ZIMMER BIOMET HOLDINGS, INC. - Quarter Report: 2020 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, 2020
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
Securities registered pursuant to Section 12(b) of the Act:
Title of each class |
Trading Symbol(s) |
Name of each exchange on which registered |
Common Stock, $0.01 par value |
ZBH |
New York Stock Exchange |
1.414% Notes due 2022 |
ZBH 22A |
New York Stock Exchange |
2.425% Notes due 2026 |
ZBH 26 |
New York Stock Exchange |
1.164% Notes due 2027 |
ZBH 27 |
New York Stock Exchange |
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 |
☒ |
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Accelerated filer |
☐ |
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Non-accelerated filer |
☐ |
Smaller reporting company |
☐ |
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Emerging growth company |
☐ |
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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 23, 2020, 207,278,375 shares of the registrant’s $.01 par value common stock were outstanding.
ZIMMER BIOMET HOLDINGS, INC.
INDEX TO FORM 10-Q
September 30, 2020
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Item 1. |
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3 |
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3 |
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4 |
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Condensed Consolidated Balance Sheets as of September 30, 2020 and December 31, 2019 |
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5 |
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6 |
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7 |
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Notes to Interim Condensed Consolidated Financial Statements |
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8 |
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Item 2. |
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Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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31 |
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Item 3. |
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44 |
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Item 4. |
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44 |
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Item 1. |
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45 |
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Item 1A. |
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45 |
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Item 2. |
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45 |
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Item 3. |
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45 |
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Item 4. |
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45 |
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Item 5. |
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45 |
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Item 6. |
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46 |
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47 |
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)
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Three Months Ended |
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Nine Months Ended |
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September 30, |
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September 30, |
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2020 |
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2019 |
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2020 |
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2019 |
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Net Sales |
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$ |
1,929.3 |
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$ |
1,892.4 |
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$ |
4,939.2 |
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$ |
5,856.5 |
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Cost of products sold, excluding intangible asset amortization |
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569.4 |
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535.7 |
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1,481.0 |
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1,670.4 |
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Intangible asset amortization |
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149.7 |
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146.6 |
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445.0 |
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436.9 |
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Research and development |
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85.9 |
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114.4 |
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272.0 |
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328.2 |
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Selling, general and administrative |
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790.0 |
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826.4 |
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2,283.9 |
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2,461.6 |
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Goodwill and intangible asset impairment |
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- |
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- |
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645.0 |
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70.1 |
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Restructuring and other cost reduction initiatives |
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16.2 |
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5.4 |
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89.2 |
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17.0 |
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Quality remediation |
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9.8 |
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20.7 |
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35.9 |
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63.1 |
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Acquisition, integration and related |
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9.1 |
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(2.6 |
) |
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15.7 |
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8.5 |
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Operating expenses |
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1,630.1 |
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1,646.6 |
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5,267.7 |
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5,055.8 |
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Operating Profit (Loss) |
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299.2 |
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245.8 |
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(328.5 |
) |
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800.7 |
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Other income (expense), net |
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10.6 |
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(4.4 |
) |
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17.4 |
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(9.6 |
) |
Interest expense, net |
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(54.0 |
) |
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(56.8 |
) |
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(158.9 |
) |
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(174.5 |
) |
Earnings (loss) before income taxes |
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255.8 |
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184.6 |
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(470.0 |
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616.6 |
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Provision (benefit) for income taxes |
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9.7 |
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(247.4 |
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1.2 |
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(193.5 |
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Net Earnings (Loss) |
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246.1 |
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432.0 |
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(471.2 |
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810.1 |
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Less: Net earnings (loss) attributable to noncontrolling interest |
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3.6 |
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0.9 |
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1.4 |
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(0.8 |
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Net Earnings (Loss) of Zimmer Biomet Holdings, Inc. |
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$ |
242.5 |
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$ |
431.1 |
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$ |
(472.6 |
) |
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$ |
810.9 |
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Earnings (Loss) Per Common Share |
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Basic |
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$ |
1.17 |
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$ |
2.10 |
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$ |
(2.29 |
) |
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$ |
3.96 |
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Diluted |
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$ |
1.16 |
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$ |
2.08 |
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$ |
(2.29 |
) |
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$ |
3.93 |
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Weighted Average Common Shares Outstanding |
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Basic |
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207.1 |
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205.3 |
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206.8 |
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204.8 |
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Diluted |
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208.5 |
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207.0 |
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206.8 |
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206.3 |
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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 (LOSS)
(in millions, unaudited)
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Three Months Ended |
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Nine Months Ended |
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September 30, |
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September 30, |
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2020 |
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2019 |
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2020 |
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2019 |
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Net Earnings (Loss) |
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$ |
246.1 |
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$ |
432.0 |
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$ |
(471.2 |
) |
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$ |
810.1 |
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Other Comprehensive (Loss) Income: |
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Foreign currency cumulative translation adjustments, net of tax |
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8.5 |
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(70.8 |
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(22.7 |
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(60.1 |
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Unrealized cash flow hedge (losses) gains, net of tax |
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(23.4 |
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26.1 |
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8.7 |
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41.0 |
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Reclassification adjustments on hedges, net of tax |
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(7.0 |
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(9.7 |
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(33.6 |
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(24.1 |
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Adjustments to prior service cost and unrecognized actuarial assumptions, net of tax |
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0.7 |
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3.0 |
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2.5 |
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7.4 |
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Total Other Comprehensive Loss |
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(21.2 |
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(51.4 |
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(45.1 |
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(35.8 |
) |
Comprehensive Income (Loss) |
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224.9 |
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380.6 |
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(516.3 |
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774.3 |
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Comprehensive income (loss) attributable to the noncontrolling interest |
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3.5 |
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0.9 |
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1.3 |
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(0.8 |
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Comprehensive Income (Loss) Attributable to |
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Zimmer Biomet Holdings, Inc. |
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$ |
221.4 |
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$ |
379.7 |
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$ |
(517.6 |
) |
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$ |
775.1 |
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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, except share amounts, unaudited)
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September 30, |
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December 31, |
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2020 |
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2019 |
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ASSETS |
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Current Assets: |
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Cash and cash equivalents |
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$ |
967.3 |
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$ |
617.9 |
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Accounts receivable, less allowance for doubtful accounts |
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1,340.7 |
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1,363.9 |
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Inventories |
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2,492.2 |
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2,385.0 |
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Prepaid expenses and other current assets |
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352.4 |
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357.1 |
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Total Current Assets |
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5,152.6 |
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4,723.9 |
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Property, plant and equipment, net |
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2,042.5 |
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2,077.4 |
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Goodwill |
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9,038.8 |
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9,599.7 |
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Intangible assets, net |
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6,850.6 |
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7,257.6 |
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Other assets |
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941.0 |
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980.1 |
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Total Assets |
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$ |
24,025.5 |
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$ |
24,638.7 |
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LIABILITIES AND STOCKHOLDERS' EQUITY |
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Current Liabilities: |
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Accounts payable |
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$ |
334.8 |
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$ |
400.9 |
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Income taxes payable |
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120.7 |
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126.7 |
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Other current liabilities |
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1,360.7 |
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1,413.9 |
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Current portion of long-term debt |
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450.0 |
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1,500.0 |
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Total Current Liabilities |
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2,266.2 |
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3,441.5 |
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Deferred income taxes, net |
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747.8 |
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840.1 |
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Long-term income tax payable |
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|
699.7 |
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685.1 |
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Other long-term liabilities |
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593.4 |
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557.8 |
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Long-term debt |
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7,840.2 |
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6,721.4 |
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Total Liabilities |
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12,147.3 |
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12,245.9 |
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Commitments and Contingencies (Note 16) |
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Stockholders' Equity: |
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Zimmer Biomet Holdings, Inc. Stockholders' Equity: |
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Common stock, $0.01 par value, one billion shares authorized, 311.1 million shares in 2020 (309.9 million in 2019) issued |
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3.1 |
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3.1 |
|
Paid-in capital |
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9,073.0 |
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8,920.1 |
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Retained earnings |
|
|
9,802.9 |
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10,427.3 |
|
Accumulated other comprehensive loss |
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(287.0 |
) |
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(241.9 |
) |
Treasury stock, 103.8 million shares in 2020 (103.9 million shares in 2019) |
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(6,719.8 |
) |
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(6,720.5 |
) |
Total Zimmer Biomet Holdings, Inc. stockholders' equity |
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|
11,872.2 |
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12,388.1 |
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Noncontrolling interest |
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|
6.0 |
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4.7 |
|
Total Stockholders' Equity |
|
|
11,878.2 |
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|
12,392.8 |
|
Total Liabilities and Stockholders' Equity |
|
$ |
24,025.5 |
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$ |
24,638.7 |
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in millions, except per share amounts, unaudited)
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Zimmer Biomet Holdings, Inc. Stockholders |
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Accumulated |
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Other |
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Total |
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Common Shares |
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Paid-in |
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Retained |
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Comprehensive |
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Treasury Shares |
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Noncontrolling |
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Stockholders' |
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Number |
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Amount |
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Capital |
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Earnings |
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Loss |
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Number |
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Amount |
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Interest |
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Equity |
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Balance July 1, 2020 |
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|
310.7 |
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$ |
3.1 |
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|
$ |
9,014.0 |
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$ |
9,610.0 |
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|
$ |
(265.8 |
) |
|
|
(103.8 |
) |
|
$ |
(6,719.9 |
) |
|
$ |
2.5 |
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$ |
11,643.9 |
|
Net earnings |
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|
- |
|
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|
- |
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|
- |
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|
242.5 |
|
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|
- |
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- |
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- |
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3.6 |
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|
246.1 |
|
Other comprehensive loss |
|
|
- |
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|
- |
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|
- |
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|
- |
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(21.2 |
) |
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- |
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- |
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(0.1 |
) |
|
|
(21.3 |
) |
Cash dividends declared ($0.24 per share) |
|
|
- |
|
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|
- |
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|
- |
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|
(49.8 |
) |
|
|
- |
|
|
|
- |
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|
- |
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|
|
- |
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(49.8 |
) |
Stock compensation plans |
|
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0.4 |
|
|
|
- |
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59.0 |
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0.2 |
|
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|
- |
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- |
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|
|
0.1 |
|
|
|
- |
|
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|
59.3 |
|
Balance September 30, 2020 |
|
|
311.1 |
|
|
$ |
3.1 |
|
|
$ |
9,073.0 |
|
|
$ |
9,802.9 |
|
|
$ |
(287.0 |
) |
|
|
(103.8 |
) |
|
$ |
(6,719.8 |
) |
|
$ |
6.0 |
|
|
$ |
11,878.2 |
|
|
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Balance July 1, 2019 |
|
|
308.8 |
|
|
$ |
3.1 |
|
|
$ |
8,776.5 |
|
|
$ |
9,772.7 |
|
|
$ |
(171.8 |
) |
|
|
(103.9 |
) |
|
$ |
(6,721.4 |
) |
|
$ |
3.1 |
|
|
$ |
11,662.2 |
|
Net earnings |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
431.1 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
0.9 |
|
|
|
432.0 |
|
Other comprehensive loss |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(51.4 |
) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(51.4 |
) |
Cash dividends declared ($0.24 per share) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(49.4 |
) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(49.4 |
) |
Stock compensation plans |
|
|
0.7 |
|
|
|
- |
|
|
|
90.7 |
|
|
|
0.9 |
|
|
|
- |
|
|
|
- |
|
|
|
0.5 |
|
|
|
- |
|
|
|
92.1 |
|
Balance September 30, 2019 |
|
|
309.5 |
|
|
$ |
3.1 |
|
|
$ |
8,867.2 |
|
|
$ |
10,155.3 |
|
|
$ |
(223.2 |
) |
|
|
(103.9 |
) |
|
$ |
(6,720.9 |
) |
|
$ |
4.0 |
|
|
$ |
12,085.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance January 1, 2020 |
|
|
309.9 |
|
|
$ |
3.1 |
|
|
$ |
8,920.1 |
|
|
$ |
10,427.3 |
|
|
$ |
(241.9 |
) |
|
|
(103.9 |
) |
|
$ |
(6,720.5 |
) |
|
$ |
4.7 |
|
|
$ |
12,392.8 |
|
Net loss |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(472.6 |
) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
1.4 |
|
|
|
(471.2 |
) |
Other comprehensive loss |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(45.1 |
) |
|
|
- |
|
|
|
- |
|
|
|
(0.1 |
) |
|
|
(45.2 |
) |
Cash dividends declared ($0.72 per share) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(149.1 |
) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(149.1 |
) |
Adoption of new accounting standard |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(3.1 |
) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(3.1 |
) |
Stock compensation plans |
|
|
1.2 |
|
|
|
- |
|
|
|
152.9 |
|
|
|
0.4 |
|
|
|
- |
|
|
|
0.1 |
|
|
|
0.7 |
|
|
|
- |
|
|
|
154.0 |
|
Balance September 30, 2020 |
|
|
311.1 |
|
|
$ |
3.1 |
|
|
$ |
9,073.0 |
|
|
$ |
9,802.9 |
|
|
$ |
(287.0 |
) |
|
|
(103.8 |
) |
|
$ |
(6,719.8 |
) |
|
$ |
6.0 |
|
|
$ |
11,878.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance January 1, 2019 |
|
|
307.9 |
|
|
$ |
3.1 |
|
|
$ |
8,686.1 |
|
|
$ |
9,491.2 |
|
|
$ |
(187.4 |
) |
|
|
(103.9 |
) |
|
$ |
(6,721.7 |
) |
|
$ |
4.8 |
|
|
$ |
11,276.1 |
|
Net earnings |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
810.9 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(0.8 |
) |
|
|
810.1 |
|
Other comprehensive loss |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(35.8 |
) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(35.8 |
) |
Cash dividends declared ($0.72 per share) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(147.7 |
) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(147.7 |
) |
Stock compensation plans |
|
|
1.6 |
|
|
|
- |
|
|
|
181.1 |
|
|
|
0.9 |
|
|
|
- |
|
|
|
- |
|
|
|
0.8 |
|
|
|
- |
|
|
|
182.8 |
|
Balance September 30, 2019 |
|
|
309.5 |
|
|
$ |
3.1 |
|
|
$ |
8,867.2 |
|
|
$ |
10,155.3 |
|
|
$ |
(223.2 |
) |
|
|
(103.9 |
) |
|
$ |
(6,720.9 |
) |
|
$ |
4.0 |
|
|
$ |
12,085.5 |
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
6
ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions, unaudited)
|
|
|
|
|||||
|
|
For the Nine Months Ended September 30, |
|
|||||
|
|
2020 |
|
|
2019 |
|
||
Cash flows provided by (used in) operating activities: |
|
|
|
|
|
|
|
|
Net (loss) earnings |
|
$ |
(471.2 |
) |
|
$ |
810.1 |
|
Adjustments to reconcile net (loss) earnings to cash provided by operating activities: |
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
767.3 |
|
|
|
752.2 |
|
Share-based compensation |
|
|
62.0 |
|
|
|
61.6 |
|
Goodwill and intangible asset impairment |
|
|
645.0 |
|
|
|
70.1 |
|
Changes in operating assets and liabilities, net of acquired assets and liabilities |
|
|
|
|
|
|
|
|
Income taxes |
|
|
(55.0 |
) |
|
|
(356.3 |
) |
Receivables |
|
|
13.6 |
|
|
|
109.5 |
|
Inventories |
|
|
(108.6 |
) |
|
|
(106.0 |
) |
Accounts payable and accrued liabilities |
|
|
(131.4 |
) |
|
|
(162.7 |
) |
Other assets and liabilities |
|
|
57.7 |
|
|
|
(16.0 |
) |
Net cash provided by operating activities |
|
|
779.4 |
|
|
|
1,162.5 |
|
Cash flows provided by (used in) investing activities: |
|
|
|
|
|
|
|
|
Additions to instruments |
|
|
(222.8 |
) |
|
|
(239.5 |
) |
Additions to other property, plant and equipment |
|
|
(89.8 |
) |
|
|
(155.3 |
) |
Net investment hedge settlements |
|
|
43.0 |
|
|
|
37.5 |
|
Acquisition of intellectual property rights |
|
|
- |
|
|
|
(197.6 |
) |
Investments in other assets |
|
|
(28.3 |
) |
|
|
(36.4 |
) |
Net cash used in investing activities |
|
|
(297.9 |
) |
|
|
(591.3 |
) |
Cash flows provided by (used in) financing activities: |
|
|
|
|
|
|
|
|
Proceeds from senior notes |
|
|
1,497.1 |
|
|
|
- |
|
Redemption of senior notes |
|
|
(1,500.0 |
) |
|
|
- |
|
Proceeds from term loans |
|
|
- |
|
|
|
200.0 |
|
Payments on term loans |
|
|
- |
|
|
|
(750.0 |
) |
Net payments on other debt |
|
|
- |
|
|
|
(5.0 |
) |
Dividends paid to stockholders |
|
|
(148.7 |
) |
|
|
(147.3 |
) |
Proceeds from employee stock compensation plans |
|
|
97.7 |
|
|
|
125.9 |
|
Net cash flows from unremitted collections from factoring programs |
|
|
(39.6 |
) |
|
|
(15.4 |
) |
Business combination contingent consideration payments |
|
|
(13.0 |
) |
|
|
- |
|
Debt issuance costs |
|
|
(22.3 |
) |
|
|
- |
|
Other financing activities |
|
|
(6.7 |
) |
|
|
(5.4 |
) |
Net cash used in financing activities |
|
|
(135.5 |
) |
|
|
(597.2 |
) |
Effect of exchange rates on cash and cash equivalents |
|
|
3.4 |
|
|
|
(4.3 |
) |
Increase (decrease) in cash and cash equivalents |
|
|
349.4 |
|
|
|
(30.3 |
) |
Cash and cash equivalents, beginning of year |
|
|
617.9 |
|
|
|
542.8 |
|
Cash and cash equivalents, end of period |
|
$ |
967.3 |
|
|
$ |
512.5 |
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
7
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, 2019.
