ZIMMER BIOMET HOLDINGS, INC. - Quarter Report: 2020 March (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 MARCH 31, 2020

Commission File Number 001-16407

ZIMMER BIOMET HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

345 East Main Street, Warsaw, IN  46580

(Address of principal executive offices)

Telephone:  (574) 267-6131

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

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

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

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

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

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

As of May 1, 2020, 206,802,113 shares of the registrant’s $.01 par value common stock were outstanding.

ZIMMER BIOMET HOLDINGS, INC.

INDEX TO FORM 10-Q

March 31, 2020

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Part I – Financial Information

Item 1.  Financial  Statements

ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(in millions, except per share amounts, unaudited)

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

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ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in millions, unaudited)

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

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ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in millions, except share amounts, unaudited)

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

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ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in millions, except per share amounts, unaudited)

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

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ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions, unaudited)

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

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ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.  Basis of Presentation

The financial data presented herein is unaudited and should be read in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 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 significantly 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 and stay-at-home measures.  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 is expected to 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 US 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:

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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 $66.3 million and $65.0 million as of March 31, 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):

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

Starting in the first quarter of 2020, we have updated our product category revenue reporting format.  These changes are designed to further align with our recent reorganization.  Product category sales include the following changes:

Prior period product category sales have been reclassified to conform to the current presentation.

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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 will 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 first quarter of 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):

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 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

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6.  Property, Plant and Equipment

We had $39.8 million of property, plant and equipment included in accounts payable as of each of March 31, 2020 and December 31, 2019.

7.  Goodwill

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):

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 is 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.

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

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last annual goodwill impairment test.  As discussed in our Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part I, Item 2 of this report, we expect that our second quarter of 2020 will experience the most significant negative impact, followed by sequential improvement in the rate of deferred procedures.  The change in reportable segments resulted in additional impairment due to additional assets being allocated to the EMEA reporting unit.  After the goodwill impairment charge, $288.4 million of goodwill remains in the EMEA reporting unit as of March 31, 2020.  

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 expect that the deferral of elective dental procedures will have a significant adverse effect to our cash flows.  We estimate 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, economic uncertainty will likely result in patients deferring dental procedures for a longer period of time than procedures involving our other products.  After the goodwill impairment charge, $253.5 million of goodwill remains in the Dental reporting unit as of March 31, 2020.  

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 has also been 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 is 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, 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.

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 March 31, 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 $21.1 million and $21.8 million as of March 31, 2020 and December 31, 2019, respectively.

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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 three-month periods ended March 31, 2020 and 2019, we sold receivables having an aggregate face value of $560.5 million and $799.4 million to third parties in exchange for cash proceeds of $560.1 million and $798.7 million, respectively.  Expenses recognized on these sales during the three-month periods ended March 31, 2020 and 2019 were not significant.  In the three-month periods ended March 31, 2020 and 2019, under the U.S. and Japan programs, we collected $335.3 million and $698.4 million, respectively, from our customers and remitted that amount to the third party, and we effectively repurchased $39.3 million and $34.7 million, respectively, of previously sold accounts receivable from the third party, due to the programs’ revolving nature.  At March 31, 2020 and December 31, 2019, we had collected $67.0 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 March 31, 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 $421.8 million and $270.2 million, respectively.

9.  Debt

Our debt consisted of the following (in millions):

At March 31, 2020, our total current and non-current debt of $9.7 billion consisted of $9.4 billion aggregate principal amount of our senior notes, which included $1.6 billion of 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 $5.5 million, partially offset by debt discount and issuance costs of $49.8 million.

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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 five-year 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 three months ended March 31, 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 March 31, 2020, there were no outstanding borrowings under the 2019 Multicurrency Revolving Facility.

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.  We were in compliance with all covenants under the 2019 Credit Agreement as of March 31, 2020.  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).  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 (the “2020 Credit Agreement”) which is an unsecured revolving credit facility of $1.0 billion (the “2020 Revolving Facility”).  The 2020 Credit Agreement matures on December 31, 2020.  Borrowings under the 2020 Credit Agreement will generally bear interest at floating rates.  We will pay a facility fee on the aggregate amount of the 2020 Revolving Facility.  The 2020 Credit Agreement contains customary affirmative and negative covenants and events of default for unsecured financing arrangement including, among other things, limitations on consolidations, mergers, and sales of assets.  The 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 5.75 to 1.00.  The 2020 Revolving Facility is also subject to certain mandatory prepayment requirements and corresponding commitment reductions upon the issuance of indebtedness above $25.0 million, subject to specified carve-outs.

The estimated fair value of our senior notes as of March 31, 2020, based on quoted prices for the specific securities from transactions in over-the-counter markets (Level 2), was $9,371.1 million.  The estimated fair value of Japan Term Loan A and Japan Term Loan B, in the aggregate, as of March 31, 2020, based upon publicly available market yield curves and the terms of the debt (Level 2), was $304.1 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.

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

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

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

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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):