subject to separate proceedings and it is reasonably possible that our estimate of the loss we may incur may change in the future.  Although we are vigorously defending these lawsuits, their ultimate resolution is uncertain.

Stryker patent infringement lawsuit:  On December 10, 2010, Stryker Corporation and related entities (“Stryker”) filed suit against us in the U.S. District Court for the Western District of Michigan, alleging that certain of our Pulsavac® Plus Wound Debridement Products infringe three U.S. patents assigned to Stryker.  The case was tried beginning on January 15, 2013, and on February 5, 2013, the jury found that we infringed certain claims of the subject patents.  The jury awarded  $70.0 million in monetary damages for lost profits.  The jury also found that we willfully infringed the subject patents.  We filed multiple post-trial motions, including a motion seeking a new trial.  On August 7, 2013, the trial court issued a ruling denying all of our motions and awarded treble damages and attorneys’ fees to Stryker.  We filed a notice of appeal to the Court of Appeals for the Federal Circuit to seek reversal of both the jury’s verdict and the trial court’s rulings on our post-trial motions.  Oral argument before the Court of Appeals for the Federal Circuit took place on September 8, 2014.  On December 19, 2014, the Federal Circuit issued a decision affirming the $70.0 million lost profits award but reversed the willfulness finding, vacating the treble damages award and vacating and remanding the attorneys’ fees award.  We accrued an estimated loss of $70.0 million related to this matter in the three month period ended December 31, 2014.  On January 20, 2015, Stryker filed a motion with the Federal Circuit for a rehearing en banc.  On March 23, 2015, the Federal Circuit denied Stryker’s petition.  Stryker subsequently filed a petition for certiorari to the U.S. Supreme Court.  In July 2015, we paid the final award of $90.3 million, which includes the original $70.0 million plus pre- and post-judgment interest and damages for sales that occurred post-trial but prior to our entry into a license agreement with Stryker.  On October 19, 2015, the U.S. Supreme Court granted Stryker’s petition for certiorari.  Oral argument took place on February 23, 2016.  On June 13, 2016, the U.S. Supreme Court issued its decision, vacating the judgment of the Federal Circuit and remanding the case for further proceedings related to the willfulness issue.  On September 12, 2016, the Federal Circuit issued an opinion affirming the jury’s willfulness finding and vacating and remanding the trial court’s award of treble damages, its finding that this was an exceptional case and its award of attorneys’ fees.  The case was remanded back to the trial court.  Oral argument on Stryker’s renewed consolidated motion for enhanced damages and attorneys’ fees took place on June 28, 2017.  On July 12, 2017, the trial court issued an order reaffirming its award of treble damages, its finding that this was an exceptional case and its award of attorney’s fees.  On July 24, 2017, we appealed the ruling to the Federal Circuit and obtained a supersedeas bond staying enforcement of the judgment pending appeal.  Oral argument before the Federal Circuit is scheduled for December 3, 2018.  Although we are defending this lawsuit vigorously, the ultimate resolution of this matter is uncertain.  In the future, we could be required to record a charge of up to $170.0 million that could have a material adverse effect on our results of operations and cash flows.

Putative Securities Class Action:  On December 2, 2016, a complaint was filed in the U.S. District Court for the Northern District of Indiana (Shah v. Zimmer Biomet Holdings, Inc. et al.), naming us, one of our officers and two of our now former officers as defendants.  On June 28, 2017, the plaintiffs filed a corrected amended complaint, naming as defendants, in addition to those previously named, current and former members of our Board of Directors, one additional officer, and the underwriters in connection with secondary offerings of our common stock by certain selling stockholders in 2016.  On October 6, 2017, the plaintiffs voluntarily dismissed the underwriters without prejudice.  On October 8, 2017, the plaintiffs filed a second amended complaint, naming as defendants, in addition to those current and former officers and Board members previously named, certain former stockholders of ours who sold shares of our common stock in secondary public offerings in 2016.  We and our current and former officers and Board

26


members named as defendants are sometimes hereinafter referred to as the “Zimmer Biomet Defendant group”.  The former stockholders of ours who sold shares of our common stock in secondary public offerings in 2016 are sometimes hereinafter referred to as the “Private Equity Fund Defendant group”.  The second amended complaint relates to a putative class action on behalf of persons who purchased our common stock between June 7, 2016 and November 7, 2016.  The second amended complaint generally alleges that the defendants violated federal securities laws by making materially false and/or misleading statements and/or omissions about our compliance with FDA regulations and our ability to continue to accelerate our organic revenue growth rate in the second half of 2016.  The defendants filed their respective motions to dismiss on December 20, 2017, plaintiffs filed their omnibus response to the motions to dismiss on March 13, 2018 and the defendants filed their respective reply briefs on May 18, 2018.  On September 27, 2018, the court denied the Zimmer Biomet Defendant group’s motion to dismiss in its entirety.  The court granted the Private Equity Fund Defendant group’s motion to dismiss, without prejudice.  On October 9, 2018, the Zimmer Biomet Defendant group filed a motion to amend the court’s order on the motion to certify two issues for interlocutory appeal, and a motion to stay proceedings pending appeal.  That motion remains pending.  The plaintiffs seek unspecified damages and interest, attorneys’ fees, costs and other relief.  We believe this lawsuit is without merit, and we and the individual defendants are defending it vigorously.

Regulatory Matters, Government Investigations and Other Matters  

FDA warning letters:  In August 2018, we received a warning letter from the FDA related to observed non-conformities with current good manufacturing practice requirements of the FDA’s Quality System Regulation (21 CFR Part 820) (“QSR”) at our legacy Biomet manufacturing facility in Warsaw, Indiana (this facility is sometimes referred to in this report as the “Warsaw North Campus”).  In May 2016, we received a warning letter from the FDA related to observed non-conformities with current good manufacturing practice requirements of the QSR at our facility in Montreal, Quebec, Canada.  In September 2012, we received a warning letter from the FDA citing concerns relating to certain processes pertaining to products manufactured at our Ponce, Puerto Rico manufacturing facility.  We have provided detailed responses to the FDA as to our corrective actions and will continue to work expeditiously to address the issues identified by the FDA during inspections in Warsaw, Montreal and Ponce.  As of November 1, 2018, these warning letters remained pending.  Until the violations cited in the pending warning letters are corrected, we may be subject to additional regulatory action by the FDA, as described more fully below.  Additionally, requests for Certificates to Foreign Governments related to products manufactured at certain of our facilities may not be granted and premarket approval applications for Class III devices to which the Quality System Regulation deviations at these facilities are reasonably related will not be approved until the violations have been corrected.  In addition to responding to the warning letters described above, we are in the process of addressing various FDA Form 483 inspectional observations at certain of our manufacturing facilities, including at both the legacy Zimmer and the legacy Biomet manufacturing facilities in Warsaw, Indiana.  The ultimate outcome of these matters is presently uncertain.  Among other available regulatory actions, the FDA may impose operating restrictions, including a ceasing of operations, at one or more facilities, enjoining and restraining certain violations of applicable law pertaining to medical devices and assessing civil or criminal penalties against our officers, employees or us.  The FDA could also issue a corporate warning letter, a recidivist warning letter or a consent decree of permanent injunction.  The FDA may also recommend prosecution by the U.S. Department of Justice (“DOJ”).  Any adverse regulatory action, depending on its magnitude, may restrict us from effectively manufacturing, marketing and selling our products and could have a material adverse effect on our business, financial condition and results of operations.