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, 2019 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.
Risks and Uncertainties - Our results have been and are expected to continue to be impacted by the COVID-19 global pandemic. The vast majority of our net sales are derived from products used in elective surgical procedures which are being deferred due to lockdowns, stay-at-home measures and other precautions in certain markets. The consequences of COVID-19 continue to be extremely fluid and there are many market dynamics and impacts that we are unable to quantify at this time. The COVID-19 pandemic may have a significant unfavorable effect on our financial position, results of operations and cash flows in the near term.
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.
We reclassified certain prior period amounts to conform to the current period presentation.
2. Significant Accounting Policies
Use of Estimates - The accompanying unaudited condensed consolidated financial statements are prepared in conformity with GAAP, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We have made our best estimates, as appropriate under GAAP, in the recognition of our assets and liabilities. These estimates have considered the impact the COVID-19 pandemic may have on our financial position, results of operations and cash flows. Such estimates included, but were not limited to, variable consideration to our customers, our allowance for doubtful accounts for expected credit losses, the net realizable value of our inventory, the fair value of our goodwill and the recoverability of other long-lived assets. Actual results could differ materially from these estimates.
Accounting Pronouncements Recently Adopted
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2016-13, Financial Instruments – Credit Losses (Topic 326). The new guidance describes the current expected credit loss (“CECL”) model which requires an estimate of expected impairment on financial instruments over the lifetime of the assets at each reporting date. Financial instruments in scope of the guidance include financial assets measured at amortized cost. Previous accounting guidance required recognition of impairment when it was probable the loss has been incurred. Under the CECL model, lifetime expected credit losses are measured and recognized at each reporting date based on historical experience, current conditions and forecasted information. We adopted this standard as of January 1, 2020. Adoption of this standard required the modified retrospective transition method, which resulted in a cumulative-effect adjustment to retained earnings of $3.1 million. The adoption primarily impacted our trade receivables. Our concentrations of credit risks are limited due to the large number of customers and their dispersion across a number of geographic areas. 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. Our historical credit losses have not been significant due to this dispersion and the financial stability of our customers. We consider credit losses immaterial to our business and, therefore, have not provided all the disclosures otherwise required by the standard. We have updated our accounting policy disclosure for accounts receivable as follows:
8
Accounts receivable consists of trade and other miscellaneous receivables. We grant credit to customers in the normal course of business and maintain an allowance for doubtful accounts for expected credit losses. Our concentrations of credit risks are limited due to the large number of customers and their dispersion across a number of geographic areas. We determine the allowance for doubtful accounts by geographic market and take into consideration historical credit experience, creditworthiness of the customer and other pertinent information. We make concerted efforts to collect all accounts receivable, but sometimes we have to write-off the account against the allowance when we determine the account is uncollectible. The allowance for doubtful accounts was $76.3 million and $65.0 million as of September 30, 2020 and December 31, 2019, respectively.
In August 2018, the FASB issued ASU 2018-15, Intangibles-Goodwill and Other-Internal-Use Software. ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. Our policy for capitalizing implementation costs in a hosting arrangement was already aligned with the new guidance. ASU 2018-15 also provides guidance on how these implementation costs are to be recorded in the statement of earnings, balance sheet and statement of cash flows. We adopted this standard on a prospective basis as of January 1, 2020. The adoption of this standard did not have a material impact on our financial position, results of operations or cash flows.
There are no 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
Net sales by geography are as follows (in millions):
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
||||||||||
|
|
September 30, |
|
|
September 30, |
|
||||||||||
|
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
||||
Americas |
|
$ |
1,216.5 |
|
|
$ |
1,179.2 |
|
|
$ |
3,051.5 |
|
|
$ |
3,587.6 |
|
EMEA |
|
|
366.2 |
|
|
|
374.6 |
|
|
|
983.0 |
|
|
|
1,276.5 |
|
Asia Pacific |
|
|
346.6 |
|
|
|
338.6 |
|
|
|
904.7 |
|
|
|
992.4 |
|
Total |
|
$ |
1,929.3 |
|
|
$ |
1,892.4 |
|
|
$ |
4,939.2 |
|
|
$ |
5,856.5 |
|
Net sales by product category are as follows (in millions):
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
||||||||||
|
|
September 30, |
|
|
September 30, |
|
||||||||||
|
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
||||
Knees |
|
$ |
648.7 |
|
|
$ |
651.9 |
|
|
$ |
1,652.7 |
|
|
$ |
2,049.5 |
|
Hips |
|
|
484.1 |
|
|
|
459.2 |
|
|
|
1,246.4 |
|
|
|
1,421.1 |
|
S.E.T. |
|
|
359.9 |
|
|
|
348.5 |
|
|
|
946.1 |
|
|
|
1,062.3 |
|
Dental, Spine & CMFT |
|
|
295.5 |
|
|
|
275.5 |
|
|
|
729.7 |
|
|
|
855.2 |
|
Other |
|
|
141.1 |
|
|
|
157.3 |
|
|
|
364.3 |
|
|
|
468.4 |
|
Total |
|
$ |
1,929.3 |
|
|
$ |
1,892.4 |
|
|
$ |
4,939.2 |
|
|
$ |
5,856.5 |
|
In the first quarter of 2020, we updated our product category revenue reporting format to further align with our announced reorganization. Product category sales include the following changes:
|
• |
Surgical products, previously reported in the S.E.T. (Sports Medicine, Extremities and Trauma) product category, are included in the Other product category; |
|
• |
Dental products are combined with Spine and CMF (Craniomaxillofacial) products into one product category; |
|
• |
The CMF product category name has been changed to CMFT (Craniomaxillofacial and Thoracic), to reflect the Thoracic business, which is included in that category; and |
|
• |
Other immaterial adjustments related to brand alignment within product categories in the Asia Pacific region have been made. |
Prior period product category sales have been reclassified to conform to the current presentation.
9
4. Restructuring
In December 2019, our Board of Directors approved, and we initiated, a new global restructuring program (the “2019 Restructuring Plan”) with an objective of reducing costs to allow us to further invest in higher priority growth opportunities. The 2019 Restructuring Plan is expected to result in total pre-tax restructuring charges of approximately $350 million to $400 million and reduce gross annual pre-tax operating expenses by approximately $200 million to $300 million by the end of 2023 as program benefits are realized. The pre-tax restructuring charges consist of employee termination benefits; contract terminations for facilities and sales agents; and other charges, such as consulting fees, project management and relocation costs. The restructuring charges incurred in the nine months ended September 30, 2020 primarily related to employee termination benefits, distributor contract terminations, consulting and project management. The following table summarizes the liabilities recognized related to the 2019 Restructuring Plan (in millions):
|
|
Employee |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Termination |
|
|
Contract |
|
|
|
|
|
|
|
|
|
||
|
|
Benefits |
|
|
Terminations |
|
|
Other |
|
|
Total |
|
||||
Expenses incurred in the three months ended September 30, 2020 |
|
$ |
6.9 |
|
|
$ |
1.4 |
|
|
$ |
7.2 |
|
|
$ |
15.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2019 |
|
$ |
23.2 |
|
|
$ |
- |
|
|
$ |
4.1 |
|
|
$ |
27.3 |
|
Expenses incurred in the nine months ended September 30, 2020 |
|
|
43.6 |
|
|
|
10.7 |
|
|
|
28.5 |
|
|
|
82.8 |
|
Cash payments |
|
|
(37.0 |
) |
|
|
(4.3 |
) |
|
|
(17.0 |
) |
|
|
(58.3 |
) |
Foreign currency exchange rate changes |
|
|
0.3 |
|
|
|
- |
|
|
|
- |
|
|
|
0.3 |
|
Balance, September 30, 2020 |
|
$ |
30.1 |
|
|
$ |
6.4 |
|
|
$ |
15.6 |
|
|
$ |
52.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expense incurred since the start of the 2019 Restructuring Plan |
|
$ |
66.8 |
|
|
$ |
10.7 |
|
|
$ |
41.6 |
|
|
$ |
119.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expense estimated to be recognized for the 2019 Restructuring Plan |
|
$ |
210.0 |
|
|
$ |
25.0 |
|
|
$ |
140.0 |
|
|
$ |
375.0 |
|
For the expense estimated to be recognized for the 2019 Restructuring Plan, we have disclosed the midpoint in our estimated range of expenses. We do not include restructuring charges in the operating profit of our reportable segments.
In our condensed consolidated statement of earnings, we report restructuring charges in our “Restructuring and other cost reduction initiatives” financial statement line item. We report the expenses for other cost reduction initiatives with restructuring expenses because these activities also have the goal of reducing costs across the organization. However, since the cost reduction initiative expenses are not considered restructuring, they have been excluded from the amounts presented in this note.
5. Inventories
|
|
September 30, |
|
|
December 31, |
|
||
|
|
2020 |
|
|
2019 |
|
||
|
|
(in millions) |
|
|||||
Finished goods |
|
$ |
1,990.4 |
|
|
$ |
1,875.4 |
|
Work in progress |
|
|
226.3 |
|
|
|
231.0 |
|
Raw materials |
|
|
275.5 |
|
|
|
278.6 |
|
Inventories |
|
$ |
2,492.2 |
|
|
$ |
2,385.0 |
|
10
6. Property, Plant and Equipment
|
|
September 30, |
|
|
December 31, |
|
||
|
|
2020 |
|
|
2019 |
|
||
|
|
(in millions) |
|
|||||
Land |
|
$ |
26.6 |
|
|
$ |
27.6 |
|
Buildings and equipment |
|
|
2,155.4 |
|
|
|
2,007.0 |
|
Capitalized software costs |
|
|
472.4 |
|
|
|
482.4 |
|
Instruments |
|
|
3,428.8 |
|
|
|
3,250.5 |
|
Construction in progress |
|
|
134.4 |
|
|
|
149.3 |
|
|
|
|
6,217.6 |
|
|
|
5,916.8 |
|
Accumulated depreciation |
|
|
(4,175.1 |
) |
|
|
(3,839.4 |
) |
Property, plant and equipment, net |
|
$ |
2,042.5 |
|
|
$ |
2,077.4 |
|
We had $28.7 million and $39.8 million of property, plant and equipment included in accounts payable as of September 30, 2020 and December 31, 2019, respectively.
7. Goodwill and Intangible Assets
The following table summarizes the changes in the carrying amount of goodwill by reportable segment, including the effects of changes to our reportable segments (in millions):
|
|
Americas and Global Businesses |
|
|
EMEA |
|
|
Asia Pacific |
|
|
Immaterial Product Category Operating Segments |
|
|
Total |
|
|||||
Balance at December 31, 2019 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill |
|
$ |
7,699.8 |
|
|
$ |
1,316.8 |
|
|
$ |
507.4 |
|
|
$ |
1,729.3 |
|
|
$ |
11,253.3 |
|
Accumulated impairment losses |
|
|
- |
|
|
|
(567.0 |
) |
|
|
- |
|
|
|
(1,086.6 |
) |
|
|
(1,653.6 |
) |
|
|
$ |
7,699.8 |
|
|
$ |
749.8 |
|
|
$ |
507.4 |
|
|
$ |
642.7 |
|
|
$ |
9,599.7 |
|
Goodwill reportable segment change |
|
|
1,661.3 |
|
|
|
17.0 |
|
|
|
51.0 |
|
|
|
(1,729.3 |
) |
|
|
- |
|
Accumulated impairment losses reportable segment change |
|
|
(1,086.6 |
) |
|
|
- |
|
|
|
- |
|
|
|
1,086.6 |
|
|
|
- |
|
Purchase accounting adjustments |
|
|
0.2 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
0.2 |
|
Impairment |
|
|
(142.0 |
) |
|
|
(470.0 |
) |
|
|
- |
|
|
|
- |
|
|
|
(612.0 |
) |
Currency translation |
|
|
39.6 |
|
|
|
6.9 |
|
|
|
4.4 |
|
|
|
- |
|
|
|
50.9 |
|
Balance at September 30, 2020 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill |
|
$ |
9,400.9 |
|
|
$ |
1,340.7 |
|
|
$ |
562.8 |
|
|
$ |
- |
|
|
$ |
11,304.4 |
|
Accumulated impairment losses |
|
|
(1,228.6 |
) |
|
|
(1,037.0 |
) |
|
|
- |
|
|
|
- |
|
|
|
(2,265.6 |
) |
|
|
$ |
8,172.3 |
|
|
$ |
303.7 |
|
|
$ |
562.8 |
|
|
$ |
- |
|
|
$ |
9,038.8 |
|
As discussed further in Note 15, in connection with the 2019 Restructuring Plan, our operating segments and reportable segments have changed. Goodwill has been reallocated from our previous reportable segments to reflect the new structure. We now have five reporting units with goodwill assigned to them.
As of March 31, 2020, we tested three of our reporting units for impairment due to: i) the significant adverse effect the COVID-19 pandemic was expected to have on our operating results, and ii) the change in reportable segments, which changed the cash flows and asset compositions of certain reporting units. This resulted in goodwill impairment charges of $470.0 million and $142.0 million recognized for our Europe, Middle East and Africa (“EMEA”) reporting unit and Dental reporting unit, respectively. The remaining two reporting units with goodwill assigned to them were not tested for impairment as we concluded it is more likely than not the fair value of these reporting units exceeds their carrying value.
11
The impairment charge of $470.0 million in our EMEA reporting unit was due to the COVID-19 pandemic and reportable segment change. The COVID-19 pandemic has had a significant adverse effect on both the operational and non-operational assumptions used to estimate the fair value of our EMEA reporting unit. The significant decline in our share price and that of most other publicly-traded companies resulted in us utilizing a higher risk-adjusted discount rate compared to the rate used in our last annual goodwill impairment test to discount our future estimated cash flows to present value. On an operational basis, due to the deferral of elective surgical procedures, our estimated cash flows in 2020 will be significantly lower than previously estimated in our last annual goodwill impairment test. The change in reportable segments resulted in additional impairment due to additional assets being allocated to the EMEA reporting unit. As of September 30, 2020, $303.7 million of goodwill remains in the EMEA reporting unit.
The impairment charge of $142.0 million in our Dental reporting unit was driven by the COVID-19 pandemic. Similar to our EMEA reporting unit, changes in the market have caused an increase to the risk-adjusted discount rates utilized to discount our future estimated cash flows to present value, and we expected that the deferral of elective dental procedures would have an adverse effect on our cash flows. We estimated the cash flows from our Dental reporting unit may recover more slowly than our other reporting units because many dental procedures are not covered by insurance. Therefore, we estimated economic uncertainty will likely result in patients deferring dental procedures for a longer period of time than procedures involving our other products. As of September 30, 2020, $257.3 million of goodwill remains in the Dental reporting unit.
The third reporting unit we tested for impairment, Americas CMFT, had an estimated fair value that exceeded its carrying value by less than 5 percent. The Americas CMFT reporting unit’s estimated fair value was also adversely impacted by the COVID-19 pandemic similar to our EMEA and Dental reporting units.
We estimated the fair value of the EMEA, Dental and Americas CMFT reporting units based on income and market approaches. Fair value under the income approach was determined by discounting to present value the estimated future cash flows of the reporting unit. Fair value under the market approach utilized the guideline public company methodology, which uses valuation indicators from publicly-traded companies that are similar to our EMEA, Dental and Americas CMFT reporting units and considers differences between our reporting unit and the comparable companies.
In estimating the future cash flows of the reporting units, we utilized a combination of market and company-specific inputs that a market participant would use in assessing the fair value of the reporting units. The primary market input was revenue growth rates. These rates were based upon historical trends and estimated future growth drivers such as an aging global population, obesity and more active lifestyles. In the near term, the COVID-19 pandemic was expected to result in a decline to our revenue when compared to the same prior year periods. Significant company specific inputs included assumptions regarding how the reporting units could leverage operating expenses as revenue grows and the impact any of our differentiated products or new products will have on revenues.
