ZIMMER BIOMET HOLDINGS, INC. - Quarter Report: 2019 June (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 JUNE 30, 2019

Commission File Number 001-16407

ZIMMER BIOMET HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

345 East Main Street, Warsaw, IN  46580

(Address of principal executive offices)

Telephone:  (574) 267-6131

Securities registered pursuant to Section 12(b) of the Act:

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. 

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 August 1, 2019, 205,314,527 shares of the registrant’s $.01 par value common stock were outstanding.

ZIMMER BIOMET HOLDINGS, INC.

INDEX TO FORM 10-Q

June 30, 2019

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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)

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

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ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in millions, unaudited)

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

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ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in millions, except share amounts, unaudited)

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

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ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in millions, except per share amounts, unaudited)

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

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ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions, unaudited)

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

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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, 2018.

In our opinion, the accompanying unaudited condensed consolidated financial statements include all adjustments, consisting of only normal recurring adjustments, necessary for a fair statement of the financial position, results of operations and cash flows for the interim periods presented.  The December 31, 2018 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.

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  

Accounting Pronouncements Recently Adopted

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2016-02 – Leases (Topic 842).  This ASU requires lessees to recognize right-of-use assets and lease liabilities on the balance sheet. This ASU was effective for us as of January 1, 2019.  This ASU required a modified retrospective transition method that could either be applied at the earliest comparative period in the financial statements or the period of adoption.  We elected to use the period of adoption (January 1, 2019) transition method and therefore did not recast prior periods.  This ASU allowed for certain practical expedients to make the adoption of the ASU less burdensome.  We elected the practical expedients upon transition which permitted us to not reassess lease identification, classification, and initial direct costs under the new standard for leases that commenced prior to the effective date.  We also elected not to recognize a right-of-use asset nor a lease liability for leases with an initial term of twelve months or less.  Finally, we elected not to separate non-lease components from the leased components in the valuation of our right-of-use asset and lease liability for all asset classes.

On January 1, 2019, we recognized a right-of-use asset of $274.7 million in other assets and lease liabilities of $62.2 million and $221.2 million in other current liabilities and other long-term liabilities, respectively.  No cumulative adjustment to retained earnings was required upon adoption.  We do not have any significant finance leases.  See Note 7 for additional information.

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

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

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

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“S.E.T.” refers to our Surgical, Sports Medicine, Extremities and Trauma product category.  “CMF” refers to our craniomaxillofacial and thoracic products.

4.  Inventories

5.  Property, Plant and Equipment

We had $38.1 million and $49.3 million of property, plant and equipment included in accounts payable as of June 30, 2019 and December 31, 2018, respectively.

6.  Intangible Assets

In the second quarter of 2019, we entered into an agreement and paid $192.5 million to buy out certain licensing arrangements from an unrelated third party.  This new agreement and the related payment replace the variable royalty payments that otherwise would have been due under the terms of previous licensing arrangements through 2029.  Under the new agreement, we maintain the rights to the counterparty’s intellectual property provided under the previous licensing arrangements.  The $192.5 million payment was recognized as an intangible asset and will be amortized through 2029, which represents the useful life of the intellectual property.

In the second quarter of 2019, we recognized $70.1 million of in-process research and development (“IPR&D”) intangible asset impairment due to the termination of certain IPR&D projects.  The termination of these projects is the result of the progress we are making to prioritize our internal research and development portfolio and focus our engineering resources on the opportunities that most closely link to our mission.  Since these projects were not a priority, their terminations are not expected to have a significant impact to our future cash flows.

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7.  Leases

We own most of our manufacturing facilities, but lease various office space, vehicles and other less significant assets throughout the world.  Our contracts contain a lease if they convey a right to control the use of an identified asset, either explicitly or implicitly, in exchange for consideration.  Our lease contracts are a necessary part of our business, but we do not believe they are significant to our overall operations.  We do not have any significant finance leases.  Additionally, we do not have significant leases: where we are considered a lessor; where we sublease our assets; with an initial term of twelve months or less; with related parties; with residual value guarantees; that impose restrictions or covenants on us; or that have not yet commenced, but create significant rights and obligations against us.

  Our real estate leases generally have terms of between 5 to 10 years and contain lease extension options that can vary from month-to-month extensions to up to 5 year extensions.  We include extension options in our lease term if we are reasonably certain to exercise that option.  In determining whether an extension is reasonably certain, we consider the uniqueness of the property for our needs, the availability of similar properties, whether the extension period payments remain the same or may change due to market rates or fixed price increases in the contract, and other economic factors.  Our vehicle leases generally have terms of between 3 to 5 years and contain lease extension options on a month-to-month basis. Our vehicle leases are generally not reasonably certain to be extended.

Under GAAP, we are required to discount our lease liabilities to present value using the rate implicit in the lease, or our incremental borrowing rate for a similar term as the lease term if the implicit rate is not readily available.  We generally do not have adequate information to know the implicit rate in a lease and therefore use our incremental borrowing rate.  Under GAAP, the incremental borrowing rate must be on a collateralized basis, but our debt arrangements are unsecured.  We have determined our incremental borrowing rate by using our credit rating to estimate our unsecured borrowing rate and applying reasonable assumptions to reduce the unsecured rate for a risk adjustment effect from collateral.