Deferred Prosecution Agreement (“DPA”) relating to U.S. Foreign Corrupt Practices Act (“FCPA”) matters:  On January 12, 2017, we resolved previously-disclosed FCPA matters involving Biomet and certain of its subsidiaries.  As part of the settlement, (i) Biomet resolved matters with the U.S. Securities and Exchange Commission (the “SEC”) through an administrative cease-and-desist order (the “Order”); (ii) we entered into a DPA with the DOJ; and (iii) JERDS Luxembourg Holding S.à r.l. (“JERDS”), the direct parent company of Biomet 3i Mexico SA de CV and an indirect, wholly-owned subsidiary of Biomet, entered into a plea agreement (the “Plea Agreement”) with the DOJ.  The conduct underlying these resolutions occurred prior to our acquisition of Biomet.

Pursuant to the terms of the Order, Biomet resolved claims with the SEC related to violations of the books and records, internal controls and anti-bribery provisions of the FCPA by disgorging profits to the U.S. government in an aggregate amount of approximately $6.5 million, inclusive of pre-judgment interest, and paying a civil penalty in the amount of $6.5 million (collectively, the “Civil Settlement Payments”).  We also agreed to pay a criminal penalty of approximately $17.5 million (together with the Civil Settlement Payments, the “Settlement Payments”) to the U.S. government pursuant to the terms of the DPA.  We made the Settlement Payments in January 2017 and, as previously disclosed, had accrued, as of June 24, 2015, the closing date of the Biomet merger, an amount sufficient to cover this matter.

Under the DPA, which has a term of three years, the DOJ agreed to defer criminal prosecution of us in connection with the charged violation of the internal controls provision of the FCPA as long as we comply with the terms of the DPA.  In addition, we are subject to oversight by an independent compliance monitor.  The monitor, who was appointed effective as of July 2017, will focus on legacy Biomet operations as integrated into our operations.  If we remain in compliance with the DPA during its term, the charges against us will be dismissed with prejudice.  The term of the DPA may be extended for up to one additional year at the DOJ’s discretion.  In addition, under its Plea Agreement with the DOJ, JERDS pleaded guilty on January 13, 2017 to aiding and abetting a

27


violation of the books and records provision of the FCPA.  In light of the DPA we entered into, JERDS paid only a nominal assessment and no criminal penalty.

If we do not comply with the terms of the DPA, we could be subject to prosecution for violating the internal controls provisions of the FCPA and the conduct of Biomet and its subsidiaries described in the DPA, which conduct pre-dated our acquisition of Biomet, as well as any new or continuing violations.  We could also be subject to exclusion by the Office of Inspector General of the Department of Health and Human Services (“OIG”) from participation in federal healthcare programs, including Medicaid and Medicare.  Any of these events could have a material adverse effect on our business, financial condition, results of operations and cash flows.

OIG subpoena:  In June 2017, we received a subpoena from the OIG.  The subpoena requests that we produce a variety of records primarily related to our healthcare professional consulting arrangements (including in the areas of medical education, product development, and clinical research) for the period spanning January 1, 2010 to the present.  The subpoena does not indicate the nature of the OIG’s investigation beyond reference to possible false or otherwise improper claims submitted for payment.  We are in the process of responding to the subpoena.  We cannot currently predict the outcome of this investigation

 

28


Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the interim condensed consolidated financial statements and corresponding notes included elsewhere in this Form 10-Q.  Certain percentages presented in this discussion and analysis are calculated from the underlying whole-dollar amounts and, therefore, may not recalculate from the rounded numbers used for disclosure purposes.  In addition, certain amounts in the 2017 interim condensed consolidated financial statements have been reclassified to conform to the 2018 presentation and to reflect the impact of the adoption of ASU 2017-07 and ASU 2014-09, as described in Note 2 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report.

Executive Level Overview

Results for the Three and Nine Month Periods ended September 30, 2018

Net sales increased by 1.3 percent and 2.2 percent in the three and nine month periods ended September 30, 2018, respectively, compared to the same prior year periods.  The sales increases were driven primarily by volume/mix in our Knees and Hips product categories and continued strong performance in our Asia Pacific operating segment.  We continue to make progress addressing our ongoing supply and quality remediation challenges at our Warsaw North Campus facility.  In the three month period ended September 30, 2018, our net sales also benefited from the timing of capital equipment sales in the Americas in our S.E.T. product category and customer tenders in EMEA.  

Our net earnings increased in the three month period ended September 30, 2018 compared to the same prior year period and declined in the nine month period ended September 30, 2018 compared to the same prior year period.  In the three month period ended September 30, 2018, sales increases and lower acquisition, integration and related expenses, goodwill and intangible asset impairment and quality remediation expenses were partially offset by increased excess and obsolescence charges, incremental production and inventory costs at our Warsaw North Campus facility and continued investments in research and development (“R&D) and selling, general and administrative (“SG&A”).  The decline in net earnings in the nine month period ended September 30, 2018 was primarily due to the same reasons, as well as tax benefits recognized in the nine month period ended September 30, 2017 of $69.7 million resulting from a tax restructuring that lowered the tax rate on certain deferred tax liabilities recorded on intangible assets recognized in acquisition-related accounting and $128.6 million related to resolution of certain tax matters.  

2018 Outlook

  

We estimate our sales growth in 2018 over 2017 will be in a range of 1.0 to 2.5 percent.  This estimate assumes foreign currency exchange rates will increase sales by slightly less than 1.0 percent.  Beginning in the fourth quarter of 2018, our revenues will be impacted by disruption related to the pending termination of our U.S. distribution agreement with a bone cement supplier.  We are actively working to mitigate this issue by transitioning customers to our internally-produced bone cement, but at this time, we anticipate the termination of this distribution agreement may have a negative impact of between $10 million and $15 million per quarter on our Other product category revenue.  

We estimate cost of products sold will be higher in 2018 compared to the prior year due to the higher costs of products manufactured at our Warsaw North Campus facility.  Based on our inventory turns, these costs are expected to continue to impact our costs of product sold into 2019.  We expect ongoing benefits from the reduction of the U.S. corporate income tax rate, and we plan to reinvest those savings into the business to drive sales growth.  Accordingly, we expect R&D and SG&A expenses to be higher in 2018 compared to 2017.  We expect our acquisition, integration and related expenses to decline in 2018 compared to 2017 as we complete our integration activities related to the Biomet merger and other 2016 acquisitions.   We expect quality remediation expense to remain consistent in 2018 compared to 2017 as we continue our quality remediation at our Warsaw North Campus facility.  We expect interest expense to be lower in 2018 compared to 2017 due to lower debt levels.  

We continue to refine our estimates related to impacts of the 2017 Tax Act.  In the year ended December 31, 2017, we recognized an income tax benefit of $1,272.4 million.  In accordance with authoritative guidance issued by the SEC, the income tax effect for certain aspects of the 2017 Tax Act represents provisional amounts for which our accounting is incomplete, but with respect to which a reasonable estimate could be determined.  In the three and nine month periods ended September 30, 2018, we have refined our estimate of the impacts of the 2017 Tax Act and have reduced the income tax benefit by $12.0 million.  The actual effects of the 2017 Tax Act and final amounts recorded may differ materially from our current estimate of provisional amounts due to, among other things, further interpretive guidance that may be issued by U.S. tax authorities or regulatory bodies, including the SEC and the FASB.  We will continue to analyze the 2017 Tax Act and any additional guidance that may be issued so we can finalize the full effects of applying the new legislation on our financial statements in the measurement period, which ends in the fourth quarter of 2018.  See Note 11 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report for additional details related to the 2017 Tax Act.

29


Results of Operations

We analyze sales by three geographies, the Americas, EMEA and Asia Pacific, and by the following product categories: Knees, Hips, S.E.T., Dental, Spine & CMF and Other.  This sales analysis differs from our reportable operating segments, which are based upon our senior management organizational structure and how we allocate resources towards achieving operating profit goals.  We analyze sales by geography because the underlying market trends in any particular geography tend to be similar across product categories and because we primarily sell the same products in all geographies.  Our business is seasonal in nature to some extent, as many of our products are used in elective procedures, which typically decline during the summer months and can increase at the end of the year once annual deductibles have been met on health insurance plans.