Under the guideline public company methodology, we took into consideration specific risk differences between our reporting unit and the comparable companies, such as recent financial performance, size risks and product portfolios, among other considerations.
We will continue to monitor the fair value of our EMEA, Dental and Americas CMFT reporting units as well as our other two reporting units in our interim and annual reporting periods. If our estimated cash flows for these reporting units decrease, we may have to record further impairment charges in the future. Factors that could result in our cash flows being lower than our current estimates include: 1) the COVID-19 pandemic causes elective surgical procedures to be deferred longer than our estimates, or additional recurrence of the virus causes hospitals to defer elective surgical procedures, 2) decreased revenues caused by unforeseen changes in the healthcare market, or our inability to generate new product revenue from our research and development activities, and 3) our inability to achieve the estimated operating margins in our forecasts due to unforeseen factors. Additionally, changes in the broader economic environment could cause changes to our estimated discount rates and comparable company valuation indicators, which may impact our estimated fair values.
In the second quarter of 2020 and 2019, we recognized $33.0 million and $70.1 million, respectively, of in-process research and development (“IPR&D”) intangible asset impairments on certain IPR&D projects. The $33.0 million charge in 2020 includes a $19.0 million impairment related to a project that requires additional research and development costs to complete, which delays the cash inflows and results in a decreased estimated fair value. The remaining $14.0 million impairment charge in 2020 and the entire $70.1 million charge from 2019 are related to terminated IPR&D projects. The termination of these projects is the result of prioritizing our internal research and development portfolio as a result of COVID-19 and to 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 on our future cash flows.
12
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 September 30, 2020 of $450.0 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 $4.4 million and $21.8 million as of September 30, 2020 and December 31, 2019, 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 nine-month periods ended September 30, 2020 and 2019, we sold receivables having an aggregate face value of $1,225.5 million and $2,384.7 million to third parties in exchange for cash proceeds of $1,224.3 million and $2,383.2 million, respectively. Expenses recognized on these sales during the nine-month periods ended September 30, 2020 and 2019 were not significant. In the nine-month periods ended September 30, 2020 and 2019, under the U.S. and Japan programs, we collected $1,186.7 million and $2,167.4 million, respectively, from our customers and remitted that amount to the third party, and we effectively repurchased $131.4 million and $106.0 million, respectively, of previously sold accounts receivable from the third party, due to the programs’ revolving nature. At September 30, 2020 and December 31, 2019, we had collected $14.7 million and $54.6 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 September 30, 2020 and December 31, 2019, the outstanding principal amount of receivables that has been derecognized under the U.S. and Japan revolving arrangements amounted to $87.0 million and $270.2 million, respectively.
13
9. Debt
Our debt consisted of the following (in millions):
|
|
September 30, |
|
|
December 31, |
|
||
|
|
2020 |
|
|
2019 |
|
||
Current portion of long-term debt |
|
|
|
|
|
|
|
|
2.700% Senior Notes due 2020 |
|
$ |
- |
|
|
$ |
1,500.0 |
|
Floating Rate Notes due 2021 |
|
|
450.0 |
|
|
|
- |
|
Total current portion of long-term debt |
|
$ |
450.0 |
|
|
$ |
1,500.0 |
|
Long-term debt |
|
|
|
|
|
|
|
|
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 |
|
|
|
300.0 |
|
3.550% Senior Notes due 2025 |
|
|
2,000.0 |
|
|
|
2,000.0 |
|
3.050% Senior Notes due 2026 |
|
|
600.0 |
|
|
|
- |
|
3.550% Senior Notes due 2030 |
|
|
900.0 |
|
|
|
- |
|
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 |
|
|
586.3 |
|
|
|
561.3 |
|
2.425% Euro Notes due 2026 |
|
|
586.3 |
|
|
|
561.3 |
|
1.164% Euro Notes due 2027 |
|
|
586.3 |
|
|
|
561.3 |
|
Japan Term Loan A |
|
|
110.8 |
|
|
|
106.9 |
|
Japan Term Loan B |
|
|
201.7 |
|
|
|
194.7 |
|
Debt discount and issuance costs |
|
|
(51.7 |
) |
|
|
(37.1 |
) |
Adjustment related to interest rate swaps |
|
|
3.9 |
|
|
|
6.4 |
|
Total long-term debt |
|
$ |
7,840.2 |
|
|
$ |
6,721.4 |
|
At September 30, 2020, our total current and non-current debt of $8.3 billion consisted of $8.0 billion aggregate principal amount of our senior notes, which included 1.5 billion Euro-denominated senior notes (“Euro Notes”), 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 $3.9 million, partially offset by debt discount and issuance costs of $51.7 million.
On March 20, 2020, we completed the offering of $600.0 million aggregate principal amount of our 3.050% senior notes due on January 15, 2026 and $900.0 million aggregate principal amount of our 3.550% senior notes due on March 20, 2030. Interest payable on the 3.050% senior notes is payable semi-annually, commencing on July 15, 2020 until maturity. Interest payable on the 3.550% senior notes is payable semi-annually, commencing on September 20, 2020 until maturity. The proceeds from the offering, together with cash on hand, were used to repay at maturity the $1.5 billion principal amount of 2.700% senior notes due on April 1, 2020.
On November 1, 2019, we entered into a revolving credit agreement (the “2019 Credit Agreement”), which contains a
unsecured multicurrency revolving facility of $1.5 billion (the “2019 Multicurrency Revolving Facility”), which replaced the previous $1.5 billion multicurrency revolving credit facility (the “2016 Multicurrency Revolving Facility”) and U.S term loan (“U.S Term Loan B”) under our credit agreement executed in September 2016 (as amended, the “2016 Credit Agreement”). U.S. Term Loan B was paid in full during the nine months ended September 30, 2019. The 2019 Credit Agreement will mature on November 1, 2024, with two one-year extensions exercisable at our discretion and subject to required lender consent. As of September 30, 2020, there were no outstanding borrowings under the 2019 Multicurrency Revolving Facility.14
Borrowings under the 2019 Credit Agreement generally bear interest at floating rates. We pay a facility fee on the aggregate amount of the 2019 Multicurrency Revolving Facility. The 2019 Credit Agreement contains 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. On April 23, 2020, we entered into an amendment to the 2019 Credit Agreement to temporarily increase the maximum permitted consolidated indebtedness to consolidated EBITDA ratio (“Consolidated Leverage Ratio”), temporarily increase the interest rate margin applicable to revolving loans and the facility fee, and make other administrative changes. Pursuant to the amendment, the maximum permitted Consolidated Leverage Ratio as of the last day of any period of four consecutive fiscal quarters under the 2019 Credit Agreement will be (i) 5.75 to 1.00 for periods ending between April 1, 2020 and including December 31, 2020, (ii) 5.00 to 1.00 for the period ending March 31, 2021, and (iii) 4.50 to 1.00 for periods ending after April 1, 2021 (with such maximum permitted Consolidated Leverage Ratio subject to increase to 5.00 to 1.00 for a period of time in connection with a qualified material acquisition on or after July 1, 2021). We were in compliance with all covenants under the 2019 Credit Agreement as of September 30, 2020. The amendment also increases the interest rate margin applicable to revolving loans and the facility fee, each of which are determined by reference to our senior unsecured long-term debt credit rating, through March 31, 2021.
On April 23, 2020, we entered into a revolving credit agreement which was an unsecured revolving credit facility of $1.0 billion (the “April 2020 Revolving Facility”). In conjunction with a new revolving credit agreement (the “September 2020 Credit Agreement”) entered into on September 18, 2020, the April 2020 Revolving Facility was terminated. We never borrowed against the April 2020 Revolving Facility. The September 2020 Credit Agreement is a $1.0 billion 364-day unsecured revolving credit facility (the “September 2020 Revolving Facility”). The September 2020 Revolving Facility will be used for general corporate purposes. The September 2020 Credit Agreement matures on September 17, 2021. Borrowings under the September 2020 Credit Agreement generally bear interest at floating rates. We pay a facility fee on the aggregate amount of the September 2020 Revolving Facility. The September 2020 Credit Agreement contains customary affirmative and negative covenants and events of default for an unsecured financing arrangement including, among other things, limitations on consolidations, mergers, and sales of assets. The September 2020 Credit Agreement requires us to maintain a Consolidated Leverage Ratio as of the last day of any period of four consecutive fiscal quarters of no greater than (i) 5.75 to 1.00 for periods ending during the period from September 18, 2020 to and including December 31, 2020, (ii) 5.00 to 1.00 for the period ending March 31, 2021, and (iii) 4.50 to 1.00 for periods ending after April 1, 2021 (with such permitted Consolidated Leverage Ratio subject to increase to 5.00 to 1.00 for a period of time in connection with a qualified material acquisition on or after July 1, 2021). We were in compliance with all covenants under the September 2020 Credit Agreement, as of September 30, 2020. As of September 30, 2020, there were no outstanding borrowings under the September 2020 Credit Agreement.
The estimated fair value of our senior notes as of September 30, 2020, based on quoted prices for the specific securities from transactions in over-the-counter markets (Level 2), was $8,693.4 million. The estimated fair value of Japan Term Loan A and Japan Term Loan B, in the aggregate, as of September 30, 2020, based upon publicly available market yield curves and the terms of the debt (Level 2), was $310.8 million.
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 related to 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 gains (losses), net of tax (in millions):
|
|
Foreign |
|
|
Cash |
|
|
Defined |
|
|
|
|
|
|||
|
|
Currency |
|
|
Flow |
|
|
Benefit |
|
|
Total |
|
||||
|
|
Translation |
|
|
Hedges |
|
|
Plan Items |
|
|
AOCI |
|
||||
Balance at December 31, 2019 |
|
$ |
(32.8 |
) |
|
$ |
16.4 |
|
|
$ |
(225.5 |
) |
|
$ |
(241.9 |
) |
AOCI before reclassifications |
|
|
(22.7 |
) |
|
|
8.7 |
|
|
|
- |
|
|
|
(14.0 |
) |
Reclassifications to statements of earnings |
|
|
- |
|
|
|
(33.6 |
) |
|
|
2.5 |
|
|
|
(31.1 |
) |
Balance at September 30, 2020 |
|
$ |
(55.5 |
) |
|
$ |
(8.5 |
) |
|
$ |
(223.0 |
) |
|
$ |
(287.0 |
) |
15
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 |
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
|
Statements of Earnings |
||||
Cash flow hedges |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange forward contracts |
|
$ |
8.7 |
|
|
$ |
11.3 |
|
|
$ |
39.4 |
|
|
$ |
25.8 |
|
|
Cost of products sold |
Interest rate swaps |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
2.8 |
|
|
Interest expense, net |
Forward starting interest rate swaps |
|
|
(0.2 |
) |
|
|
(0.1 |
) |
|
|
(0.5 |
) |
|
|
(0.4 |
) |
|
Interest expense, net |
|
|
|
8.5 |
|
|
|
11.2 |
|
|
|
38.9 |
|
|
|
28.2 |
|
|
Total before tax |
|
|
|
1.5 |
|
|
|
1.5 |
|
|
|
5.3 |
|
|
|
4.1 |
|
|
Provision for income taxes |
|
|
$ |
7.0 |
|
|
$ |
9.7 |
|
|
$ |
33.6 |
|
|
$ |
24.1 |
|
|
Net of tax |
Defined benefit plans |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prior service cost |
|
$ |
1.0 |
|
|
$ |
1.8 |
|
|
$ |
3.0 |
|
|
$ |
5.5 |
|
|
Other expense, net |
Unrecognized actuarial loss |
|
|
(2.6 |
) |
|
|
(5.5 |
) |
|
|
(8.0 |
) |
|
|
(16.3 |
) |
|
Other expense, net |
|
|
|
(1.6 |
) |
|
|
(3.7 |
) |
|
|
(5.0 |
) |
|
|
(10.8 |
) |
|
Total before tax |
|
|
|
(0.9 |
) |
|
|
(0.7 |
) |
|
|
(2.5 |
) |
|
|
(3.4 |
) |
|
Provision for income taxes |
|
|
$ |
(0.7 |
) |
|
$ |
(3.0 |
) |
|
$ |
(2.5 |
) |
|
$ |
(7.4 |
) |
|
Net of tax |
Total reclassifications |
|
$ |
6.3 |
|
|
$ |
6.7 |
|
|
$ |
31.1 |
|
|
$ |
16.7 |
|
|
Net of tax |
The following table shows the tax effects on each component of AOCI recognized in our condensed consolidated statements of comprehensive income (loss) (in millions):
|
|
Three Months Ended September 30, 2020 |
|
|
Nine Months Ended September 30, 2020 |
|
||||||||||||||||||
|
|
Before Tax |
|
|
Tax |
|
|
Net of Tax |
|
|
Before Tax |
|
|
Tax |
|
|
Net of Tax |
|
||||||
Foreign currency cumulative translation adjustments |
|
$ |
(28.3 |
) |
|
$ |
(36.8 |
) |
|
$ |
8.5 |
|
|
$ |
(53.2 |
) |
|
$ |
(30.5 |
) |
|
$ |
(22.7 |
) |
Unrealized cash flow hedge (losses) gains |
|
|
(29.1 |
) |
|
|
(5.7 |
) |
|
|
(23.4 |
) |
|
|
9.0 |
|
|
|
0.3 |
|
|
|
8.7 |
|
Reclassification adjustments on cash flow hedges |
|
|
(8.5 |
) |
|
|
(1.5 |
) |
|
|
(7.0 |
) |
|
|
(38.9 |
) |
|
|
(5.3 |
) |
|
|
(33.6 |
) |
Adjustments to prior service cost and unrecognized actuarial assumptions |
|
|
1.6 |
|
|
|
0.9 |
|
|
|
0.7 |
|
|
|
5.0 |
|
|
|
2.5 |
|
|
|
2.5 |
|
Total Other Comprehensive Loss |
|
$ |
(64.3 |
) |
|
$ |
(43.1 |
) |
|
$ |
(21.2 |
) |
|
$ |
(78.1 |
) |
|
$ |
(33.0 |
) |
|
$ |
(45.1 |
) |
|
|
Three Months Ended September 30, 2019 |
|
|
Nine Months Ended September 30, 2019 |
|
||||||||||||||||||
|
|
Before Tax |
|
|
Tax |
|
|
Net of Tax |
|
|
Before Tax |
|
|
Tax |
|
|
Net of Tax |
|
||||||
Foreign currency cumulative translation adjustments |
|
$ |
(41.6 |
) |
|
$ |
29.2 |
|
|
$ |
(70.8 |
) |
|
$ |
(25.6 |
) |
|
$ |
34.5 |
|
|
$ |
(60.1 |
) |
Unrealized cash flow hedge gains |
|
|
33.6 |
|
|
|
7.5 |
|
|
|
26.1 |
|
|
|
46.4 |
|
|
|
5.4 |
|
|
|
41.0 |
|
Reclassification adjustments on cash flow hedges |
|
|
(11.2 |
) |
|
|
(1.5 |
) |
|
|
(9.7 |
) |
|
|
(28.2 |
) |
|
|
(4.1 |
) |
|
|
(24.1 |
) |
Adjustments to prior service cost and unrecognized actuarial assumptions |
|
|
3.7 |
|
|
|
0.7 |
|
|
|
3.0 |
|
|
|
10.8 |
|
|
|
3.4 |
|
|
|
7.4 |
|
Total Other Comprehensive (Loss) Income |
|
$ |
(15.5 |
) |
|
$ |
35.9 |
|
|
$ |
(51.4 |
) |
|
$ |
3.4 |
|
|
$ |
39.2 |
|
|
$ |
(35.8 |
) |
16
11. 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, 2020 |
|
|||||||||||||
|
|
|
|
|
|
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 |
|
$ |
11.8 |
|
|
$ |
- |
|
|
$ |
11.8 |
|
|
$ |
- |
|
Cross-currency interest rate swaps |
|
|
19.6 |
|
|
|
- |
|
|
|
19.6 |
|
|
|
- |
|
Total Assets |
|
$ |
31.4 |
|
|
$ |
- |
|
|
$ |
31.4 |
|
|
$ |
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives, current and long-term |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency forward contracts |
|
$ |
5.6 |
|
|
$ |
- |
|
|
$ |
5.6 |
|
|
$ |
- |
|
Cross-currency interest rate swaps |
|
|
15.1 |
|
|
|
- |
|
|
|
15.1 |
|
|
|
- |
|
Total Liabilities |
|
$ |
20.7 |
|
|
$ |
- |
|
|
$ |
20.7 |
|
|
$ |
- |
|
|
|
As of December 31, 2019 |
|
|||||||||||||
|
|
|
|
|
|
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 |
|
$ |
39.1 |
|
|
$ |
- |
|
|
$ |
39.1 |
|
|
$ |
- |
|
Cross-currency interest rate swaps |
|
|
60.5 |
|
|
|
- |
|
|
|
60.5 |
|
|
|
- |
|
Total Assets |
|
$ |
99.6 |
|
|
$ |
- |
|
|
$ |
99.6 |
|
|
$ |
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives, current and long-term |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency forward contracts |
|
$ |
0.6 |
|
|
$ |
- |
|
|
$ |
0.6 |
|
|
$ |
- |
|
Total Liabilities |
|
$ |
0.6 |
|
|
$ |
- |
|
|
$ |
0.6 |
|
|
$ |
- |
|
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 cross-currency interest rate swaps using a market approach based on publicly available market yield curves, foreign currency exchange rates and the terms of our swaps, and we perform ongoing assessments of counterparty credit risk.