Information on our leases is as follows ($ in millions):

Our variable lease costs are not significant.

Our future minimum lease payments as of June 30, 2019 were (in millions):

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Under GAAP, since we adopted the new standard using the period of adoption transition method (see Note 2 for additional information regarding the new standard), we are not required to present 2018 comparative disclosures.  However, we are required to present the required annual disclosures under the previous GAAP lease accounting standard.  Accordingly, the following were the future minimum rental commitments under non-cancelable operating leases as of December 31, 2018 (in millions):

8.  Transfers of Financial Assets

We have 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 are 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 June 30, 2019 of $400.0 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 $33.5 million and $33.0 million as of June 30, 2019 and December 31, 2018, respectively.

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

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 six month periods ended June 30, 2019 and 2018, we sold receivables having an aggregate face value of $1,595.9 million and $1,260.7 million to third parties in exchange for cash proceeds of $1,594.9 million and $1,260.1 million, respectively.  Expenses recognized on these sales during the six month periods ended June 30, 2019 and 2018 were not significant.  In the six month periods ended June 30, 2019 and 2018, under the U.S. and Japan programs, we collected $1,438.3 million and $1,007.8 million, respectively, from our customers and remitted that amount to the third party, and we effectively repurchased $73.9 million and $121.0 million, respectively, of previously sold accounts receivable from the third party, due to the programs’ revolving nature.  As of June 30, 2019 and December 31, 2018, we had collected $41.2 million and $66.8 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.  

At June 30, 2019 and December 31, 2018, the outstanding principal amount of receivables that has been derecognized under the U.S. and Japan revolving arrangements amounted to $378.1 million and $365.9 million, respectively.

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9.  Debt

Our debt consisted of the following (in millions):

At June 30, 2019, our total current and non-current debt of $8.7 billion consisted of $7.9 billion aggregate principal amount of our senior notes, which included $1.1 billion of Euro-denominated senior notes (“Euro Notes”), $535.0 million outstanding under a U.S. term loan (“U.S. Term Loan C”) that will mature on December 14, 2020, 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 $10.4 million, partially offset by debt discount and issuance costs of $38.1 million.

On December 14, 2018, we entered into a credit agreement (the “2018 Credit Agreement”) that provides for U.S. Term Loan C, which is a two-year unsecured multi-draw term loan facility in the principal amount of $900.0 million, with a maturity date of December 14, 2020, and borrowed $675.0 million under that facility.  In January 2019, we borrowed an additional $200.0 million under U.S. Term Loan C and used those proceeds, along with cash on hand, to repay the remaining $225.0 million outstanding under a U.S. term loan issued under the 2016 Credit Agreement (as defined below) (“U.S. Term Loan B”).  Under the applicable accounting rules, since $200.0 million of U.S. Term Loan B was refinanced on a long-term basis before the issuance of our consolidated financial statements for the year ended December 31, 2018, we classified the refinanced portion of U.S. Term Loan B as long-term as of December 31, 2018.

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.

In addition to the 2018 Credit Agreement, we have a revolving credit and term loan agreement (the “2016 Credit Agreement”), which contains a five-year unsecured multicurrency revolving facility of $1.5 billion (the “Multicurrency Revolving Facility”), and previously contained U.S. Term Loan B, which was paid in full during the six month period ended June 30, 2019.  The Multicurrency Revolving Facility replaced the previous multicurrency revolving facility under our credit agreement executed in 2014 (as amended,

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the “2014 Credit Agreement”) and will mature on September 30, 2021, with two available one-year extensions at our discretion.  The 2014 Credit Agreement previously contained a term loan (“U.S. Term Loan A”), which was paid in full in December 2018.

Borrowings under the 2018 and 2016 Credit Agreements generally bear interest at floating rates. We pay a facility fee on the aggregate amount of the Multicurrency Revolving Facility.  The 2018 and 2016 Credit Agreements contain customary affirmative and negative covenants and events of default for unsecured financing arrangements, including, among other things, limitations on consolidations, mergers and sales of assets.  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 covenants under the 2018 and 2016 Credit Agreements as of June 30, 2019. As of June 30, 2019, we had no borrowings outstanding under the Multicurrency Revolving Facility.   

During the six month period ended June 30, 2019, we repaid $200.0 million on U.S. Term Loan C with cash generated from operations.  Under the terms of U.S. Term Loan C, the remaining balance as of June 30, 2019 of $535.0 million is due on the maturity date of December 14, 2020.      

The estimated fair value of our senior notes as of June 30, 2019, based on quoted prices for the specific securities from transactions in over-the-counter markets (Level 2), was $8,126.5 million.  The estimated fair value of Japan Term Loan A and Japan Term Loan B, in the aggregate, as of June 30, 2019, based upon publicly available market yield curves and the terms of the debt (Level 2), was $303.1 million.  The carrying value of U.S. Term Loan C approximates its fair value as it bears interest at short-term variable market rates.

10.  Accumulated Other Comprehensive Income

Accumulated other comprehensive income (loss) (“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.      

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

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