Net Sales by Geography

The following tables present our net sales by geography and the components of the percentage changes (dollars in millions):

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30,

 

 

% Inc /

 

 

Volume /

 

 

 

 

 

 

Foreign

 

 

 

 

2018

 

 

2017

 

 

(Dec)

 

 

Mix

 

 

Price

 

 

Exchange

 

 

Americas

 

$

1,153.6

 

 

$

1,137.0

 

 

 

1.5

 

%

 

4.1

 

%

 

(2.4

)

%

 

(0.2

)

%

EMEA

 

 

372.1

 

 

 

381.1

 

 

 

(2.3

)

 

 

2.0

 

 

 

(2.0

)

 

 

(2.3

)

 

Asia Pacific

 

 

311.0

 

 

 

295.0

 

 

 

5.4

 

 

 

10.8

 

 

 

(3.2

)

 

 

(2.2

)

 

Total

 

$

1,836.7

 

 

$

1,813.1

 

 

 

1.3

 

 

 

4.7

 

 

 

(2.4

)

 

 

(1.0

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30,

 

 

 

 

 

 

Volume /

 

 

 

 

 

 

Foreign

 

 

 

 

2018

 

 

2017

 

 

% Inc

 

 

Mix

 

 

Price

 

 

Exchange

 

 

Americas

 

$

3,578.0

 

 

$

3,570.8

 

 

 

0.2

 

%

 

2.5

 

%

 

(2.4

)

%

 

0.1

 

%

EMEA

 

 

1,326.3

 

 

 

1,272.5

 

 

 

4.2

 

 

 

0.6

 

 

 

(2.3

)

 

 

5.9

 

 

Asia Pacific

 

 

957.6

 

 

 

891.7

 

 

 

7.4

 

 

 

8.8

 

 

 

(3.6

)

 

 

2.2

 

 

Total

 

$

5,861.9

 

 

$

5,735.0

 

 

 

2.2

 

 

 

3.0

 

 

 

(2.5

)

 

 

1.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

“Foreign Exchange,” as used in the tables in this report, represents the effect of changes in foreign currency exchange rates on sales.  

30


Net Sales by Product Category

The following tables present our net sales by product category and the components of the percentage changes (dollars in millions):

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30,

 

 

% Inc /

 

 

Volume /

 

 

 

 

 

 

Foreign

 

 

 

 

2018

 

 

2017

 

 

(Dec)

 

 

Mix

 

 

Price

 

 

Exchange

 

 

Knees

 

$

627.9

 

 

$

622.9

 

 

 

0.8

 

%

 

5.0

 

%

 

(2.9

)

%

 

(1.3

)

%

Hips

 

 

444.8

 

 

 

432.8

 

 

 

2.8

 

 

 

7.2

 

 

 

(3.3

)

 

 

(1.1

)

 

S.E.T.

 

 

414.6

 

 

 

404.8

 

 

 

2.4

 

 

 

4.9

 

 

 

(1.8

)

 

 

(0.7

)

 

Dental

 

 

92.3

 

 

 

92.9

 

 

 

(0.6

)

 

 

-

 

 

 

(0.2

)

 

 

(0.4

)

 

Spine & CMF

 

 

184.9

 

 

 

184.5

 

 

 

0.2

 

 

 

2.1

 

 

 

(1.4

)

 

 

(0.5

)

 

Other

 

 

72.2

 

 

 

75.2

 

 

 

(4.0

)

 

 

(1.4

)

 

 

(1.9

)

 

 

(0.7

)

 

Total

 

$

1,836.7

 

 

$

1,813.1

 

 

 

1.3

 

 

 

4.7

 

 

 

(2.4

)

 

 

(1.0

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30,

 

 

% Inc /

 

 

Volume /

 

 

 

 

 

 

Foreign

 

 

 

 

2018

 

 

2017

 

 

(Dec)

 

 

Mix

 

 

Price

 

 

Exchange

 

 

Knees

 

$

2,044.2

 

 

$

2,003.7

 

 

 

2.0

 

%

 

3.3

 

%

 

(2.9

)

%

 

1.6

 

%

Hips

 

 

1,423.7

 

 

 

1,374.6

 

 

 

3.6

 

 

 

4.4

 

 

 

(3.0

)

 

 

2.2

 

 

S.E.T.

 

 

1,290.7

 

 

 

1,249.4

 

 

 

3.3

 

 

 

4.0

 

 

 

(2.2

)

 

 

1.5

 

 

Dental

 

 

306.8

 

 

 

311.1

 

 

 

(1.4

)

 

 

(2.6

)

 

 

(1.1

)

 

 

2.3

 

 

Spine & CMF

 

 

566.2

 

 

 

564.1

 

 

 

0.4

 

 

 

1.2

 

 

 

(1.8

)

 

 

1.0

 

 

Other

 

 

230.3

 

 

 

232.1

 

 

 

(0.8

)

 

 

(0.6

)

 

 

(1.5

)

 

 

1.3

 

 

Total

 

$

5,861.9

 

 

$

5,735.0

 

 

 

2.2

 

 

 

3.0

 

 

 

(2.5

)

 

 

1.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 The following table presents our net sales by geography for our Knees and Hips product categories, which represent our most significant product categories (dollars in millions):  

 

 

 

Three Months Ended September 30,

 

 

% Inc /

 

 

 

Nine Months Ended September 30,

 

 

% Inc /

 

 

 

 

2018

 

 

2017

 

 

(Dec)

 

 

 

2018

 

 

2017

 

 

(Dec)

 

 

Knees

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Americas

 

$

384.6

 

 

$

381.5

 

 

 

0.8

 

%

 

$

1,209.9

 

 

$

1,214.9

 

 

 

(0.4

)

%

EMEA

 

 

134.3

 

 

 

135.1

 

 

 

(0.6

)

 

 

 

494.0

 

 

 

462.8

 

 

 

6.8

 

 

Asia Pacific

 

 

109.0

 

 

 

106.3

 

 

 

2.5

 

 

 

 

340.3

 

 

 

326.0

 

 

 

4.4

 

 

Total

 

$

627.9

 

 

$

622.9

 

 

 

0.8

 

 

 

$

2,044.2

 

 

$

2,003.7

 

 

 

2.0

 

 

Hips

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Americas

 

$

240.0

 

 

$

226.6

 

 

 

5.9

 

%

 

$

737.8

 

 

$

714.5

 

 

 

3.3

 

%

EMEA

 

 

107.6

 

 

 

115.1

 

 

 

(6.4

)

 

 

 

383.6

 

 

 

382.0

 

 

 

0.4

 

 

Asia Pacific

 

 

97.2

 

 

 

91.1

 

 

 

6.7

 

 

 

 

302.3

 

 

 

278.1

 

 

 

8.7

 

 

Total

 

$

444.8

 

 

$

432.8

 

 

 

2.8

 

 

 

$

1,423.7

 

 

$

1,374.6

 

 

 

3.6

 

 

 

Demand (Volume and Mix) Trends  

Increased volume and changes in the mix of product sales had a positive effect of 4.7 percent and 3.0 percent on year-over-year sales during the three and nine month periods ended September 30, 2018, respectively.  Volume/mix growth was driven by recent product introductions, sales in key emerging markets and an aging population.  In the three month period, we also had additional growth driven by the timing of capital equipment sales in the Americas in our S.E.T. product category and customer tenders in EMEA.

We believe long-term indicators point toward sustained growth driven by an aging global population, growth in emerging markets, obesity, proven clinical benefits, new material technologies, advances in surgical techniques and more active lifestyles, among other factors.  In addition, demand for clinically proven premium products and patient specific devices are expected to continue to positively affect sales growth in markets that recognize the value of these advanced technologies.    