12. 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.
17
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 4.625% Senior Notes were repaid at maturity in 2019. The remaining unamortized balance related to the 3.375% Senior Notes as of September 30, 2020 related to these discontinued hedges was $3.9 million, which will be recognized using the effective interest rate method over the remaining maturity period of the hedged notes. As of September 30, 2020 and December 31, 2019, 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, 2020 |
|
|
December 31, 2019 |
|
|
|
September 30, 2020 |
|
|
December 31, 2019 |
|
||||
Long-term debt |
|
$ |
303.8 |
|
|
$ |
306.2 |
|
|
|
$ |
3.9 |
|
|
$ |
6.4 |
|
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
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 notes offering. The interest rate swaps were settled, and the remaining loss to be recognized at September 30, 2020 was $26.1 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 minimized the exposure to changes in the LIBOR interest rates while the variable-rate debt was outstanding. In the first quarter of 2019, we terminated these interest rate swaps concurrently with the repayment of the remaining balance of U.S. Term Loan B, and we recognized proceeds and interest income of $2.8 million related to the termination.
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, 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 November 2019 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.
At September 30, 2020, we had receive-fixed-rate, pay-fixed-rate cross-currency interest swaps with notional amounts outstanding of Euro 1,450 million, Japanese Yen 7 billion and Swiss Franc 50 million. These transactions further hedge our net investment in certain wholly-owned foreign subsidiaries that have a functional currency of Euro, Japanese Yen and Swiss Franc. 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. We recognize the excluded component in interest expense, net on our condensed consolidated statements of earnings. The net cash received related to the receive-fixed-rate, pay-fixed-rate component of the cross-currency interest rate swaps is reflected in investing cash flows in our condensed consolidated statements of cash flows.
18
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, 2020, 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, 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 2020 through February 2023. As of September 30, 2020, the notional amounts of outstanding forward contracts and options entered into with third parties to purchase U.S. Dollars were $1,397.5 million. As of September 30, 2020, the notional amounts of outstanding forward contracts and options entered into with third parties to purchase Swiss Francs were $260.6 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, net. These contracts are settled on the last day of each reporting period. Therefore, there is no outstanding balance related to these contracts recorded on 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 (loss) 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 |
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
|
Statements of Earnings |
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
||||||||
Foreign exchange forward contracts |
|
$ |
(29.1 |
) |
|
$ |
33.6 |
|
|
$ |
9.0 |
|
|
$ |
46.4 |
|
|
Cost of products sold |
|
$ |
8.7 |
|
|
$ |
11.3 |
|
|
$ |
39.4 |
|
|
$ |
25.8 |
|
Interest rate swaps |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
Interest expense, net |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
2.8 |
|
Forward starting interest rate swaps |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
Interest expense, net |
|
|
(0.2 |
) |
|
|
(0.1 |
) |
|
|
(0.5 |
) |
|
|
(0.4 |
) |
|
|
$ |
(29.1 |
) |
|
$ |
33.6 |
|
|
$ |
9.0 |
|
|
$ |
46.4 |
|
|
|
|
$ |
8.5 |
|
|
$ |
11.2 |
|
|
$ |
38.9 |
|
|
$ |
28.2 |
|
19
The fair value of outstanding derivative instruments designated as cash flow hedges and recorded on our condensed consolidated balance sheet at September 30, 2020, together with settled derivatives where the hedged item has not yet affected earnings, was a net unrealized loss of $12.5 million, or $25.2 million after taxes, which is deferred in AOCI. A gain of $14.0 million, or $11.5 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, net over the next twelve months.
The following table presents the effect of fair value, cash flow and net investment hedge accounting on our condensed consolidated statements of earnings (in millions):
|
|
Location and Amount of Gain/(Loss) Recognized in Income on Fair Value, Cash Flow and Net Investment Hedging Relationships for the Period Ended: |
|
|||||||||||||||||||||||||||||
|
|
Three Months Ended |
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
Nine Months Ended |
|
||||||||||||||||||||
|
|
September 30, 2020 |
|
|
September 30, 2019 |
|
|
September 30, 2020 |
|
|
September 30, 2019 |
|
||||||||||||||||||||
|
|
Cost of |
|
|
Interest |
|
|
Cost of |
|
|
Interest |
|
|
Cost of |
|
|
Interest |
|
|
Cost of |
|
|
Interest |
|
||||||||
|
|
Products |
|
|
Expense, |
|
|
Products |
|
|
Expense, |
|
|
Products |
|
|
Expense, |
|
|
Products |
|
|
Expense, |
|
||||||||
|
|
Sold |
|
|
Net |
|
|
Sold |
|
|
Net |
|
|
Sold |
|
|
Net |
|
|
Sold |
|
|
Net |
|
||||||||
Total amounts of income and expense line items presented in the statements of earnings in which the effects of fair value, cash flow and net investment hedges are recorded |
|
$ |
569.4 |
|
|
$ |
(54.0 |
) |
|
$ |
535.7 |
|
|
$ |
(56.8 |
) |
|
$ |
1,481.0 |
|
|
$ |
(158.9 |
) |
|
$ |
1,670.4 |
|
|
$ |
(174.5 |
) |
The effects of fair value, cash flow and net investment hedging: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
Gain on fair value hedging relationships |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Discontinued interest rate swaps |
|
|
- |
|
|
|
0.8 |
|
|
|
- |
|
|
|
2.0 |
|
|
|
- |
|
|
|
2.5 |
|
|
|
- |
|
|
|
6.2 |
|
Gain (loss) on cash flow hedging relationships |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange forward contracts |
|
|
8.7 |
|
|
|
- |
|
|
|
11.3 |
|
|
|
- |
|
|
|
39.4 |
|
|
|
- |
|
|
|
25.8 |
|
|
|
- |
|
Interest rate swaps |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
2.8 |
|
Forward starting interest rate swaps |
|
|
- |
|
|
|
(0.2 |
) |
|
|
- |
|
|
|
(0.1 |
) |
|
|
- |
|
|
|
(0.5 |
) |
|
|
- |
|
|
|
(0.4 |
) |
Gain on net investment hedging relationships |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cross-currency interest rate swaps |
|
|
- |
|
|
|
13.4 |
|
|
|
- |
|
|
|
13.4 |
|
|
|
- |
|
|
|
40.2 |
|
|
|
- |
|
|
|
38.8 |
|
Derivatives Not Designated as Hedging Instruments
The following gains / (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 |
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
||||
Foreign exchange forward contracts |
|
Other expense, net |
|
$ |
0.1 |
|
|
$ |
0.7 |
|
|
$ |
15.5 |
|
|
$ |
(8.2 |
) |
These gains/(losses) do not reflect offsetting losses of $2.8 and $24.7 million in the three and nine-month periods ended September 30, 2020, respectively, and offsetting losses of $4.2 million and $2.3 million in the three and nine-month periods ended September 30, 2019, 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.
20
Balance Sheet Presentation
As of September 30, 2020 and December 31, 2019, all derivatives designated as fair value hedges, cash flow hedges and net investment hedges are recorded at fair value on our condensed consolidated balance sheets. On our condensed consolidated balance sheets, we recognize individual forward contracts 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, 2020 |
|
|
As of December 31, 2019 |
|
||||||
|
|
Balance |
|
|
|
|
|
Balance |
|
|
|
|
|
|
Sheet |
|
Fair |
|
|
Sheet |
|
Fair |
|
||
|
|
Location |
|
Value |
|
|
Location |
|
Value |
|
||
Asset Derivatives |
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange forward contracts |
|
Other current assets |
|
$ |
18.1 |
|
|
Other current assets |
|
$ |
41.8 |
|
Cross-currency interest rate swaps |
|
Other current assets |
|
|
2.9 |
|
|
Other current assets |
|
|
- |
|
Foreign exchange forward contracts |
|
Other assets |
|
|
5.5 |
|
|
Other assets |
|
|
9.8 |
|
Cross-currency interest rate swaps |
|
Other assets |
|
|
16.7 |
|
|
Other assets |
|
|
60.5 |
|
Total asset derivatives |
|
|
|
$ |
43.2 |
|
|
|
|
$ |
112.1 |
|
Liability Derivatives |
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange forward contracts |
|
Other current liabilities |
|
$ |
8.3 |
|
|
Other current liabilities |
|
$ |
7.9 |
|
Cross-currency interest rate swaps |
|
Other current liabilities |
|
|
13.3 |
|
|
Other current liabilities |
|
|
- |
|
Foreign exchange forward contracts |
|
Other long-term liabilities |
|
|
9.1 |
|
|
Other long-term liabilities |
|
|
5.2 |
|
Cross-currency interest rate swaps |
|
Other long-term liabilities |
|
|
1.8 |
|
|
Other long-term liabilities |
|
|
- |
|
Total liability derivatives |
|
|
|
$ |
32.5 |
|
|
|
|
$ |
13.1 |
|
The table below presents the effects of our master netting agreements on our condensed consolidated balance sheets (in millions):
|
|
|
|
As of September 30, 2020 |
|
|
As of December 31, 2019 |
|
||||||||||||||||||
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 |
|
$ |
18.1 |
|
|
$ |
7.1 |
|
|
$ |
11.0 |
|
|
$ |
41.8 |
|
|
$ |
7.9 |
|
|
$ |
33.9 |
|
Cash flow hedges |
|
Other assets |
|
|
5.5 |
|
|
|
4.7 |
|
|
|
0.8 |
|
|
|
9.8 |
|
|
|
4.6 |
|
|
|
5.2 |
|
Liability Derivatives |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flow hedges |
|
Other current liabilities |
|
|
8.3 |
|
|
|
7.1 |
|
|
|
1.2 |
|
|
|
7.9 |
|
|
|
7.9 |
|
|
|
- |
|
Cash flow hedges |
|
Other long-term liabilities |
|
|
9.1 |
|
|
|
4.7 |
|
|
|
4.4 |
|
|
|
5.2 |
|
|
|
4.6 |
|
|
|
0.6 |
|
The following net investment hedge gains (losses) were recognized on our condensed consolidated statements of comprehensive income (loss) (in millions):
|
|
Amount of Gain (Loss) |
|
|||||||||||||
|
|
Recognized in AOCI |
|
|||||||||||||
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
||||||||||
|
|
September 30, |
|
|
September 30, |
|
||||||||||
Derivative Instrument |
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
||||
Euro Notes |
|
$ |
(74.1 |
) |
|
$ |
48.6 |
|
|
$ |
(75.0 |
) |
|
$ |
53.0 |
|
Cross-currency interest rate swaps |
|
|
(84.1 |
) |
|
|
75.6 |
|
|
|
(56.0 |
) |
|
|
94.8 |
|
|
|
$ |
(158.2 |
) |
|
$ |
124.2 |
|
|
$ |
(131.0 |
) |
|
$ |
147.8 |
|
21
13. Income Taxes
On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was enacted and signed into law and includes, among other things, refundable payroll tax credits, deferment of employer side social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations, and technical corrections to tax depreciation methods for qualified improvement property. We do not expect the provisions of the CARES Act to have a material impact on our tax provision.
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 $350 million decrease to a $20 million increase.
We are under continuous audit by the Internal Revenue Service (“IRS”) and other taxing authorities. During the course of these audits, we receive proposed adjustments from taxing authorities that may be material. Therefore, there is a possibility that an adverse outcome in these audits could have a material effect on our results of operations and financial condition. Our U.S. Federal income tax returns have been audited through 2012 and are currently under audit for years 2013-2015. In October 2020, we reached an agreement with the IRS for tax years 2006-2012 related to the reallocation of profits between the U.S. and Puerto Rico as well as other miscellaneous adjustments. Due to this agreement, we anticipate recording a net tax benefit within a range of approximately $50.0 million to $80.0 million in the fourth quarter of 2020. The IRS has proposed adjustments for tax years 2010-2012, primarily related to reallocating profits between certain of our U.S. and foreign subsidiaries, which remain unsettled. We have disputed these adjustments and intend to continue to vigorously defend our positions as we pursue resolution through the administrative process with the IRS Independent Office of Appeals.
While we have not yet received a complete and final Revenue Agents’ Report generally issued at the conclusion of an IRS examination, during the second quarter of 2020, we received a draft Notice of Proposed Adjustment (“NOPA”) from the IRS for the 2013 through 2015 calendar years relating to transfer pricing involving our cost sharing agreement between the U.S. and Switzerland affiliated companies and reallocating profits between certain of our U.S. and foreign subsidiaries.
The draft NOPA related to the cost sharing agreement proposes an increase to our U.S. taxable income, which would result in additional tax expense related to 2013 of approximately $600 million, subject to interest and penalties. We strongly believe that the position of the IRS, with regard to this matter, is inconsistent with the applicable U.S. Treasury regulations governing our cost sharing agreement. This is a draft NOPA and the final adjustments asserted by the IRS may differ materially. We anticipate receiving a final NOPA prior to the end of the calendar year 2020 and do not expect changes to our reserves relative to these matters within the next twelve months. We intend to vigorously contest the draft NOPA and if we are not able to remediate the draft NOPA at the IRS examination level, we will pursue all available administrative and, if necessary, judicial remedies. If we pursue judicial remedies in the U.S. Tax Court for years 2013-2015, a number of years will likely elapse before such matters are finally resolved. No payment of any amount related to the draft NOPA is required to be made, if at all, until all applicable proceedings have been completed. We believe the tax liability we have previously accrued is correct, and accordingly, have not recognized any additional reserve for tax uncertainty based on the draft NOPA received.
A public referendum held in Switzerland passed the Federal Act on Tax Reform and AHV Financing (“TRAF”), effective January 1, 2020, and includes the abolishment of various favorable federal and cantonal tax regimes. The TRAF provides transitional relief measures for companies that are losing the tax benefit of a ruling, including a "step-up" for amortizable goodwill, equal to the amount of future tax benefit they would have received under their existing ruling, subject to certain limitations. Certain provisions of the TRAF were enacted in the third quarter of 2019, resulting in us recognizing a provisional net tax benefit of $263.8 million. In the fourth quarter of 2019 and third quarter of 2020, we recognized an additional $51.2 million and $6.5 million, respectively, of tax benefit related to TRAF as well as the tax impact of certain restructuring transactions in Switzerland. We received notification from the Swiss authorities in October 2020 regarding our TRAF ruling and anticipate recording a net tax benefit of approximately $30 million in the fourth quarter of 2020 based on this notification. We anticipate that TRAF will have a minimal impact on our ongoing consolidated effective tax rate.
22
In the three and nine-month periods ended September 30, 2020, our effective tax rate (“ETR”) was 3.8 percent and negative 0.3 percent, respectively. The 3.8 percent ETR in the three-month period ended September 30, 2020 was the result of the mix of some of our jurisdictions recognizing earnings while others had losses. The negative 0.3 percent ETR in the nine-month period ended September 30, 2020 was primarily due to the $612.0 million goodwill impairment charge, which resulted in a loss before taxes, but had no corresponding tax benefit, as well as the mix of earnings and losses among our jurisdictions. In the three and nine-month periods ended September 30, 2019, our ETR was negative 134.1 percent and negative 31.4 percent, respectively. We recognized net tax benefits in the three and nine-month periods ended September 30, 2019, primarily due to Switzerland tax reform that resulted in us recognizing a provisional net tax benefit of $263.8 million. Absent discrete tax events, we expect our future ETR will be lower than the U.S. corporate income tax rate of 21.0 percent due to our mix of earnings between U.S. and foreign locations, which have lower corporate income tax rates. 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.
14. 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, |
|
||||||||||
|
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
||||
Weighted average shares outstanding for basic net earnings (loss) per share |
|
|
207.1 |
|
|
|
205.3 |
|
|
|
206.8 |
|
|
|
204.8 |
|
Effect of dilutive stock options and other equity awards |
|
|
1.4 |
|
|
|
1.7 |
|
|
|
- |
|
|
|
1.5 |
|
Weighted average shares outstanding for diluted net earnings (loss) per share |
|
|
208.5 |
|
|
|
207.0 |
|
|
|
206.8 |
|
|
|
206.3 |
|
Since we incurred a net loss in the nine-month period ended September 30, 2020, no dilutive stock options or other equity awards were included as diluted shares. During the three-month period ended September 30, 2020, an average of 1.3 million options 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. During the nine-month period ended September 30, 2019, an average of 1.2 million options were not included for the same reason, with minimal options excluded in the three-month period ended September 30, 2019.