31


Pricing Trends

Global selling prices had a negative effect of 2.4 percent and 2.5 percent on year-over-year sales during the three and nine month periods ended September 30, 2018, respectively.  The majority of countries in which we operate continue to experience pricing pressure from governmental healthcare cost containment efforts and from local hospitals and health systems.  

Foreign Currency Exchange Rates

For the three and nine month periods ended September 30, 2018, changes in foreign currency exchange rates had a negative effect of 1.0 percent and a positive effect of 1.7 percent, respectively, on year-over-year sales.  If foreign currency exchange rates remain consistent with recent rates, we estimate foreign currency exchange rates will have a positive effect of slightly less than 1.0 percent for the entire year.  

Sales by Product Category

Knees

Knee sales increased in the three and nine month periods ended September 30, 2018 when compared to the same prior year periods primarily due to volume/mix growth in the EMEA and Asia Pacific operating segments.  Knee sales volume/mix growth was led by Persona® The Personalized Knee System and the Oxford® Partial Knee.  

Hips

Hip sales increased in the three and nine month periods ended September 30, 2018 when compared to the same prior year periods primarily due volume/mix growth in the Americas and Asia Pacific operating segments.  Hip sales volume/mix growth was led by our Taperloc® Complete Hip System, Arcos® Modular Hip System and G7® Acetabular System.  Improved supply contributed positively to our results in the Hips product category.

S.E.T.

Our S.E.T. product category sales increased in the three and nine month periods ended September 30, 2018 when compared to the same prior year periods, driven primarily by a growing emphasis on sales force specialization, strong performance by certain key brands and notable capital equipment sales in the third quarter.

Dental

Dental sales declined in the three and nine month periods ended September 30, 2018 when compared to the same prior year periods.  The decline is due to ongoing competitive challenges in the U.S. and EMEA.

Spine and CMF

Spine and CMF sales increased in the three and nine month periods ended September 30, 2018 when compared to the same prior year periods, primarily due to continuing strong sales of our Thoracic products partially offset by a decline in Spine sales driven by continuing U.S. distributor integration issues.

Expenses as a Percentage of Net Sales

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

 

 

 

 

 

 

 

September 30,

 

 

 

% Inc /

 

 

 

September 30,

 

 

 

% Inc /

 

 

 

 

2018

 

 

 

2017

 

 

 

(Dec)

 

 

 

2018

 

 

 

2017

 

 

 

(Dec)

 

 

Cost of products sold, excluding intangible

   asset amortization

 

 

28.8

 

%

 

 

27.6

 

%

 

 

1.2

 

%

 

 

28.8

 

%

 

 

26.9

 

%

 

 

1.9

 

%

Intangible asset amortization

 

 

8.0

 

 

 

 

8.4

 

 

 

 

(0.4

)

 

 

 

7.6

 

 

 

 

7.9

 

 

 

 

(0.3

)

 

Research and development

 

 

5.2

 

 

 

 

5.0

 

 

 

 

0.2

 

 

 

 

5.0

 

 

 

 

4.8

 

 

 

 

0.2

 

 

Selling, general and administrative

 

 

42.9

 

 

 

 

39.3

 

 

 

 

3.6

 

 

 

 

40.6

 

 

 

 

39.1

 

 

 

 

1.5

 

 

Goodwill and intangible asset impairment

 

 

0.2

 

 

 

 

1.8

 

 

 

 

(1.6

)

 

 

 

0.1

 

 

 

 

1.0

 

 

 

 

(0.9

)

 

Acquisition, integration and related

 

 

0.9

 

 

 

 

3.4

 

 

 

 

(2.5

)

 

 

 

1.9

 

 

 

 

3.4

 

 

 

 

(1.5

)

 

Quality remediation

 

 

1.8

 

 

 

 

2.8

 

 

 

 

(1.0

)

 

 

 

1.9

 

 

 

 

2.4

 

 

 

 

(0.5

)

 

Operating profit

 

 

12.2

 

 

 

 

11.6

 

 

 

 

0.6

 

 

 

 

14.1

 

 

 

 

14.6

 

 

 

 

(0.5

)

 

32


 

The increase in cost of products sold as a percentage of net sales for the three and nine month periods ended September 30, 2018 compared to the same prior year periods was primarily due to lower average selling prices, increased manufacturing costs at our Warsaw North Campus facility and higher excess and obsolete inventory charges.  Additionally, the nine month period ended September 30, 2018 was negatively affected by our hedging program and positively affected by lower inventory step-up charges.  We incurred hedge losses of $26.5 million in the nine month period ended September 30, 2018 compared to hedge gains of $12.0 million in the same prior year period.  For derivatives which qualify as hedges of future cash flows, the effective portion of changes in fair value is temporarily recorded in other comprehensive income and then recognized in cost of products sold when the hedged items affect earnings.  Inventory step-up charges represent the difference in cost of products sold between inventory expensed at fair value after business combination accounting is applied versus what cost of products sold would have been had inventory been recognized at historical cost.  The reduction in inventory step-up charges during the 2018 periods was primarily the result of the step-up to fair value of the LDR Holding Corporation inventory having been fully recognized by September 30, 2017.

Intangible asset amortization expense and intangible asset amortization expense as a percentage of net sales remained generally consistent between the three and nine month periods ended September 30, 2018 and 2017 as there were no significant business combinations in the past year.

R&D expenses and R&D expenses as a percentage of net sales increased slightly in the three and nine month periods ended September 30, 2018 compared to the same prior year periods, primarily due to increased investment in our Knee product pipeline.

SG&A expenses and SG&A expenses as a percentage of net sales increased in the three and nine month periods ended September 30, 2018 when compared to the same prior year periods.  The primary drivers of the increased expense were higher sales, increased investments in our specialized sales force, increased expenses related to our compliance with the DPA, increased incentive compensation due to better performance versus our operating budgets and various spending on other special business transformation initiatives.  

We recognized $3.8 million of goodwill and intangible asset impairment in the three and nine month periods ended September 30, 2018, respectively.  The impairment was due to the termination of certain in-process research and development (“IPR&D”) projects.  We recognized $32.7 million and $59.5 million of goodwill and intangible asset impairment in the three and nine month periods ended September 30, 2017, respectively.  The $32.7 million in the three month period of 2017 was goodwill impairment on our Office Based Technologies reporting unit.  The reporting unit’s operating performance had been lower than expected due to integration issues, management turnover and poor execution of its operating plans, resulting in our decision to write off all goodwill on that reporting unit.  In the nine month period of 2017, we also recognized $26.8 million of intangible asset impairment that was primarily due to the termination of certain IPR&D projects.

Acquisition, integration and related expenses declined in the three and nine month periods ended September 30, 2018 compared to the same prior year periods due to the natural regression of integration activities related to the 2015 Biomet merger and other various acquisitions that were consummated in 2016.  We are nearing completion of our integration plans for these businesses.    

Our quality enhancement and remediation efforts began in late 2016, accelerated throughout 2017 and will continue throughout 2018.  These costs primarily relate to fees paid to temporary external consultants engaged to assist in the remediation of our Warsaw North Campus facility.

Other Expense, Net, Interest Income, Interest Expense and Income Taxes

In the three and nine month periods ended September 30, 2018 and 2017, other expense, net, was primarily related to certain components of pension expense and remeasuring monetary assets and liabilities denominated in a foreign currency other than an entity’s functional currency, partially offset by foreign currency forward exchange contracts we entered into to mitigate any gain or loss.  

Net interest expense decreased in the three and nine month periods ended September 30, 2018, compared to the same prior year periods, primarily due to lower average outstanding debt balances during the 2018 periods resulting from debt repayments throughout 2017 and hedging strategies that have lowered our effective interest rate.    

In the three and nine month periods ended September 30, 2018, our effective tax rate (“ETR”) was negative 5.5 percent and positive 12.1 percent, respectively.  In the three and nine month periods ended September 30, 2018, we recognized tax benefits resulting from return to provision adjustments related to changes in estimated tax rates on deferred tax liabilities recorded on acquisition-related intangible assets.  The change in estimates from these adjustments resulted in tax benefits of $16.9 million in the

33


three and nine month periods ended September 30, 2018.  In the prior year periods, we had certain discrete adjustments that significantly impacted our ETR.  In the nine month period ended September 30, 2017, we recognized a tax benefit of $69.7 million resulting from a tax restructuring that lowered the tax rate on certain deferred tax liabilities recorded on intangible assets recognized in acquisition-related accounting.  In the three and nine month periods ended September 30, 2017, we recognized tax benefits of $39.8 million and $128.6 million, respectively, related to resolution of certain tax matters.  In addition, our prior year ETR was affected by the significant expenses associated with the Biomet merger and other acquisitions which have generally been recognized in higher income tax jurisdictions.  Accordingly, this has reduced our ETR as our earnings have been lower in these higher income tax jurisdictions.  

Our future ETR is expected to be unfavorably impacted by the 2017 Tax Act as we establish an estimate for a new U.S. tax on certain off-shore earnings, referred to as GILTI, at an effective tax rate of 10.5 percent for tax years beginning after December 31, 2017 (increasing to 13.125 percent for tax years beginning after December 31, 2025), with a partial offset from foreign tax credits.  See Note 11 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report for further details related to the 2017 Tax Act.  Our ETR in future periods could also potentially be impacted by changes in our mix of pre-tax earnings; changes in tax rates, tax laws or their interpretation, including the European Union rules on state aid; the outcome of various federal, state and foreign audits; and the expiration of certain statutes of limitations.  Currently, we cannot reasonably estimate the impact of these items on our financial results.

Segment Operating Profit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Profit as a

 

 

 

 

Net Sales

 

 

Operating Profit

 

 

Percentage of Net Sales

 

 

 

 

Three Months Ended

 

 

Three Months Ended

 

 

Three Months Ended

 

 

 

 

September 30,

 

 

September 30,

 

 

September 30,

 

 

(dollars in millions)

 

2018

 

 

2017

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

 

Americas

 

$

934.5

 

 

$

916.7

 

 

$

479.8

 

 

$

501.4

 

 

 

51.3

 

%

 

54.7

 

%

EMEA

 

 

326.8

 

 

 

335.4

 

 

 

85.5

 

 

 

96.4

 

 

 

26.2

 

 

 

28.7

 

 

Asia Pacific

 

 

295.9

 

 

 

281.7

 

 

 

94.8

 

 

 

98.3

 

 

 

32.0

 

 

 

34.9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Profit as a

 

 

 

 

Net Sales

 

 

Operating Profit

 

 

Percentage of Net Sales

 

 

 

 

Nine Months Ended

 

 

Nine Months Ended

 

 

Nine Months Ended

 

 

 

 

September 30,

 

 

September 30,

 

 

September 30,

 

 

(dollars in millions)

 

2018

 

 

2017

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

 

Americas

 

$

2,904.7

 

 

$

2,886.5

 

 

$

1,515.0

 

 

$

1,566.6

 

 

 

52.2

 

%

 

54.3

 

%

EMEA

 

 

1,159.4

 

 

 

1,108.5

 

 

 

344.5

 

 

 

345.0

 

 

 

29.7

 

 

 

31.1

 

 

Asia Pacific

 

 

914.1

 

 

 

850.5

 

 

 

309.7

 

 

 

308.7

 

 

 

33.9

 

 

 

36.3

 

 

 

In the Americas, operating profit as a percentage of net sales decreased in the three and nine month periods ended September 30, 2018 compared to the same prior year periods primarily due to price declines and higher excess and obsolete inventory charges caused by the Warsaw North Campus facility supply issues and quality remediation efforts.  

In EMEA and Asia Pacific, operating profit as a percentage of net sales decreased in the three and nine month periods ended September 30, 2018 compared to the same prior year periods primarily due to price declines and higher excess and obsolete inventory charges.  

Non-GAAP Operating Performance Measures

34


We use financial measures that differ from financial measures determined in accordance with GAAP to evaluate our operating performance.  These non-GAAP financial measures exclude the impact of inventory step-up; certain inventory and manufacturing-related charges including charges to discontinue certain product lines; intangible asset amortization; goodwill and intangible asset impairment; acquisition, integration and related expenses; quality remediation expenses; certain litigation gains and charges; other charges; any related effects on our income tax provision associated with these items; and other certain tax adjustments.  We use these non-GAAP financial measures internally to evaluate the performance of the business.  Additionally, we believe these non-GAAP measures provide meaningful incremental information to investors to consider when evaluating our performance.  We believe these measures offer the ability to make period-to-period comparisons that are not impacted by certain items that can cause dramatic changes in reported income but that do not impact the fundamentals of our operations.  The non-GAAP measures enable the evaluation of operating results and trend analysis by allowing a reader to better identify operating trends that may otherwise be masked or distorted by these types of items that are excluded from the non-GAAP measures.  In addition, adjusted diluted earnings per share is used as a performance metric in our incentive compensation programs.

The following are reconciliations from our GAAP net earnings and diluted earnings per share to our non-GAAP adjusted net earnings and non-GAAP adjusted diluted earnings per share used for internal management purposes (in millions, except per share amounts):

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Net Earnings of Zimmer Biomet Holdings, Inc.

 

$

162.2

 

 

$

98.8

 

 

$

521.9

 

 

$

582.4

 

Inventory step-up and other inventory and

   manufacturing-related charges(1)

 

 

5.0

 

 

 

11.5

 

 

 

24.7

 

 

 

52.7

 

Intangible asset amortization(2)

 

 

147.6

 

 

 

152.7

 

 

 

447.9

 

 

 

452.4

 

Goodwill and intangible asset impairment(3)

 

 

3.8

 

 

 

32.7

 

 

 

3.8

 

 

 

59.5

 

Acquisition, integration and related(4)

 

 

17.4

 

 

 

61.6

 

 

 

113.9

 

 

 

192.3

 

Quality remediation(5)

 

 

34.2

 

 

 

50.0

 

 

 

125.8

 

 

 

141.2

 

Litigation(6)

 

 

14.0

 

 

 

8.0

 

 

 

15.5

 

 

 

15.0

 

Other charges(7)

 

 

25.0

 

 

 

11.6

 

 

 

47.7

 

 

 

32.4

 

Taxes on above items(8)

 

 

(54.1

)

 

 

(79.2

)

 

 

(149.5

)

 

 

(264.4

)

Other certain tax adjustments(9)

 

 

(20.5

)

 

 

2.2

 

 

 

(34.2

)

 

 

(55.6

)

Adjusted Net Earnings

 

$

334.6

 

 

$

349.9

 

 

$

1,117.5

 

 

$

1,207.9

 

 

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Diluted Earnings Per Share

 

$

0.79

 

 

$

0.48

 

 

$

2.55

 

 

$

2.86

 

Inventory step-up and other inventory and

   manufacturing-related charges(1)

 

 

0.02

 

 

 

0.06

 

 

 

0.12

 

 

 

0.26

 

Intangible asset amortization(2)

 

 

0.72

 

 

 

0.75

 

 

 

2.19

 

 

 

2.22

 

Goodwill and intangible asset impairment(3)

 

 

0.02

 

 

 

0.16

 

 

 

0.02

 

 

 

0.29

 

Acquisition, integration and related(4)

 

 

0.08

 

 

 

0.30

 

 

 

0.56

 

 

 

0.94

 

Quality remediation(5)

 

 

0.17

 

 

 

0.25

 

 

 

0.61

 

 

 

0.70

 

Litigation(6)

 

 

0.07

 

 

 

0.04

 

 

 

0.08

 

 

 

0.07

 

Other charges(7)

 

 

0.12

 

 

 

0.06

 

 

 

0.23

 

 

 

0.16

 