15. Segment Information
We design, manufacture and market orthopedic reconstructive products; sports medicine, biologics, extremities and trauma products; spine, craniomaxillofacial and thoracic products (“CMFT”); office based technologies; dental implants; and related surgical products. Due to the 2019 Restructuring Plan that was initiated in late 2019, our operating segments have changed beginning in the first quarter of 2020. Our chief operating decision maker (“CODM”) now allocates resources to achieve our operating profit goals through three operating segments. These operating segments, which also constitute our reportable segments, are Americas and Global Businesses; EMEA; and Asia Pacific. Previously, we had seven operating segments, which resulted in three reportable segments and four individually insignificant operating segments that were aggregated together and not considered a reportable segment.
Our CODM evaluates performance based upon segment operating profit exclusive of operating expenses pertaining to inventory and manufacturing-related charges, intangible asset amortization, goodwill and intangible asset impairment, restructuring and other cost reduction initiatives, quality remediation, acquisition, integration and related, litigation, litigation settlement gain, certain European Union Medical Device Regulation expenses, other charges and corporate functions. Corporate functions include corporate legal, finance, information technology, human resources and other corporate departments. Intercompany transactions have been eliminated from segment operating profit.
23
Our Americas and Global Businesses operating segment is comprised principally of the U.S. and includes other North, Central and South American markets for all of our product categories as well as the global results for our Dental product category. This segment also includes our global manufacturing operations for all product categories and research, development engineering, medical education, and brand management for our global product category headquarter locations. Our EMEA operating segment is comprised principally of Europe and includes the Middle East and African markets for all product categories except Dental. Our Asia Pacific operating segment is comprised principally of Japan, China and Australia and includes other Asian and Pacific markets for all product categories except Dental. The EMEA and Asia Pacific operating segments include the commercial operations as well as regional headquarter expenses to operate in those markets.
Since the Americas and Global Businesses includes additional costs related to global manufacturing operations and other centralized global product category headquarter expenses, profitability metrics in this operating segment are not comparable to the EMEA and Asia Pacific operating segments.
Our CODM does not review asset information by operating segment. Instead, our CODM reviews cash flow and other financial ratios by operating segment.
Prior period reportable segment financial information has been reclassified to conform to our new reportable segments.
Net sales and operating profit by segment are as follows (in millions):
|
|
Net Sales |
|
|
Operating (Loss) Profit |
|
||||||||||
|
|
Three Months Ended |
|
|
Three Months Ended |
|
||||||||||
|
|
September 30, |
|
|
September 30, |
|
||||||||||
|
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
||||
Americas and Global Businesses |
|
$ |
1,253.5 |
|
|
$ |
1,212.3 |
|
|
$ |
413.9 |
|
|
$ |
394.3 |
|
EMEA |
|
|
339.7 |
|
|
|
351.8 |
|
|
|
84.6 |
|
|
|
93.7 |
|
Asia Pacific |
|
|
336.1 |
|
|
|
328.3 |
|
|
|
113.4 |
|
|
|
109.6 |
|
Corporate Functions |
|
|
- |
|
|
|
- |
|
|
|
(103.8 |
) |
|
|
(96.6 |
) |
Total |
|
$ |
1,929.3 |
|
|
$ |
1,892.4 |
|
|
|
|
|
|
|
|
|
Inventory and manufacturing-related charges |
|
|
|
|
|
|
|
|
|
|
(2.3 |
) |
|
|
(11.6 |
) |
Intangible asset amortization |
|
|
|
|
|
|
|
|
|
|
(149.7 |
) |
|
|
(146.6 |
) |
Restructuring and other cost reduction initiatives |
|
|
|
|
|
|
|
|
|
|
(16.2 |
) |
|
|
(5.4 |
) |
Quality remediation |
|
|
|
|
|
|
|
|
|
|
(10.0 |
) |
|
|
(21.5 |
) |
Acquisition, integration and related |
|
|
|
|
|
|
|
|
|
|
(9.1 |
) |
|
|
2.6 |
|
Litigation |
|
|
|
|
|
|
|
|
|
|
(19.3 |
) |
|
|
(42.8 |
) |
European Union Medical Device Regulation |
|
|
|
|
|
|
|
|
|
|
(2.0 |
) |
|
|
(11.4 |
) |
Other charges |
|
|
|
|
|
|
|
|
|
|
(0.3 |
) |
|
|
(18.5 |
) |
Operating profit |
|
|
|
|
|
|
|
|
|
$ |
299.2 |
|
|
$ |
245.8 |
|
24
|
|
Net Sales |
|
|
Operating (Loss) Profit |
|
||||||||||
|
|
Nine Months Ended |
|
|
Nine Months Ended |
|
||||||||||
|
|
September 30, |
|
|
September 30, |
|
||||||||||
|
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
||||
Americas and Global Businesses |
|
$ |
3,147.6 |
|
|
$ |
3,703.0 |
|
|
$ |
865.7 |
|
|
$ |
1,211.5 |
|
EMEA |
|
|
915.1 |
|
|
|
1,186.5 |
|
|
|
213.4 |
|
|
|
350.4 |
|
Asia Pacific |
|
|
876.5 |
|
|
|
967.0 |
|
|
|
284.4 |
|
|
|
341.1 |
|
Corporate Functions |
|
|
- |
|
|
|
- |
|
|
|
(319.4 |
) |
|
|
(331.8 |
) |
Total |
|
$ |
4,939.2 |
|
|
$ |
5,856.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventory and manufacturing-related charges |
|
|
|
|
|
|
|
|
|
|
(4.3 |
) |
|
|
(47.7 |
) |
Intangible asset amortization |
|
|
|
|
|
|
|
|
|
|
(445.0 |
) |
|
|
(436.9 |
) |
Goodwill and intangible asset impairment |
|
|
|
|
|
|
|
|
|
|
(645.0 |
) |
|
|
(70.1 |
) |
Restructuring and other cost reduction initiatives |
|
|
|
|
|
|
|
|
|
|
(89.2 |
) |
|
|
(17.0 |
) |
Quality remediation |
|
|
|
|
|
|
|
|
|
|
(35.8 |
) |
|
|
(64.6 |
) |
Acquisition, integration and related |
|
|
|
|
|
|
|
|
|
|
(15.7 |
) |
|
|
(8.5 |
) |
Litigation |
|
|
|
|
|
|
|
|
|
|
(100.4 |
) |
|
|
(48.0 |
) |
Litigation settlement gain |
|
|
|
|
|
|
|
|
|
|
- |
|
|
|
23.5 |
|
European Union Medical Device Regulation |
|
|
|
|
|
|
|
|
|
|
(19.1 |
) |
|
|
(18.1 |
) |
Other charges |
|
|
|
|
|
|
|
|
|
|
(18.1 |
) |
|
|
(83.1 |
) |
Operating (loss) profit |
|
|
|
|
|
|
|
|
|
$ |
(328.5 |
) |
|
$ |
800.7 |
|
25
16. 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 pending finalization of 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 Germany, Netherlands and Italy.
Our estimate as of September 30, 2020 of the remaining liability for all Durom Cup-related claims, including estimated legal fees, is $52.9 million. 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.
Zimmer M/L Taper, M/L Taper with Kinectiv Technology, and Versys Femoral Head-related claims (“Metal Reaction” 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 head/stem junction resulting in, among other things, pain, inflammation and revision surgery.
The majority of the cases are consolidated in an MDL that was created on October 3, 2018 in the U.S. 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 and federal courts. Additional lawsuits are likely to be filed. Following higher than expected filings in the nine-month period ended September 30, 2020, and an extension of the MDL schedule given the COVID-19 pandemic, we increased our estimate of the number of Metal Reaction-related claims that we expect to litigate in the future, resulting in additional litigation-related expense in the period. Our estimate as of September 30, 2020 of the remaining liability for all Metal Reaction-related claims, including our estimated legal fees, is $58.2 million. 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-Magnum hip system. 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) and in various state, federal 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, or have been or are in the process of being remanded to their originating jurisdictions. 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. Trials have commenced, and other trials are currently scheduled to occur in the future. Although each trial will be tried on its particular facts, a verdict and subsequent final judgment for the plaintiff in one or more of these cases could have a substantial impact on our potential liability. We continue to refine our estimates of the potential liability to resolve the remaining claims and lawsuits and recognized additional litigation-related expense in the nine-month period ended September 30, 2020. Our estimate as of September 30, 2020 of the remaining liability for all Biomet metal-on-metal hip implant claims, including estimated legal fees, is $58.6 million. Although we are vigorously defending these lawsuits, their ultimate resolution is uncertain.
26
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 (now Zimmer Biomet Nederland 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 then-current line of European Cements and to compensate Heraeus for any damages incurred.
Germany: 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 (now Zimmer 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 first increased to €125.9 million and with a filing in June 2019 further increased to €146.7 million plus statutory interest. In a court filing, Heraeus indicated that it might further increase its claims in the course of the proceedings. As of September 30, 2020, these two proceedings remained pending in front of the Darmstadt court. 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 Freiburg concerning the sale of the European Cements with certain changed raw materials. Heraeus sought an injunction on the basis that the continued use of the product names for the European Cements was misleading for customers and thus an act of unfair competition. On June 29, 2018, the court in Freiburg, 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 appealed this decision to the Court of Appeals in Karlsruhe, Germany. The appeals hearing occurred in December 2019 and on June 19, 2020, the court dismissed the appeal on different grounds, namely that the appeals court did not find any unfair competition in the continued use of the product names. The appeals court did not grant leave to appeal, but Heraeus filed a request for appeal with the German Supreme Court, which request remained pending as of September 30, 2020.
United States: 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 sold to Biomet, which Biomet incorporated 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 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 the U.S. Court of Appeals for the Third Circuit, which heard oral argument on the appeal on October 23, 2018. On June 21, 2019, the Third Circuit partially reversed the decision of the U.S. District Court for the Eastern District of Pennsylvania granting Esschem summary judgment and remanded the case back to the lower court. On July 5, 2019, Esschem filed a petition in the Third Circuit for rehearing en banc and a motion in the alternative to certify a question of state law to the Supreme Court of Pennsylvania, which was denied on August 1, 2019. On June 1, 2020, as ordered by the court, the parties filed a joint status report, which remained pending as of September 30, 2020.
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. On March 8, 2019, the court stayed the
27
case pending the Third Circuit’s decision in the Esschem case described above. In September 2019, the Zimmer Biomet parties filed a motion to stay the proceedings pending (1) the court’s decision on Esschem’s motion for summary judgment in the Esschem case described above and (2) the outcome of the U.S. International Trade Commission complaint filed by Heraeus asserting similar claims, described below under “Regulatory Matters, Government Investigations and Other Matters.” On May 2, 2020, the court granted the Zimmer Biomet parties’ motion to stay the proceedings pending the outcome of the U.S. International Trade Commission complaint filed by Heraeus.
Other European Countries: Heraeus continues to pursue other related legal proceedings in Europe seeking various forms of relief, including injunctive relief and damages, against various Biomet-related and local Zimmer Biomet entities relating to the European Cements, including those described herein. 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 (the “Belgian Decision”). We appealed this judgment to the Belgian Supreme Court. The Belgian Supreme Court dismissed our appeal in October 2019 and this decision is final. Heraeus filed a suit in Belgium concerning the continued sale of the European Cements with certain changed materials. Like its suit in Germany, 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 May 7, 2019, the Liège Commercial Court issued a judgment that Zimmer Biomet failed to inform its hospital and surgeon customers of the changes made to the composition of the cement with certain changed materials and ordered, as a sole remedy, that Zimmer Biomet send letters to those customers, which we have done. We and Heraeus have each filed an appeal to the judgment.
On February 13, 2019, a Norwegian court of first instance issued a judgment in favor of Heraeus on its claim for misappropriation of trade secrets. The court awarded damages of 19,500,000 NOK, or approximately $2.3 million, plus attorneys’ fees, and issued an injunction, which is not final and thus not currently being enforced, preventing Zimmer Biomet Norway from marketing in Norway bone cements identified with the current product names and bone cements making use of the trade secrets which were acknowledged in the Frankfurt Decision. We have appealed the Norwegian judgment to the court of second instance.
On October 29, 2019, an Italian court of first instance issued a judgment in favor of Heraeus on its claim of misappropriation of trade secrets, but did not yet order an award of damages. We filed a timely appeal of the decision.
On January 23, 2020, a Finnish Market Court issued a judgment partly in favor of Heraeus on its claim of misappropriation of certain trade secrets. Damage claims were not raised in the proceedings. We appealed the decision to the Finnish Supreme Court. On July 3, 2020, the Finnish Supreme Court declined to review the case, rendering the Market Court decision final. As of September 30, 2020, Heraeus had not yet initiated damages proceedings against us but has indicated it intends to do so.
Heraeus is pursuing damages and injunctive relief in France in an effort to prevent us from manufacturing, marketing and selling the European Cements (the “France Litigation”). The European Cements are manufactured at our facility in Valence, France. On December 11, 2018, a hearing was held in the France Litigation before the commercial court in Romans-sur-Isère. On May 23, 2019, the commercial court ruled in our favor. On July 12, 2019, Heraeus filed an appeal to the court of second instance in Grenoble, France. Although we are vigorously defending the France Litigation, the ultimate outcome is uncertain. An adverse ruling in the France Litigation could have a material adverse effect on our business, financial condition and results of operations.
We have accrued an estimated loss relating to the collective trade secret litigation, including estimated legal costs to defend. Damages relating to the Frankfurt Decision are subject to separate proceedings, and the Belgian court appointed an expert to determine the amount of damages related to the Belgian Decision. Thus, 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.
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 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 U.S. Food and Drug Administration (“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
28
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 (i) to amend the court’s order on the motion to certify two issues for interlocutory appeal, and (ii) to stay proceedings pending appeal. On February 21, 2019, that motion was denied. On April 11, 2019, the plaintiffs moved for class certification. On June 20, 2019, the Zimmer Biomet Defendant group filed its response. The plaintiffs sought unspecified damages and interest, attorneys’ fees, costs, and other relief. Although we believe this lawsuit is without merit, during a mediation in December 2019, plaintiffs and defendants, along with Zimmer Biomet’s insurers, reached a settlement in principle to resolve the claims for $50.0 million. We made an accrual for the proposed settlement that we expect to be fully covered by our insurers. On May 21, 2020, the Court granted preliminary approval of the settlement. On or before June 12, 2020, all responsible insurers made their payments to the qualified settlement fund. On September 19, 2020, the court granted final approval of the settlement.
Shareholder Derivative Actions: On June 14, 2019 and July 29, 2019, two shareholder derivative actions, Green v. Begley et al. and Detectives Endowment Association Annuity Fund v. Begley et al., were filed in the Court of Chancery in the State of Delaware. On October 2, 2019 and October 11, 2019, two additional shareholder derivative actions, Karp v. Begley et al. and DiGaudio v. Begley et al., were filed in the U.S. District Court for the District of Delaware. The plaintiff in each action seeks to maintain the action purportedly on our behalf against certain of our current and former directors and officers (the “individual defendants”) and certain former stockholders of ours who sold shares of our common stock in various secondary public offerings in 2016 (the “private equity fund defendants”). The plaintiff in each action alleges, among other things, breaches of fiduciary duties against the individual defendants and insider trading against two individual defendants and the private equity fund defendants, based on substantially the same factual allegations as the putative federal securities class action referenced above (Shah v. Zimmer Biomet Holdings, Inc. et al.). On June 4, 2020, the plaintiffs in the Chancery Court actions filed a consolidated amended complaint adding three new counts and expanding the scope of the alleged material false statements. On September 14, 2020, the defendants filed motions to dismiss the Chancery Court actions. Also on September 14, 2020, the plaintiffs in the U.S. District Court actions filed a consolidated amended complaint adding certain details to their allegations. On October 9, 2020, the U.S. District Court granted the parties’ joint motion to stay the U.S. District Court actions pending resolution of the motions to dismiss the Chancery Court actions. The plaintiffs in the Chancery Court and the U.S. District Court actions do not seek damages from us, but instead request damages on our behalf from the defendants of an unspecified amount, as well as attorneys’ fees, costs and other relief.