Taxes on above items(8)

 

 

(0.26

)

 

 

(0.39

)

 

 

(0.74

)

 

 

(1.30

)

Other certain tax adjustments(9)

 

 

(0.10

)

 

 

0.01

 

 

 

(0.17

)

 

 

(0.27

)

Adjusted Diluted Earnings Per Share

 

$

1.63

 

 

$

1.72

 

 

$

5.45

 

 

$

5.93

 

 

(1)

Inventory step-up and other inventory and manufacturing-related charges relate to inventory step-up expense, excess and obsolete inventory charges on certain product lines we intend to discontinue and other inventory and manufacturing-related charges.  Inventory step-up expense represents the incremental expense of inventory sold recognized at its fair value after business combination accounting is applied versus the expense that would have been recognized if sold at its cost to manufacture.  Since only the inventory that existed at the business combination date was stepped-up to fair value, we believe excluding the incremental expense provides investors useful information as to what our costs may have been if we had not been required to increase the inventory’s book value to fair value.  Only the 2017 periods include inventory step-up expenses.  The excess and

35


obsolete inventory charges on certain product lines are driven by acquisitions where there are competing product lines and we have plans to discontinue one of the competing product lines.  

 

(2)

We exclude intangible asset amortization from our non-GAAP financial measures because we internally assess our performance against our peers without this amortization.  Due to various levels of acquisitions among our peers, intangible asset amortization can vary significantly from company to company.

 

(3)

In the 2018 periods, we recognized $3.8 million of intangible asset impairment.  In the 2017 periods, we recognized $32.7 million of goodwill impairment and $26.8 million of intangible asset impairment.  

 

(4)

The acquisition, integration and related expenses we have excluded from our non-GAAP financial measures resulted from our merger with Biomet in 2015 and various acquisitions we consummated in 2016.  For Biomet, we have detailed integration roadmaps that cover a three year period from the merger date to accomplish the tasks we feel are necessary to integrate the businesses.  For the various 2016 acquisitions, we also have integration plans that are necessary to integrate the businesses.  The acquisition, integration and related expenses include the following types of expenses:  

 

Consulting and professional fees related to third-party integration consulting performed in a variety of areas, such as tax, compliance, logistics and human resources, and legal fees related to the consummation of mergers and acquisitions.  

 

Employee termination benefits related to various areas of our business.  

 

Dedicated project personnel expenses which include the salary, benefits, travel expenses and other costs directly associated with employees who are 100 percent dedicated to our integration of acquired businesses and employees who have been notified of termination.  

 

Contract termination expenses related to terminated contracts, primarily with sales agents and distribution agreements.  

 

Other various expenses to relocate facilities, integrate information technology, losses incurred on assets resulting from the applicable acquisition, and other various expenses.

 

(5)

We are addressing inspectional observations on Form 483 and a warning letter issued by the FDA following its inspections of our Warsaw North Campus facility, among other matters.  This quality remediation has required us to devote significant financial resources and is for a discrete period of time.  The majority of these expenses are related to consultants who are helping us to update previous documents and redesign certain processes.

 

(6)

We are involved in routine patent litigation, product liability litigation, commercial litigation and other various litigation matters.  We review litigation matters from both a qualitative and quantitative perspective to determine if excluding the losses or gains will provide our investors with useful incremental information.  Litigation matters can vary in their characteristics, frequency and significance to our operating results.  The litigation charges or gains excluded from our non-GAAP financial measures in the periods presented relate to product liability matters where we have received numerous claims on specific products and intellectual property litigation.  Due to the complexities involved and claims filed in multiple districts, the expenses associated with these matters are significant to our operating results.  Once the litigation matter has been excluded from our non-GAAP financial measures in a particular period, any additional expenses or gains from changes in estimates are also excluded, even if they are not significant, to ensure consistency in our non-GAAP financial measures from period-to-period.

 

(7)

We have incurred other various expenses from specific events or projects that we consider highly variable or have a significant impact to our operating results that we have excluded from our non-GAAP measures.  This includes our costs of complying with our DPA with the U.S. government related to certain FCPA matters involving Biomet and certain of its subsidiaries.  Under the DPA, which has a three-year term, we are subject to oversight by an independent compliance monitor, which monitorship commenced in July 2017.  The excluded costs include the fees paid to the independent compliance monitor and to external legal counsel assisting in the matter.

 

(8)

Represents the tax effects on the previously specified items.  The tax effect for the U.S. jurisdiction is calculated based on an effective rate considering federal and state taxes, as well as permanent items.  For jurisdictions outside the U.S., the tax effect is calculated based upon the statutory rates where the items were incurred.

 

36


(9)

Other certain tax adjustments in the three and nine month periods ended September 30, 2018 primarily related to changes in tax rates on deferred tax liabilities recorded on intangible assets recognized in acquisition-related accounting and adjustments from internal restructuring transactions that provide us access to offshore funds in a tax efficient manner.  In the three and nine month periods ended September 30, 2017, other certain tax adjustments related to tax restructuring that lowered the tax rate on deferred tax liabilities recorded on intangible assets recognized in acquisition-related accounting, net favorable resolutions of various tax matters, and charges from internal restructuring transactions that provide us access to cash in a tax efficient manner.

 

Liquidity and Capital Resources

Cash flows provided by operating activities were $1,367.9 million in the nine month period ended September 30, 2018, compared to $1,179.4 million in the same prior year period.  The increase was driven by additional cash flows from our sale of accounts receivable in certain countries as well as certain significant payments made in the 2017 period.  In the 2017 period, we made payments related to the U.S. Durom Cup Settlement Program, and we paid $30.5 million in Settlement Payments to resolve previously-disclosed FCPA matters involving Biomet and certain of its subsidiaries as discussed in Note 15 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report.

Cash flows used in investing activities were $334.2 million in the nine month period ended September 30, 2018, compared to $382.6 million in the same prior year period.  Instrument and property, plant and equipment additions reflected ongoing investments in our product portfolio and optimization of our manufacturing and logistics network.  

Cash flows used in financing activities were $1,026.7 million in the nine month period ended September 30, 2018, compared to $977.6 million in the same prior year period.  In the 2018 period, we issued $749.5 million of additional senior notes and borrowed $400.0 million from our Multicurrency Revolving Facility to repay $1,150.0 million of senior notes that became due on April 2, 2018.  We repaid the $400.0 million of Multicurrency Revolving Facility borrowings and also repaid $425.0 million on U.S. Term Loan A and $75.0 million on U.S. Term Loan B in the 2018 period.  In the 2017 period, we borrowed and subsequently repaid $400.0 million on our Multicurrency Revolving Facility in order to repay $500.0 million of senior notes that became due on April 1, 2017.  In the 2017 period, we also borrowed amounts under a new Japan Term Loan B and used the borrowings to pay down a portion of U.S. Term Loan A.  In the 2018 period, we also had net cash outflows of $54.6 million related to our factoring programs caused by the timing differences of collections from customers and repayments to the financial institution to which we sold the collected receivables.

In February, May and August 2018, our Board of Directors declared a quarterly cash dividend of $0.24 per share.  We expect to continue paying cash dividends on a quarterly basis; however, future dividends are subject to approval of the Board of Directors and may be adjusted as business needs or market conditions change.  Additionally, our debt facilities restrict the payment of dividends in certain circumstances.

In February 2016, our Board of Directors authorized a new $1.0 billion share repurchase program effective March 1, 2016, with no expiration date.  The previous program expired on February 29, 2016.  As of September 30, 2018, all $1.0 billion remained authorized.  

We will continue to exercise disciplined capital allocation designed to drive stockholder value creation.  We intend to use available cash for reinvestment in the business, debt repayment and dividends.  If the right opportunities arise, we may also use available cash to pursue business development opportunities.

As discussed in Note 11 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report, the IRS has issued proposed adjustments for years 2005 through 2012 reallocating profits between certain of our U.S. and foreign subsidiaries.  We have disputed these proposed adjustments and intend to vigorously defend our positions.  Although the ultimate timing for resolution of the disputed tax issues is uncertain, future payments may be significant to our operating cash flows.

Also, as discussed in Note 15 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report, as of September 30, 2018, a short-term liability of $48.9 million and a long-term liability of $63.4 million related to Durom Cup product liability claims were recorded on our condensed consolidated balance sheet.  We expect to continue paying these claims over the next few years.  We maintain insurance for product liability claims, subject to self-insurance retention requirements.  We have recovered insurance proceeds from certain of our insurance carriers for Durom Cup-related claims.  While we may recover additional insurance proceeds in the future for Durom Cup-related claims, we do not have a receivable recorded on our condensed consolidated balance sheet as of September 30, 2018 for any possible future insurance recoveries for these claims.  As of September 30, 2018, we also had a short-term liability of $62.1 million related to Biomet metal-on-metal hip implant claims.

37


At September 30, 2018, we had twelve tranches of senior notes outstanding as follows (dollars in millions):

 

 

 

 

 

Interest

 

 

 

Principal

 

 

Rate

 

 

Maturity Date

$

500.0

 

 

 

4.625

 

 

November 30, 2019

 

1,500.0

 

 

 

2.700

 

 

April 1, 2020

 

450.0

 

 

Floating

 

 

March 19, 2021

 

300.0

 

 

 

3.375

 

 

November 30, 2021

 

750.0

 

 

 

3.150

 

 

April 1, 2022

 

580.8

 

*

 

1.414

 

 

December 13, 2022

 

300.0

 

 

 

3.700

 

 

March 19, 2023

 

2,000.0

 

 

 

3.550

 

 

April 1, 2025

 

580.8

 

*

 

2.425

 

 

December 13, 2026

 

253.4

 

 

 

4.250

 

 

August 15, 2035

 

317.8

 

 

 

5.750

 

 

November 30, 2039

 

395.4

 

 

 

4.450

 

 

August 15, 2045

 

*

Euro denominated debt securities

We also had four term loans with total principal of $1,301.9 million outstanding as of September 30, 2018.  

We have a $1.5 billion Multicurrency Revolving Facility that will mature on September 30, 2021.  There were no outstanding borrowings under this facility as of September 30, 2018.  We also have other available uncommitted credit facilities totaling $55.8 million as of September 30, 2018.

For additional information on our debt, see Note 7 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report.

We place our cash and cash equivalents in highly-rated financial institutions and limit the amount of credit exposure to any one entity.  We invest only in high-quality financial instruments in accordance with our internal investment policy.

As of September 30, 2018, $329.0 million of our cash and cash equivalents were held in jurisdictions outside of the U.S.  Of this amount, $71.0 million is denominated in U.S. Dollars and, therefore, bears no foreign currency translation risk.  The balance of these assets is denominated in currencies of the various countries where we operate.  We intend to repatriate at least $3.6 billion of unremitted earnings in future years.

Our concentrations of credit risks with respect to trade accounts receivable is limited due to the large number of customers and their dispersion across a number of geographic areas and by frequent monitoring of the creditworthiness of the customers to whom credit is granted in the normal course of business.  Substantially all of our trade receivables are concentrated in the public and private hospital and healthcare industry in the U.S. and internationally or with distributors or dealers who operate in international markets and, accordingly, are exposed to their respective business, economic and country-specific variables.  

Management believes that cash flows from operations and available borrowings under the Multicurrency Revolving Facility are sufficient to meet our working capital, capital expenditure and debt service needs, as well as return cash to stockholders in the form of dividends and share repurchases.  Should additional investment opportunities arise, we believe that our earnings, balance sheet and cash flows will allow us to obtain additional capital, if necessary.

Recent Accounting Pronouncements

Information pertaining to recent accounting pronouncements can be found in Note 2 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report.

Critical Accounting Estimates

Our financial results are affected by the selection and application of accounting policies and methods.  There were no changes in the three or nine month periods ended September 30, 2018 to the application of critical accounting policies as described in our Annual Report on Form 10-K for the year ended December 31, 2017.  

38


In the fourth quarter of 2017, we recognized a $272.0 million goodwill impairment charge related to our Spine, less Asia Pacific reporting unit.  The impairment charge represented the amount by which the reporting unit’s carrying value exceeded its estimated fair value.  We estimated the fair value of the reporting unit based on income and market approaches.  Since the carrying value of this reporting unit was written down to its estimated fair value, future impairment could occur if the estimates used in the income and market approaches change.  If our estimates of profitability in the reporting unit decline, the fair value estimate under the income approach will decline.  If there are negative outlooks of the broader economic environment, comparable company valuation indicators may decline, which would cause our fair value estimate under the market approach to decline.  The lowering of the U.S. corporate income tax rate subsequent to the goodwill impairment charge will provide a benefit to the future profitability estimates for this reporting unit.  However, any inability to execute on our operating plans could more than offset any favorable cash flows from lower U.S. corporate income tax rates.

Due to declining sales and operating profits below our expectations, we performed an impairment assessment on our Dental reporting unit goodwill in the third quarter of 2018, with a balance of $389.1 million at the time of assessment.  We estimated the fair value of the reporting unit based on income and market approaches.  Our assessment concluded the goodwill was not impaired.  However, the estimated fair value of the reporting unit only exceeded its carrying value by less than 5 percent.  If our future operating results are below the estimations used for our impairment assessment, then we may have to recognize goodwill impairment charges in the future.  

We have four other reporting units that have goodwill assigned to them.  As of the date of our last goodwill impairment test, each of the four reporting unit’s estimated fair value exceeded its carrying value by more than 10 percent.

Cautionary Note Regarding Forward-Looking Statements and Factors That May Affect Future Results

This quarterly report contains certain statements that are forward-looking statements within the meaning of federal securities laws.  Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts.  When used in this report, the words “may,” “will,” “can,” “should,” “would,” “could,” “anticipate,” “expect,” “plan,” “seek,” “believe,” “are confident that,” “predict,” “estimate,” “potential,” “project,” “target,” “forecast,” “intend,” “strategy,” “future,” “opportunity,” “assume,” “guide,” “position” and similar expressions are intended to identify forward-looking statements.  Forward-looking statements are based on current beliefs, expectations and assumptions that are subject to significant risks, uncertainties and changes in circumstances that could cause actual results to differ materially from such forward-looking statements.  These risks, uncertainties and changes in circumstances include, but are not limited to:

 

the potential impact on our business and future strategic direction resulting from our transition to a new chief executive officer and our ability to attract and retain other key members of senior management;

 

compliance with the Deferred Prosecution Agreement entered into in January 2017;

 

the possibility that the anticipated synergies and other benefits from mergers and acquisitions will not be realized, or will not be realized within the expected time periods;

 

the risks and uncertainties related to our ability to successfully integrate the operations, products, employees and distributors of acquired companies;

 

the effect of the potential disruption of management’s attention from ongoing business operations due to integration matters related to mergers and acquisitions;

 

the effect of mergers and acquisitions on our relationships with customers, vendors and lenders and on our operating results and business generally;

 

the success of our quality and operational excellence initiatives, including our ongoing quality remediation efforts at the Warsaw North Campus facility;

 

our ability to remediate matters identified in any inspectional observations or warning letters issued by the FDA, while continuing to satisfy the demand for our products;

 

challenges relating to changes in and compliance with governmental laws and regulations affecting our U.S. and international businesses, including regulations of the FDA and foreign government regulators, such as more stringent requirements for regulatory clearance of our products;

 

the outcome of government investigations;

 

competition;

 

pricing pressures;

 

changes in customer demand for our products and services caused by demographic changes or other factors;

39


 

the impact of healthcare reform measures;

 

reductions in reimbursement levels by third-party payors and cost-containment efforts of healthcare purchasing organizations;

 

dependence on new product development, technological advances and innovation;

 

shifts in the product category or the regional sales mix of our products and services;

 

supply and prices of raw materials and products;

 

control of costs and expenses;

 

our ability to obtain and maintain adequate intellectual property protection;

 

our ability to form and implement alliances;

 

changes in tax obligations arising from tax reform measures, including the European Union rules on state aid, or examinations by tax authorities;

 

product liability and intellectual property litigation losses;

 

our ability to retain the independent agents and distributors who market our products;

 

our dependence on a limited number of suppliers for key raw materials and outsourced activities;

 

changes in general industry and market conditions, including domestic and international growth rates;

 

changes in general domestic and international economic conditions, including interest rate and currency exchange rate fluctuations; and

 

the impact of the ongoing financial and political uncertainty on countries in the Euro zone on our ability to collect accounts receivable in affected countries.