Regulatory Matters, Government Investigations and Other Matters
U.S. International Trade Commission Investigation: On March 5, 2019, Heraeus filed a complaint with the U.S. International Trade Commission (“ITC”) against us and certain of our subsidiaries. The complaint alleges that Biomet misappropriated Heraeus’ trade secrets in the formulation and manufacture of two bone cement products now sold by Zimmer Biomet, both of which are imported from our Valence, France facility. Heraeus requested that the ITC institute an investigation and, after the investigation, issue a limited exclusion order and cease and desist orders. On April 5, 2019, the ITC ordered an investigation be instituted into whether we have committed an “unfair act” in the importation, sale for importation, or sale after importation of certain bone cement products. An evidentiary hearing in front of an administrative law judge at the ITC was held in January 2020 and an Initial Determination was issued on May 6, 2020. In the Initial Determination, the administrative law judge held that we did not commit an “unfair act” in the importation, sale for importation, or sale after importation of the two challenged bone cement products, and thus we are not restricted from continuing to manufacture and sell the two challenged bone cement products in the United States. On July 13, 2020, the ITC issued notice of intent to review the Initial Determination in part and is expected to issue a Final Determination in November 2020. Thereafter, the Final Determination is subject to review on appeal to the United States Court of Appeals for the Federal Circuit by either or both of Heraeus and us. We cannot currently predict the ultimate outcome of this investigation after review by the ITC and any appeals, but an adverse outcome in this ITC proceeding could have a material adverse effect on our business, financial condition and results of operations.
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 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 and Ponce. In September 2020, the FDA completed an inspection of the Ponce facility and issued no inspectional observations. As of September 30, 2020, the Warsaw and Ponce 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 QSR 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
29
process of addressing various FDA Form 483 inspectional observations at certain of our manufacturing facilities, including observations issued by the FDA following an inspection of the Warsaw North Campus in January 2020, which inspection the FDA has classified as Voluntary Action Indicated (“VAI”). 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 products, seizure of products and assessing civil or criminal penalties against our officers, employees or us. The FDA could also issue a corporate warning letter or a recidivist warning letter or negotiate the entry of a consent decree of permanent injunction with us. 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; (ii) we entered into a DPA with the DOJ; and (iii) JERDS Luxembourg Holding S.à r.l., the direct parent company of Biomet 3i Mexico SA de CV and an indirect, wholly-owned subsidiary of Biomet, entered into a plea agreement with the DOJ. The conduct underlying these resolutions occurred prior to our acquisition of Biomet.
Under the DPA, the DOJ agreed to defer criminal prosecution of us in connection with a charged violation of the internal controls provisions of the FCPA as long as we comply with the terms of the DPA. In addition, we were subject to oversight by an independent compliance monitor, who was appointed effective as of August 7, 2017. On July 17, 2020, the independent compliance monitor submitted a letter to the SEC and DOJ certifying that our compliance program, including its policies and procedures, is reasonably designed and implemented to prevent and detect violations of the FCPA and is functioning effectively. The monitorship concluded on August 7, 2020. Under its terms, the DPA was also to conclude on August 7, 2020; however, we have been informed that, pursuant to a recently adopted policy, the DOJ will wait six months from the conclusion of the monitorship to dismiss with prejudice the one-count criminal information filed against us in 2017. Accordingly, we expect the criminal information to be dismissed with prejudice and the DPA to conclude on or about February 7, 2021.
If we fail to comply with the terms of the DPA prior to its termination when the criminal information filed against us is dismissed with prejudice, 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 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.
17. Subsequent Events
We have entered into stock purchase and merger agreements to acquire two companies that will help expand and fill key gaps in our product portfolios in certain product categories. One of these transactions has closed subsequent to the September 30, 2020 while the other one is pending regulatory approval as of the date of this filing. There is no assurance that regulatory approval will be received, and if not received, the agreement will be terminated. Assuming we receive regulatory approval, these transactions will require us to pay initial aggregate consideration of approximately $225 million in the fourth quarter of 2020 and deferred payments totaling approximately $145 million in 2021. Additional information on the transaction that has closed has not been provided because it is not expected to have a material effect on our financial position, results of operations or cash flows.
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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.
Executive Level Overview
Impact of the COVID-19 Global Pandemic
Our results have been and may continue to be significantly impacted by the COVID-19 global pandemic. The vast majority of our net sales are derived from products used in elective surgical procedures. As COVID-19 rapidly started to spread throughout the world in early 2020, our net sales decreased dramatically as countries took precautions to prevent the spread of the virus with lockdowns and stay-at-home measures and as hospitals deferred elective surgical procedures. In the third quarter of 2020, various levels of recovery of elective surgical procedures resulted in net sales growth of 2.0 percent when compared to the same prior year period. This was significantly improved from the first and second quarters of 2020 when our net sales declined by 9.7 percent and 38.3 percent, respectively, when compared to the same prior year periods.
The consequences of COVID-19 continue to be extremely fluid and there are many market dynamics and impacts that we are unable to identify or quantify at this time. We were encouraged by certain developments in the third quarter, but COVID-19 continues to bring near-term uncertainty. For example, despite net sales growth of 2.0 percent in the third quarter of 2020, we saw the recovery curve flatten in the latter part of the third quarter. There are many variables and uncertainties that could impact our near-term performance, including a resurgence of the virus, policy actions, patient fear and economic downturn.
With the deferral of elective surgical procedures, we have taken prudent measures in an effort to maintain an adequate financial profile to have access to capital to fund the business during these unprecedented times. In response to the COVID-19 pandemic, we have temporarily reduced discretionary spending such as travel, meetings and other project spend that can be delayed with limited long-term detriment to the business, and we temporarily suspended or limited production at certain manufacturing facilities. However, we have not experienced significant disruptions in our supply chain, or in our ability to meet our customer demands.
Results for the Three and Nine-Month Periods ended September 30, 2020
Our net sales increased by 2.0 percent in the three-month period ended September 30, 2020 compared to the same prior year period. As discussed previously, we saw a recovery in elective surgical procedures, especially in the U.S. and certain parts of Asia Pacific, that drove net sales growth in the third quarter of 2020. However, in the nine-month period ended September 30, 2020 our net sales decreased by 15.7 percent due to the significant deferral of elective surgical procedures in the first and second quarters. While we recognized net income of $242.5 million in the three-month period ended September 30, 2020, we had a net loss of $472.6 million in the nine-month period ended September 30, 2020. In the three-month period, net income was lower than in the prior year primarily due to a provisional net tax benefit of $263.8 million related to Switzerland tax reform recorded in the 2019 period. This unfavorable headwind was partially offset by lower expenses from specific cost reductions taken due to COVID-19, such as lower travel and entertainment expenses, the continued impact of the 2019 Restructuring Plan, lower litigation-related charges and lower charges related to our compliance with the DPA. Our net loss in the nine-month period ended September 30, 2020 was largely attributable to $645.0 million of goodwill and intangible asset impairment charges. Additionally, our results declined in the nine-month period ended September 30, 2020 resulting from lower sales due to the COVID-19 pandemic. We have also temporarily suspended or limited production at certain manufacturing facilities, resulting in higher costs of products sold that relate to certain fixed overhead costs and hourly production worker labor expenses that are included in the cost of inventory when these facilities are operating at normal capacity. We also incurred higher restructuring and other cost reduction initiative expenses in the 2020 periods when compared to the same prior year periods. Lastly, in the nine-month period ended September 30, 2020, we recognized litigation-related charges of $100.4 million compared to net litigation-related charges of $24.5 million in the same prior year period.
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 & CMFT; 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 toward 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 surgical procedures, which typically decline during the summer months and can increase at
31
the end of the year once annual deductibles have been met on health insurance plans. In 2020, it is uncertain if this seasonal pattern will be similar to previous years due to COVID-19 and its related impacts.
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 |
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
|
September 30, |
|
|
|
|
|
|
Volume / |
|
|
|
|
|
|
Foreign |
|
|
|||||||
|
|
2020 |
|
|
2019 |
|
|
% Inc / (Dec) |
|
|
Mix |
|
|
Price |
|
|
Exchange |
|
|
||||||
Americas |
|
$ |
1,216.5 |
|
|
$ |
1,179.2 |
|
|
|
3.2 |
|
% |
|
6.7 |
|
% |
|
(3.4 |
) |
% |
|
(0.1 |
) |
% |
EMEA |
|
|
366.2 |
|
|
|
374.6 |
|
|
|
(2.3 |
) |
|
|
(4.8 |
) |
|
|
(0.9 |
) |
|
|
3.4 |
|
|
Asia Pacific |
|
|
346.6 |
|
|
|
338.6 |
|
|
|
2.3 |
|
|
|
2.1 |
|
|
|
(1.4 |
) |
|
|
1.6 |
|
|
Total |
|
$ |
1,929.3 |
|
|
$ |
1,892.4 |
|
|
|
2.0 |
|
|
|
3.7 |
|
|
|
(2.6 |
) |
|
|
0.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
|
September 30, |
|
|
|
|
|
|
Volume / |
|
|
|
|
|
|
Foreign |
|
|
|||||||
|
|
2020 |
|
|
2019 |
|
|
% (Dec) |
|
|
Mix |
|
|
Price |
|
|
Exchange |
|
|
||||||
Americas |
|
$ |
3,051.5 |
|
|
$ |
3,587.6 |
|
|
|
(14.9 |
) |
% |
|
(11.9 |
) |
% |
|
(2.9 |
) |
% |
|
(0.1 |
) |
% |
EMEA |
|
|
983.0 |
|
|
|
1,276.5 |
|
|
|
(23.0 |
) |
|
|
(21.5 |
) |
|
|
(1.2 |
) |
|
|
(0.3 |
) |
|
Asia Pacific |
|
|
904.7 |
|
|
|
992.4 |
|
|
|
(8.8 |
) |
|
|
(7.8 |
) |
|
|
(1.2 |
) |
|
|
0.2 |
|
|
Total |
|
$ |
4,939.2 |
|
|
$ |
5,856.5 |
|
|
|
(15.7 |
) |
|
|
(13.4 |
) |
|
|
(2.2 |
) |
|
|
(0.1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
“Foreign Exchange,” as used in the tables in this report, represents the effect of changes in foreign currency exchange rates on sales.
32
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, |
|
|
|
|
|
|
Volume / |
|
|
|
|
|
|
Foreign |
|
|
|||||||
|
|
2020 |
|
|
2019 |
|
|
% Inc / (Dec) |
|
|
Mix |
|
|
Price |
|
|
Exchange |
|
|
||||||
Knees |
|
$ |
648.7 |
|
|
$ |
651.9 |
|
|
|
(0.5 |
) |
% |
|
1.4 |
|
% |
|
(2.8 |
) |
% |
|
0.9 |
|
% |
Hips |
|
|
484.1 |
|
|
|
459.2 |
|
|
|
5.4 |
|
|
|
7.3 |
|
|
|
(2.9 |
) |
|
|
1.0 |
|
|
S.E.T. |
|
|
359.9 |
|
|
|
348.5 |
|
|
|
3.3 |
|
|
|
4.9 |
|
|
|
(2.4 |
) |
|
|
0.8 |
|
|
Dental, Spine & CMFT |
|
|
295.5 |
|
|
|
275.5 |
|
|
|
7.3 |
|
|
|
9.0 |
|
|
|
(2.5 |
) |
|
|
0.8 |
|
|
Other |
|
|
141.1 |
|
|
|
157.3 |
|
|
|
(10.3 |
) |
|
|
(10.1 |
) |
|
|
(1.0 |
) |
|
|
0.8 |
|
|
Total |
|
$ |
1,929.3 |
|
|
$ |
1,892.4 |
|
|
|
2.0 |
|
|
|
3.7 |
|
|
|
(2.6 |
) |
|
|
0.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
|
September 30, |
|
|
|
|
|
|
Volume / |
|
|
|
|
|
|
Foreign |
|
|
|||||||
|
|
2020 |
|
|
2019 |
|
|
% (Dec) |
|
|
Mix |
|
|
Price |
|
|
Exchange |
|
|
||||||
Knees |
|
$ |
1,652.7 |
|
|
$ |
2,049.5 |
|
|
|
(19.4 |
) |
% |
|
(16.7 |
) |
% |
|
(2.5 |
) |
% |
|
(0.2 |
) |
% |
Hips |
|
|
1,246.4 |
|
|
|
1,421.1 |
|
|
|
(12.3 |
) |
|
|
(9.5 |
) |
|
|
(2.7 |
) |
|
|
(0.1 |
) |
|
S.E.T. |
|
|
946.1 |
|
|
|
1,062.3 |
|
|
|
(10.9 |
) |
|
|
(8.5 |
) |
|
|
(2.3 |
) |
|
|
(0.1 |
) |
|
Dental, Spine & CMFT |
|
|
729.7 |
|
|
|
855.2 |
|
|
|
(14.7 |
) |
|
|
(13.5 |
) |
|
|
(1.2 |
) |
|
|
- |
|
|
Other |
|
|
364.3 |
|
|
|
468.4 |
|
|
|
(22.2 |
) |
|
|
(20.6 |
) |
|
|
(1.6 |
) |
|
|
- |
|
|
Total |
|
$ |
4,939.2 |
|
|
$ |
5,856.5 |
|
|
|
(15.7 |
) |
|
|
(13.4 |
) |
|
|
(2.2 |
) |
|
|
(0.1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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, |
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
|
|
|
|
||||||||||
|
|
2020 |
|
|
2019 |
|
|
% Inc / (Dec) |
|
|
|
2020 |
|
|
2019 |
|
|
% (Dec) |
|
|
||||||
Knees |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Americas |
|
$ |
402.6 |
|
|
$ |
399.2 |
|
|
|
0.9 |
|
% |
|
$ |
1,003.9 |
|
|
$ |
1,222.9 |
|
|
|
(17.9 |
) |
% |
EMEA |
|
|
126.6 |
|
|
|
135.3 |
|
|
|
(6.4 |
) |
|
|
|
344.5 |
|
|
|
474.4 |
|
|
|
(27.4 |
) |
|
Asia Pacific |
|
|
119.5 |
|
|
|
117.4 |
|
|
|
1.7 |
|
|
|
|
304.3 |
|
|
|
352.2 |
|
|
|
(13.6 |
) |
|
Total |
|
$ |
648.7 |
|
|
$ |
651.9 |
|
|
|
(0.5 |
) |
|
|
$ |
1,652.7 |
|
|
$ |
2,049.5 |
|
|
|
(19.4 |
) |
|
Hips |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Americas |
|
$ |
268.6 |
|
|
$ |
249.0 |
|
|
|
7.9 |
|
% |
|
$ |
671.8 |
|
|
$ |
749.4 |
|
|
|
(10.3 |
) |
% |
EMEA |
|
|
109.7 |
|
|
|
108.8 |
|
|
|
0.8 |
|
|
|
|
291.9 |
|
|
|
367.8 |
|
|
|
(20.6 |
) |
|
Asia Pacific |
|
|
105.8 |
|
|
|
101.4 |
|
|
|
4.4 |
|
|
|
|
282.7 |
|
|
|
303.9 |
|
|
|
(7.0 |
) |
|
Total |
|
$ |
484.1 |
|
|
$ |
459.2 |
|
|
|
5.4 |
|
|
|
$ |
1,246.4 |
|
|
$ |
1,421.1 |
|
|
|
(12.3 |
) |
|
33
Demand (Volume and Mix) Trends
Changes in volume and mix of product sales had a positive effect of 3.7 percent and negative effect of 13.4 percent on year-over-year sales during the three and nine-month periods ended September 30, 2020, respectively. In the three-month period ended September 30, 2020 we saw various levels of recovery in elective surgical procedures. However, that recovery occurred primarily in July with the recovery curve flattening in the latter part of the third quarter. Due to multiple variables and uncertainties, we cannot predict whether there will be further recovery, continued flattening or a contraction in the fourth quarter.
Based upon country dynamics, volume changes varied by region. In the Americas, we saw stronger than expected recovery in the U.S. during the quarter, but the other countries in the Americas mostly experienced net sales declines. In EMEA, the return to elective surgical procedures was slower than in other regions. While there was continued recovery in EMEA through the quarter, there was a slowing of the recovery in September, which continues with the recent COVID-19 surges and corresponding governmental policy actions in the region. Developed countries excluding the United Kingdom showed the strongest signs of recovery in the quarter. The United Kingdom and emerging markets continue to be a significant drag on overall EMEA regional growth. In Asia Pacific, there was strong recovery in China, and in Japan there was continued stability, but it was not yet back to pre-COVID-19 volumes. Australia continued to show progress, but was negatively impacted by surges late in the third quarter. Finally, India continued to vastly underperform the rest of the Asia Pacific region.
Pricing Trends
Global selling prices had a negative effect of 2.6 percent and 2.2 percent on year-over-year sales during the three and nine-month periods ended September 30, 2020, 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, 2020, changes in foreign currency exchange rates had a positive effect of 0.9 percent and a negative effect of 0.1 percent on year-over-year sales, respectively. If foreign currency exchange rates remain at levels consistent with recent rates, we estimate there will be a positive impact of less than 1 percent on full-year 2020 sales.
Expenses as a Percentage of Net Sales
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
|
|
|
|
||||||||||||
|
|
September 30, |
|
|
|
% Inc / |
|
|
|
September 30, |
|
|
|
% Inc / |
|
|
||||||||||||||
|
|
2020 |
|
|
|
2019 |
|
|
|
(Dec) |
|
|
|
2020 |
|
|
|
2019 |
|
|
|
(Dec) |
|
|
||||||
Cost of products sold, excluding intangible asset amortization |
|
|
29.5 |
|
% |
|
|
28.3 |
|
% |
|
|
1.2 |
|
% |
|
|
30.0 |
|
% |
|
|
28.5 |
|
% |
|
|
1.5 |
|
% |
Intangible asset amortization |
|
|
7.8 |
|
|
|
|
7.7 |
|
|
|
|
0.1 |
|
|
|
|
9.0 |
|
|
|
|
7.5 |
|
|
|
|
1.5 |
|
|
Research and development |
|
|
4.5 |
|
|
|
|
6.0 |
|
|
|
|
(1.5 |
) |
|
|
|
5.5 |
|
|
|
|
5.6 |
|
|
|
|
(0.1 |
) |
|
Selling, general and administrative |
|
|
40.9 |
|
|
|
|
43.7 |
|
|
|
|
(2.8 |
) |
|
|
|
46.2 |
|
|
|
|
42.0 |
|
|
|
|
4.2 |
|
|
Goodwill and intangible asset impairment |
|
|
- |
|
|
|
|
- |
|
|
|
|
- |
|
|
|
|
13.1 |
|
|
|
|
1.2 |
|
|
|
|
11.9 |
|
|
Restructuring and other cost reduction initiatives |
|
|
0.8 |
|
|
|
|
0.3 |
|
|
|
|
0.5 |
|
|
|
|
1.8 |
|
|
|
|
0.3 |
|
|
|
|
1.5 |
|
|
Quality remediation |
|
|
0.5 |
|
|
|
|
1.1 |
|
|
|
|
(0.6 |
) |
|
|
|
0.7 |
|
|
|
|
1.1 |
|
|
|
|
(0.4 |
) |
|
Acquisition, integration and related |
|
|
0.5 |
|
|
|
|
(0.1 |
) |
|
|
|
0.6 |
|
|
|
|
0.3 |
|
|
|
|
0.1 |
|
|
|
|
0.2 |
|
|
Operating profit (loss) |
|
|
15.5 |
|
|
|
|
13.0 |
|
|
|
|
2.5 |
|
|
|
|
(6.7 |
) |
|
|
|
13.7 |
|
|
|
|
(20.4 |
) |
|
The increase in cost of products sold as a percentage of net sales for the three-month period ended September 30, 2020 compared to the same prior year period was primarily due to temporarily suspended or limited production at certain manufacturing facilities, a refund for U.S. medical device excise taxes received in the 2019 period, and lower average selling prices. These unfavorable items were partially offset by a favorable geographic mix of sales in countries that have higher gross profit margins. The temporary suspension or limited production at certain manufacturing facilities resulted in us immediately expensing certain fixed overhead costs and hourly production worker labor expenses that are included in the cost of inventory when these facilities are operating at normal capacity. The refund of a portion of the U.S. medical device excise tax in 2019 was the result of a change in the methodology we used to calculate the constructive sales price upon which the taxes were paid.
The increase in cost of products sold as a percentage of net sales for the nine-month period ended September 30, 2020 compared to the same prior year period included the same factors as discussed for the three-month period ended September 30. In addition, excess and obsolete charges as a percentage of net sales increased in the nine-month period ended September 30, 2020 as these charges did not decline ratably with the significant decline in our net sales. The nine-month period ended September 30, 2019
34
included a charge of $20.8 million to terminate a long-term raw material supply agreement. Therefore, the absence of this charge in the nine-month period ended September 30, 2020 had a favorable effect on the year-over-year comparison.
Intangible asset amortization expense increased minimally in the three and nine-month periods ended September 30, 2020 compared to the same prior year periods due to additional amortization from the agreement to buy out certain licensing arrangements we entered into on April 1, 2019 and other small acquisitions made in 2019.
Research and development (“R&D”) expenses decreased in both amount and as a percentage of net sales in the three and nine-month periods ended September 30, 2020 compared to the same prior year periods. The decrease in expenses was primarily due to savings as a result of the 2019 Restructuring Plan and lower spending on travel and certain project costs due to COVID-19. In the nine-month period ended September 30, 2020, the decline in expenses as a percentage of net sales compared to the same prior year period is less significant than the three-month period ended September 30, 2020 due to the lower year-over-year sales from the impact of COVID-19 in the nine-month period as compared to higher year-over-year sales in the three-month period.
Selling, general and administrative (“SG&A”) expenses and SG&A expenses as a percentage of net sales decreased in the three-month period ended September 30, 2020 compared to the same prior year period primarily due to specific cost reductions taken due to COVID-19, such as lower travel and entertainment expenses, the continued impact of the 2019 Restructuring Plan, lower litigation-related charges and lower charges related to our compliance with the DPA.
SG&A expenses decreased in the nine-month period ended September 30, 2020 compared to the same prior year period, but increased as a percentage of net sales. SG&A expenses decreased due to lower variable selling expenses from the decline in our net sales, COVID-19 cost reductions, the impact from the 2019 Restructuring Plan and lower charges related our compliance with the DPA. However, since SG&A expenses include many fixed expenses, the decline in year-over-year sales in the nine-month period due to COVID-19 resulted in an increase in SG&A expenses as a percentage of net sales.
In the nine-month period ended September 30, 2020, we recognized goodwill and intangible asset impairment charges of $645.0 million, including charges of $470.0 million and $142.0 million related to our EMEA and Dental reporting units, respectively, in the first quarter of 2020 and $33.0 of intangible asset impairment charges in the second quarter of 2020. In the nine-month period ended September 30, 2019, we recognized intangible asset impairment charges of $70.1 million. For more information regarding these charges, see Note 7 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report.
In December 2019, our Board of Directors approved, and we initiated, the 2019 Restructuring Plan with an overall objective of reducing costs to allow us to invest in higher priority growth opportunities. We recognized expenses of $16.2 million and $89.2 million in the three and nine-month periods ended September 30, 2020, respectively, attributable to restructuring and other cost reduction initiatives, primarily related to employee termination benefits, distributor contract terminations, consulting and project management expenses associated with the 2019 Restructuring Plan. For more information regarding these charges, see Note 4 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report.
Our quality remediation expenses declined in the three and nine-month periods ended September 30, 2020 compared to the same prior year periods, due to the natural regression of completing our remediation milestones. Acquisition, integration and related expenses increased in the three and nine-month periods ended September 30, 2020 compared to the same prior year periods due to a small acquisition in the 2020 periods.
Other Income (Expense), Net, Interest Expense, Net, and Income Taxes
In the three and nine-month periods ended September 30, 2020, we recognized income in other income (expense), net, compared to net expenses in the same prior year periods, primarily due to gains recognized from changes to the fair value of our equity investments and higher gains from certain components of pension expense in the 2020 periods.
Interest expense, net, decreased in the three and nine-month periods ended September 30, 2020, compared to the same prior year periods, due to lower average outstanding debt balances during the 2020 periods resulting from debt repayments throughout 2019 and Euro notes that were issued in the fourth quarter of 2019 that were used to refinance debt with higher interest rates.
In the three and nine-month periods ended September 30, 2020, our effective tax rate (“ETR”) was 3.8 percent and negative 0.3 percent, respectively. The 3.8 percent ETR in the three-month period ended September 30, 2020 was the result of the mix of some of our jurisdictions recognizing earnings while others had losses. The negative 0.3 percent ETR in the nine-month period ended September 30, 2020 was primarily due to the $612.0 million goodwill impairment charge, which resulted in a loss before taxes, but had no corresponding tax benefit, as well as the mix of earnings and losses among our jurisdictions. In the three and nine-month periods ended September 30, 2019, our ETR was negative 134.1 percent and negative 31.4 percent, respectively. We recognized net tax benefits in the three and nine-month periods ended September 30, 2019, primarily due to Switzerland tax reform that resulted in us
35
recognizing a provisional net tax benefit of $263.8 million. Absent discrete tax events, we expect our future ETR will be lower than the U.S. corporate income tax rate of 21.0 percent due to our mix of earnings between U.S. and foreign locations, which have lower corporate income tax rates. 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) |
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
|
||||||
Americas and Global Businesses |
|
$ |
1,253.5 |
|
|
$ |
1,212.3 |
|
|
$ |
413.9 |
|
|
$ |
394.3 |
|
|
|
33.0 |
|
% |
|
32.5 |
|
% |
EMEA |
|
|
339.7 |
|
|
|
351.8 |
|
|
|
84.6 |
|
|
|
93.7 |
|
|
|
24.9 |
|
|
|
26.6 |
|
|
Asia Pacific |
|
|
336.1 |
|
|
|
328.3 |
|
|
|
113.4 |
|
|
|
109.6 |
|
|
|
33.7 |
|
|
|
33.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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) |
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
|
||||||
Americas and Global Businesses |
|
$ |
3,147.6 |
|
|
$ |
3,703.0 |
|
|
$ |
865.7 |
|
|
$ |
1,211.5 |
|
|
|
27.5 |
|
% |
|
32.7 |
|
% |
EMEA |
|
|
915.1 |
|
|
|
1,186.5 |
|
|
|
213.4 |
|
|
|
350.4 |
|
|
|
23.3 |
|
|
|
29.5 |
|
|
Asia Pacific |
|
|
876.5 |
|
|
|
967.0 |
|
|
|
284.4 |
|
|
|
341.1 |
|
|
|
32.4 |
|
|
|
35.3 |
|
|
In the three-month period ended September 30, 2020, the Americas and Global Businesses and Asia Pacific operating profit as a percentage of net sales increased compared to the same prior year period due to increased net sales combined with the cost reductions taken due to COVID-19, such as lower travel and entertainment expenses, and the continued impact of the 2019 Restructuring Plan. In EMEA, the COVID-19 recovery has been slower than in other regions, resulting in lower net sales in the three-month period ended September 30, 2020 when compared to the same prior year period. Due to fixed operating expenses that did not decline proportionally with the decrease in net sales, EMEA’s operating profit as a percentage of net sales declined in the three-month period ended September 30, 2020 when compared to the same prior year period.
In the nine-month period ended September 30, 2020, in each of our segments operating profit as a percentage of net sales declined compared to the same prior year period due to the effect of fixed operating expenses that did not decline proportionally with lower net sales from the impact of COVID-19.
36
Non-GAAP Operating Performance Measures
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, as applicable, certain inventory and manufacturing-related charges including charges to discontinue certain product lines; intangible asset amortization; goodwill and intangible asset impairment; restructuring and other cost reduction initiative expenses; quality remediation expenses; acquisition, integration and related expenses; certain litigation gains and charges; expenses to establish initial compliance with the European Union Medical Device Regulation; other charges; any related effects on our income tax provision associated with these items; tax adjustments relating to the impacts of tax only amortization in Switzerland; the effect of Switzerland tax reform; other certain tax adjustments; and, with respect to earnings per share information, provide for the effect of dilutive shares assuming net earnings in a period of a reported net loss. 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 (loss) and diluted earnings (loss) per share to our non-GAAP adjusted net earnings and non-GAAP adjusted diluted earnings per share (in millions, except per share amounts):
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
||||||||||
|
|
September 30, |
|
|
September 30, |
|
||||||||||
|
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
||||
Net Earnings (Loss) of Zimmer Biomet Holdings, Inc. |
|
$ |
242.5 |
|
|
$ |
431.1 |
|
|
$ |
(472.6 |
) |
|
$ |
810.9 |
|
Inventory and manufacturing-related charges(1) |
|
|
2.3 |
|
|
|
11.6 |
|
|
|
4.3 |
|
|
|
47.7 |
|
Intangible asset amortization(2) |
|
|
149.7 |
|
|
|
146.6 |
|
|
|
445.0 |
|
|
|
436.9 |
|
Goodwill and intangible asset impairment(3) |
|
|
- |
|
|
|
- |
|
|
|
645.0 |
|
|
|
70.1 |
|
Restructuring and other cost reduction initiatives(4) |
|
|
16.2 |
|
|
|
5.4 |
|
|
|
89.2 |
|
|
|
17.0 |
|
Quality remediation(5) |
|
|
10.0 |
|
|
|
21.5 |
|
|
|
35.8 |
|
|
|
64.6 |
|
Acquisition, integration and related(6) |
|
|
9.1 |
|
|
|
(2.6 |
) |
|
|
15.7 |
|
|
|
8.5 |
|
Litigation(7) |
|
|
19.3 |
|
|
|
42.8 |
|
|
|
100.4 |
|
|
|
48.0 |
|
Litigation settlement gain(8) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(23.5 |
) |
European Union Medical Device Regulation(9) |
|
|
2.0 |
|
|
|
11.4 |
|
|
|
19.1 |
|
|
|
18.1 |
|
Other charges(10) |
|
|
(8.3 |
) |
|
|
18.4 |
|
|
|
5.6 |
|
|
|
81.8 |
|
Taxes on above items(11) |
|
|
(58.4 |
) |
|
|
(54.8 |
) |
|
|
(152.1 |
) |
|
|
(155.4 |
) |
Tax adjustments relating to the impacts of tax only amortization in Switzerland(12) |
|
|
1.9 |
|
|
|
- |
|
|
|
18.1 |
|
|
|
- |
|
Switzerland tax reform(13) |
|
|
(6.5 |
) |
|
|
(263.8 |
) |
|
|
(6.5 |
) |
|
|
(263.8 |
) |
Other certain tax adjustments(14) |
|
|
(3.0 |
) |
|
|
(1.2 |
) |
|
|
(6.1 |
) |
|
|
(12.6 |
) |
Adjusted Net Earnings |
|
$ |
376.8 |
|
|
$ |
366.4 |
|
|
$ |
740.9 |
|
|
$ |
1,148.3 |
|
37
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
||||||||||
|
|
September 30, |
|
|
September 30, |
|
||||||||||
|
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
||||
Diluted (Loss) Earnings Per Share |
|
$ |
1.16 |
|
|
$ |
2.08 |
|
|
$ |
(2.29 |
) |
|
$ |
3.93 |
|
Inventory and manufacturing-related charges(1) |
|
|
0.01 |
|
|
|
0.06 |
|
|
|
0.02 |
|
|
|
0.23 |
|
Intangible asset amortization(2) |
|
|
0.72 |
|
|
|
0.71 |
|
|
|
2.15 |
|
|
|
2.11 |
|
Goodwill and intangible asset impairment(3) |
|
|
- |
|
|
|
- |
|
|
|
3.12 |
|
|
|
0.34 |
|
Restructuring and other cost reduction initiatives(4) |
|
|
0.08 |
|
|
|
0.03 |
|
|
|
0.43 |
|
|
|
0.08 |
|
Quality remediation(5) |
|
|
0.05 |
|
|
|
0.10 |
|
|
|
0.17 |
|
|
|
0.31 |
|
Acquisition, integration and related(6) |
|
|
0.04 |
|
|
|
(0.01 |
) |
|
|
0.08 |
|
|
|
0.04 |
|
Litigation(7) |
|
|
0.09 |
|
|
|
0.21 |
|
|
|
0.49 |
|
|
|
0.23 |
|
Litigation settlement gain(8) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(0.11 |
) |
European Union Medical Device Regulation(9) |
|
|
0.01 |
|
|
|
0.05 |
|
|
|
0.09 |
|
|
|
0.09 |
|
Other charges(10) |
|
|
(0.04 |
) |
|
|
0.09 |
|
|
|
0.03 |
|
|
|
0.40 |
|
Taxes on above items(11) |
|
|
(0.28 |
) |
|
|
(0.27 |
) |
|
|
(0.74 |
) |
|
|
(0.75 |
) |
Tax adjustments relating to the impacts of tax only amortization in Switzerland(12) |
|
|
0.01 |
|
|
|
- |
|
|
|
0.09 |
|
|
|
- |
|
Switzerland tax reform(13) |
|
|
(0.03 |
) |
|
|
(1.27 |
) |
|
|
(0.03 |
) |
|
|
(1.27 |
) |
Other certain tax adjustments(14) |
|
|
(0.01 |
) |
|
|
(0.01 |
) |
|
|
(0.03 |
) |
|
|
(0.06 |
) |
Effect of dilutive shares assuming net earnings(15) |
|
|
- |
|
|
|
- |
|
|
|
(0.02 |
) |
|
|
- |
|
Adjusted Diluted Earnings Per Share |
|
$ |
1.81 |
|
|
$ |
1.77 |
|
|
$ |
3.56 |
|
|
$ |
5.57 |
|
(1) |
Inventory and manufacturing-related charges include excess and obsolete inventory charges on certain product lines we intend to discontinue and other inventory and manufacturing-related charges. In the nine-month period ended September 30, 2019, inventory and manufacturing-related charges also included a $20.8 million charge incurred to terminate a raw material supply agreement. |
(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 first quarter of 2020, we recognized goodwill impairment charges of $470.0 million and $142.0 million related to our EMEA and Dental reporting units, respectively. In the second quarters of 2020 and 2019, we recognized $33.0 million and $70.1 million, respectively, of in-process research and development (“IPR&D”) intangible asset impairments on certain IPR&D projects. |
(4) |
In December 2019, our Board of Directors approved, and we initiated, a new global restructuring program that includes a reorganization of key businesses and an overall effort to reduce costs in order to accelerate decision-making and focus the organization on priorities to drive growth. Restructuring and other cost reduction initiatives also include other cost reduction initiatives that have the goal of reducing costs across the organization. |
(5) |
We are addressing inspectional observations on Form 483 and a Warning Letter issued by the U.S. Food and Drug Administration (“FDA”) following its previous 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 the expenses are related to consultants who are helping us to update previous documents and redesign certain processes. |
(6) |
The acquisition, integration and related gains and expenses we have excluded from our non-GAAP financial measures resulted from various acquisitions. |
38
(7) |
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 and 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, patent litigation and commercial litigation related to a common matter in multiple jurisdictions. In regards to the product liability matters, 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. |
(8) |
In the first quarter of 2019, we settled a patent infringement lawsuit out of court, and the other party agreed to pay us an upfront, lump-sum amount for a non-exclusive license to the patent. |
(9) |
The European Union Medical Device Regulation imposes significant additional premarket and postmarket requirements. The new regulations provide a transition period until May 2021 for currently-approved medical devices to meet the additional requirements. For certain devices, this transition period can be extended until May 2024. We are excluding from our non-GAAP financial measures the incremental costs incurred to establish initial compliance with the regulations related to our currently-approved medical devices. The incremental costs primarily include third-party consulting necessary to supplement our internal resources. |
(10) |
We have incurred other various expenses from specific events or projects that we consider highly variable or that have a significant impact to our operating results that we have excluded from our non-GAAP measures. These include costs related to legal entity, distribution and manufacturing optimization, including contract terminations, gains and losses from changes in fair value on our equity investments, as well as 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, we were subject to oversight by an independent compliance monitor, which monitorship concluded in August 2020. We expect the one-count criminal information filed against us in 2017 to be dismissed with prejudice in February 2021 and the DPA to conclude at that time. The excluded costs include the fees paid to the independent compliance monitor and to external legal counsel assisting in the matter. |
(11) |
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. |
(12) |
Represents tax adjustments relating to the impacts of tax only amortization resulting from Swiss Tax Reform as well as certain restructuring transactions in Switzerland. |
(13) |
Switzerland passed the TRAF, effective January 1, 2020. Certain provisions of the TRAF were enacted in the third quarter of 2019, resulting in provisional adjustments to our deferred taxes, generating a net tax benefit. |
(14) |
Other certain tax adjustments relate to various discrete tax period adjustments. |
(15) |
Diluted share count used in Adjusted Diluted EPS: |
|
Nine Months Ended |
|
|
|
September 30, 2020 |
|
|
Diluted shares |
|
206.8 |
|
Dilutive shares assuming net earnings |
|
1.4 |
|
Adjusted diluted shares |
|
208.2 |
|
Liquidity and Capital Resources
The COVID-19 pandemic has had an adverse effect on our liquidity and capital resource needs, primarily driven by the reduction in sales due to elective surgical procedure deferrals. We have taken prudent measures in an effort to maintain an adequate financial profile to have access to capital to fund the business during these unprecedented times, including reductions to discretionary spending
39
such as travel, meetings and other project spend that can be delayed with limited long-term detriment to the business. However, we continued to incur fixed expenses that resulted in lower operating cash flows in the nine-month period ended September 30, 2020 when compared to the same prior year period.