Our Annual Report on Form 10-K for the year ended December 31, 2017 and this report contain detailed discussions of these and other important factors under the heading “Risk Factors.” You should understand that it is not possible to predict or identify all factors that could cause actual results to differ materially from forward-looking statements.  Consequently, you should not consider any list or discussion of such factors to be a complete set of all potential risks or uncertainties.

Forward-looking statements speak only as of the date they are made and we expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Readers of this report are cautioned not to rely on these forward-looking statements since there can be no assurance that these forward-looking statements will prove to be accurate.  This cautionary statement is applicable to all forward-looking statements contained in this report.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes from the information provided in our Annual Report on Form 10-K for the year ended December 31, 2017.

Item 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures.  We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)) that are designed to provide reasonable assurance that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.  Because of inherent limitations, disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of disclosure controls and procedures are met.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief

40


Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective at a reasonable assurance level.

Changes in Internal Control Over Financial Reporting.  There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

41


Part II – Other Information

Item 1.

Legal Proceedings

Information pertaining to legal proceedings can be found in Note 15 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report and is incorporated herein by reference.

Item 1A.

Risk Factors

Except as set forth below, there have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2017.

The risk factor set forth below replaces in its entirety the risk factor with the same title:

We are subject to various governmental regulations relating to the manufacturing, labeling and marketing of our products, non-compliance with which could adversely affect our business, financial condition and results of operations.

The products we design, develop, manufacture and market are subject to rigorous regulation by the FDA and numerous other federal, state and foreign governmental authorities.  The process of obtaining regulatory approvals to market these products can be costly and time consuming and approvals might not be granted for future products on a timely basis, if at all.  Delays in receipt of, or failure to obtain, approvals for future products could result in delayed realization of product revenues or in substantial additional costs.

Both before and after a product is commercially released, we have ongoing responsibilities under FDA regulations and other local, state and foreign requirements.  Compliance with these requirements, including the QSR, recordkeeping regulations, labeling and promotional requirements and adverse event reporting regulations, is subject to continual review and is monitored rigorously through periodic inspections by the FDA and other regulators, which may result in observations (such as on Form 483), and in some cases warning letters, that require corrective action, or other forms of enforcement.  If the FDA or another regulator were to conclude that we are not in compliance with applicable laws or regulations, or that any of our products are ineffective or pose an unreasonable health risk, they could ban such products, detain or seize adulterated or misbranded products, order a recall, repair, replacement, or refund of payment of such products, refuse to grant pending premarket approval applications, refuse to provide certificates for exports, and/or require us to notify healthcare professionals and others that the products present unreasonable risks of substantial harm to the public health.  The FDA or other regulators may also impose operating restrictions, including a ceasing of operations, on one or more facilities, enjoin and restrain certain violations of applicable law pertaining to our products and assess civil or criminal penalties against our officers, employees or us.  The FDA or other regulators could also issue a corporate warning letter, a recidivist warning letter, a consent decree of permanent injunction, and/or recommend prosecution.  Any adverse regulatory action, depending on its magnitude, may restrict us from effectively manufacturing, marketing and selling our products and could have a material adverse effect on our business, financial condition and results of operations.

In 2012, we received a warning letter from the FDA citing concerns relating to certain processes pertaining to products manufactured at our Ponce, Puerto Rico manufacturing facility.  In May 2016, we received a warning letter from the FDA related to observed non-conformities with current good manufacturing practice requirements of the QSR at our facility in Montreal, Quebec, Canada.  In August 2018, we received a warning letter from the FDA related to observed non-conformities with current good manufacturing practice requirements of the QSR at our Warsaw North Campus manufacturing facility.  As of November 1, 2018, these warning letters remained pending.  Until the violations are corrected, we may become subject to additional regulatory action by the FDA as described above, the FDA may refuse to grant premarket approval applications and/or the FDA may refuse to grant export certificates, any of which could have a material adverse effect on our business, financial condition and results of operations.  Additional information regarding these and other FDA regulatory matters can be found in Note 15 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report.

Our products and operations are also often subject to the rules of industrial standards bodies, such as the International Standards Organization.  If we fail to adequately address any of these regulations, our business could be harmed.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3.

Defaults Upon Senior Securities

None

42


Item 4.

Mine Safety Disclosures

Not applicable

Item 5.

Other Information

During the three month period ended September 30, 2018, the Audit Committee of our Board of Directors approved the engagement of PricewaterhouseCoopers LLP, our independent registered public accounting firm, to perform certain non-audit services.  This disclosure is made pursuant to Section 10A(i)(2) of the Exchange Act, as added by Section 202 of the Sarbanes-Oxley Act of 2002.

43


Item 6.

Exhibits

The following exhibits are filed or furnished as part of this report:

 

3.1

 

Restated Certificate of Incorporation of Zimmer Biomet Holdings, Inc., dated June 24, 2015 (incorporated by reference to Exhibit 3.2 to the Registrant’s Current Report on Form 8-K filed June 26, 2015)

 

 

 

3.2

 

Restated By-Laws of Zimmer Biomet Holdings, Inc., effective June 24, 2015 (incorporated by reference to Exhibit 3.3 to the Registrant’s Current Report on Form 8-K filed June 26, 2015)

 

 

 

10.1*

 

Swiss Employment Agreement by and between Zimmer GmbH and Didier Deltort dated as of June 28, 2018

 

 

 

10.2*

 

Offer Letter by and between Zimmer Biomet Holdings. Inc. and Didier Deltort dated as of June 28, 2018

 

 

 

10.3*

 

Confidentiality, Non-Competition and Non-Solicitation Agreement by and between Zimmer GmbH and Didier Deltort dated as of June 28, 2018

 

 

 

10.4*

 

Change in Control Severance Agreement by and between Zimmer GmbH and Didier Deltort dated as of October 9, 2018

 

 

 

 21

 

List of Subsidiaries of Zimmer Biomet Holdings, Inc.

 

 

 

 31.1

 

Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934 of the Chief Executive Officer, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

 

 

 31.2

 

Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934 of the Chief Financial Officer, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

 

 

 32

 

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

 

101.INS

 

XBRL Instance Document

 

 

 

101.SCH

 

XBRL Taxonomy Extension Schema Document

 

 

 

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document

 

 

 

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document

 

 

 

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document

 

 

 

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document

 

 

 

 

 

 

*  Management contract or compensatory plan or arrangement

 

44


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

ZIMMER BIOMET HOLDINGS, INC.

 

 

 

 

 

 

 

(Registrant)

 

 

 

 

 

Date:  November 1, 2018

 

By:

 

/s/ Daniel P. Florin

 

 

 

 

Daniel P. Florin

 

 

 

 

Executive Vice President and Chief Financial Officer

 

Date:  November 1, 2018

 

By:

 

/s/ Tony W. Collins

 

 

 

 

Tony W. Collins

 

 

 

 

Vice President, Corporate Controller and

Chief Accounting Officer

 

45