As of September 30, 2020, we had $967.3 million in cash and cash equivalents. In addition, we have $1.0 billion available to borrow under our September 2020 Credit Agreement that contains the September 2020 Revolving Facility and matures on September 17, 2021, and $1.5 billion available under our 2019 Multicurrency Revolving Facility that will mature on November 1, 2024. The terms of the 2019 Multicurrency Revolving Facility and the September 2020 Revolving Facility (collectively, the “Revolving Facilities”) are described further below and in Note 9 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report.
Based on the actions described above, we believe that cash flows from operations, our cash and cash equivalents on hand, and available borrowings under our Revolving Facilities will be sufficient to meet our ongoing liquidity requirements for at least the next twelve months. At this time, we do not anticipate needing to borrow against our Revolving Facilities to fund our operations. However, due to the significant uncertainties of the COVID-19 pandemic, it is possible our needs may change. There can be no assurance that, if needed, we will be able to secure additional financing if recovery from the COVID-19 pandemic slows and has a sustained impact on our overall business and liquidity.
Sources of Liquidity
Cash flows provided by operating activities were $779.4 million in the nine-month period ended September 30, 2020, compared to $1,162.5 million in the same prior year period. The decline in cash flow from operating activities was primarily the result of COVID-19 reducing our cash inflows due to lower net sales while we continued to pay many fixed operating costs. Additionally, in the nine-month period ended September 30, 2020 we sold fewer of our accounts receivables to a third party which we estimate negatively impacted operating cash flows by approximately $230 million. The 2019 period included a payment of approximately $168 million on a patent infringement lawsuit.
Cash flows used in investing activities were $297.9 million in the nine-month period ended September 30, 2020, compared to $591.3 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. In order to preserve cash, we are prioritizing investments which are reflected in the lower investments in property, plant and equipment of $89.8 million in the 2020 period when compared to $155.3 million in the 2019 period. In the 2019 period, we paid $197.6 million to buy out certain licensing arrangements from third parties.
Cash flows used in financing activities were $135.5 million in the nine-month period ended September 30, 2020, compared to $597.2 million in the same prior year period. In the 2020 period, we issued senior notes and received $1,497.1 million in proceeds, which were used to pay our $1,500.0 million senior notes at maturity on April 1, 2020. In the 2019 period, we had $550.0 million in net repayments of term loans.
40
At September 30, 2020, our outstanding debt consisted of senior notes and term loans as follows (principal shown in U.S. Dollars in millions):
|
|
|
|
|
|
|
|
Interest |
|
|
|
|
Type |
|
Principal |
|
|
Currency |
|
Rate |
|
|
Maturity Date |
||
Notes |
|
$ |
450.0 |
|
|
U.S. Dollar |
|
Floating |
|
|
March 19, 2021 |
|
Notes |
|
|
300.0 |
|
|
U.S. Dollar |
|
|
3.375 |
|
|
November 30, 2021 |
Notes |
|
|
750.0 |
|
|
U.S. Dollar |
|
|
3.150 |
|
|
April 1, 2022 |
Term |
|
|
110.8 |
|
|
Japanese Yen |
|
|
0.635 |
|
|
September 27, 2022 |
Term |
|
|
201.7 |
|
|
Japanese Yen |
|
|
0.635 |
|
|
September 27, 2022 |
Notes |
|
|
586.3 |
|
|
Euro |
|
|
1.414 |
|
|
December 13, 2022 |
Notes |
|
|
300.0 |
|
|
U.S. Dollar |
|
|
3.700 |
|
|
March 19, 2023 |
Notes |
|
|
2,000.0 |
|
|
U.S. Dollar |
|
|
3.550 |
|
|
April 1, 2025 |
Notes |
|
|
600.0 |
|
|
U.S. Dollar |
|
|
3.050 |
|
|
January 15, 2026 |
Notes |
|
|
586.3 |
|
|
Euro |
|
|
2.425 |
|
|
December 13, 2026 |
Notes |
|
|
586.3 |
|
|
Euro |
|
|
1.164 |
|
|
November 15, 2027 |
Notes |
|
|
900.0 |
|
|
U.S. Dollar |
|
|
3.550 |
|
|
March 20, 2030 |
Notes |
|
|
253.4 |
|
|
U.S. Dollar |
|
|
4.250 |
|
|
August 15, 2035 |
Notes |
|
|
317.8 |
|
|
U.S. Dollar |
|
|
5.750 |
|
|
November 30, 2039 |
Notes |
|
|
395.4 |
|
|
U.S. Dollar |
|
|
4.450 |
|
|
August 15, 2045 |
The 2019 Multicurrency Revolving Facility will mature on November 1, 2024. There were no outstanding borrowings under the 2019 Multicurrency Revolving Facility as of September 30, 2020, nor have we borrowed against it subsequent to then. Due to the current and expected future adverse effects of COVID-19 on our operating results, on April 23, 2020 we entered into an amendment to the 2019 Credit Agreement to temporarily increase the maximum permitted Consolidated Leverage Ratio, temporarily increase the interest rate margin applicable to revolving loans and the facility fee, and make other administrative changes. We are currently in compliance with our covenants under the 2019 Multicurrency Revolving Facility. If we violate any covenants in the future, it is possible the lenders may terminate their commitments and require us to repay any outstanding borrowings immediately.
On April 23, 2020, we entered into a credit agreement which contained an unsecured revolving credit facility of $1.0 billion. On September 18, 2020, this credit agreement was terminated and we entered into the September 2020 Credit Agreement, which contains the September 2020 Revolving Facility, an unsecured revolving credit facility of $1.0 billion. The September 2020 Credit Agreement matures on September 17, 2021. We are currently in compliance with our covenants under the September 2020 Revolving Facility. If we violate any covenants in the future, it is possible the lenders may terminate their commitments and require us to repay any outstanding borrowings immediately. There were no outstanding borrowings under the September 2020 Revolving Facility as of September 30, 2020, nor have we borrowed against it subsequent to then. As of the date of this filing, we do not expect to borrow under the September 2020 Credit Agreement; however, it will provide additional financial flexibility for our cash flow needs if elective surgical procedures are deferred longer than we anticipate.
For additional information on our debt, see Note 9 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, 2020, $349.9 million of our cash and cash equivalents were held in jurisdictions outside of the U.S. Of this amount, $85.1 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 $5.1 billion of unremitted earnings in future years.
Our concentrations of credit risks with respect to trade accounts receivable are 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. We have continued to collect on outstanding receivables despite the measures hospitals have put in place to address COVID-19. However, we are closely monitoring the financial stability of our customers and the country-specific risks, including those customers in markets with hospitals sponsored by the government.
41
In February, June and September 2020, 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.
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, 2020, all $1.0 billion remained authorized.
As discussed in Note 4 to our interim condensed consolidated financial statements in Part I, Item 1 of this report, in December 2019, our Board of Directors approved, and we initiated, the 2019 Restructuring Plan with an objective of reducing costs to allow us to further invest in higher priority growth opportunities. The 2019 Restructuring Plan is expected to result in total pre-tax restructuring charges of approximately $350 million to $400 million, with approximately $155 million of that total expected to be incurred by the end of 2020. We expect to reduce gross annual pre-tax operating expenses by approximately $200 million to $300 million by the end of 2023 as program benefits under the 2019 Restructuring Plan are realized.
As discussed in Note 13 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report, the IRS has issued proposed adjustments for years 2010 through 2012, as well as a draft NOPA for years 2013 through 2015, reallocating profits between certain of our U.S. and foreign subsidiaries. We have disputed these proposed adjustments and intend to continue 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. We do not expect the agreement reached with the IRS for tax years 2006-2012 related to the reallocation of profits between the U.S. and Puerto Rico as well as other miscellaneous adjustments to have a material impact on our operating cash flows.
As discussed in Note 16 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report, we are involved in various litigation matters with respect to which we expect to continue paying settlements over the next few years.
As discussed in Note 17 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report, we entered into stock purchase and merger agreements to acquire two companies. Subsequent to September 30, 2020, one of these transactions has closed while the other one is pending regulatory approval as of the date of this filing. There is no assurance that regulatory approval will be received, and if not received, the agreement will be terminated. Assuming we receive regulatory approval, these acquisitions will require initial aggregate consideration of approximately $225 million in the fourth quarter of 2020 and deferred payments totaling approximately $145 million in 2021.
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 and nine-month periods ended September 30, 2020 to the application of critical accounting policies as described in our Annual Report on Form 10-K for the year ended December 31, 2019.
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,” “continue” 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 effects of the COVID-19 global pandemic and other adverse public health developments on the global economy, our business and operations and the business and operations of our suppliers and customers, including the deferral of elective surgical procedures and our ability to collect accounts receivable; |
|
• |
the risks and uncertainties related to our ability to successfully execute our restructuring plans; |
42
|
• |
the success of our quality and operational excellence initiatives, including ongoing quality remediation efforts at our Warsaw North Campus facility; |
|
• |
the ability to remediate matters identified in inspectional observations or warning letters issued by U.S. Food and Drug Administration (FDA), while continuing to satisfy the demand for our products; |
|
• |
compliance with the Deferred Prosecution Agreement entered into in January 2017; |
|
• |
the impact of substantial indebtedness on our ability to service our debt obligations and/or refinance amounts outstanding under our debt obligations at maturity on terms favorable to us, or at all; |
|
• |
the ability to retain the independent agents and distributors who market our products; |
|
• |
dependence on a limited number of suppliers for key raw materials and outsourced activities; |
|
• |
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; |
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the effect of mergers and acquisitions on our relationships with customers, suppliers and lenders and on our operating results and businesses generally; |
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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 products; |
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the outcome of government investigations; |
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competition; |
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pricing pressures; |
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changes in customer demand for our products and services caused by demographic changes or other factors; |
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the impact of healthcare reform measures; |
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reductions in reimbursement levels by third-party payors and cost containment efforts of healthcare purchasing organizations; |
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dependence on new product development, technological advances and innovation; |
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shifts in the product category or regional sales mix of our products and services; |
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supply and prices of raw materials and products; |
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control of costs and expenses; |
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the ability to obtain and maintain adequate intellectual property protection; |
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breaches or failures of our information technology systems or products, including by cyber-attack, unauthorized access or theft; |
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the ability to form and implement alliances; |
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changes in tax obligations arising from tax reform measures, including European Union rules on state aid, or examinations by tax authorities; |
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product liability, intellectual property and commercial litigation losses; |
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changes in general industry and market conditions, including domestic and international growth rates; |
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changes in general domestic and international economic conditions, including interest rate and currency exchange rate fluctuations; and |
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the impact of the ongoing financial and political uncertainty on countries in the Euro zone on the ability to collect accounts receivable in affected countries. |
Our Annual Report on Form 10-K for the year ended December 31, 2019, our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2020 and June 30, 2020 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
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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, 2019.
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 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, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. We are closely monitoring the effects the COVID-19 pandemic may have on our internal control over financial reporting.
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Part II – Other Information
Item 1. |
Legal Proceedings |
Information pertaining to legal proceedings can be found in Note 16 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 |
You should carefully consider the factors discussed in Part I, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2019 (“2019 Form 10-K”), as updated in Part II, Item1A “Risk Factors” of our Quarterly Report on Form 10-Q for the three months ended March 31, 2020 (“First Quarter 2020 Form 10-Q”), which could materially affect our business, financial condition and results of operations. The risks described in our 2019 Form 10-K and First Quarter 2020 Form 10-Q are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or results of operations. In addition, the COVID-19 pandemic could exacerbate or trigger other risks discussed in our 2019 Form 10-K and First Quarter 2020 Form 10-Q, any of which could materially affect our business, financial condition and results of operations.
Item 2. |
Unregistered Sales of Equity Securities and Use of Proceeds |
None
Item 3. |
Defaults Upon Senior Securities |
None
Item 4. |
Mine Safety Disclosures |
Not applicable
Item 5. |
Other Information |
During the three-month period ended September 30, 2020, 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.
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Item 6. |
Exhibits |
The following exhibits are filed or furnished as part of this report:
3.1 |
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3.2 |
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10.1 |
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21 |
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31.1 |
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31.2 |
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32 |
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101
101.SCH
101.CAL
101.DEF
101.LAB
101.PRE |
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Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because XBRL tags are embedded within the Inline XBRL document.
Inline XBRL Taxonomy Extension Schema Document
Inline XBRL Taxonomy Extension Calculation Linkbase Document
Inline XBRL Taxonomy Extension Definition Linkbase Document
Inline XBRL Taxonomy Extension Label Linkbase Document
Inline XBRL Taxonomy Extension Presentation Linkbase Document |
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104 |
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Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) |
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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.
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ZIMMER BIOMET HOLDINGS, INC. |
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(Registrant) |
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Date: November 6, 2020 |
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By: |
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/s/ Suketu Upadhyay |
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Suketu Upadhyay |
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Executive Vice President and Chief Financial Officer |
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(Principal Financial Officer) |
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Date: November 6, 2020 |
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By: |
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/s/ Carrie Nichol |
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Carrie Nichol |
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Vice President, Controller and Chief Accounting Officer |
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(Principal Accounting Officer) |
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