ZIMMER BIOMET HOLDINGS, INC. 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 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. 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. 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 second quarter, but COVID-19 continues to bring near-term uncertainty. In the second quarter, April was the lowest month for elective surgical procedures, with sequential improvement in May and June. Based upon current indications, we expect that sequential improvement will continue through the third and fourth quarters, but possibly at a more modest pace than occurred from April to June. There are many positive and negative variables and uncertainties that could impact our near-term performance, including the number of patients who deferred procedures returning to their surgeons, patients who will continue to defer procedures due to concerns of contracting the virus, patients affected by job losses and/or loss of insurance coverage, and a return of the virus to markets that had partially or mostly recovered. However, we believe that hospitals are now better prepared and informed to handle the virus than they were in March, including personal protective equipment availability, but that preparedness and availability is subject to change. 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. Late in 2019, we initiated the 2019 Restructuring Plan to reduce our costs. 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. We are also utilizing government wage assistance programs in certain global markets and other policy support mechanisms, including tax relief provisions in theU.S. CARES Act.
Results for the Three and Six-Month Periods ended
Primarily as a result of the COVID-19 pandemic, our net sales decreased by 38.3 percent and 24.1 percent in the three and six-month periods endedJune 30, 2020 , respectively, compared to the same prior year periods. We recognized a net loss in the three and six-month periods endedJune 30, 2020 , driven by lower sales due to the COVID-19 pandemic, in addition to goodwill and intangible asset impairment charges totaling$33.0 million and$645.0 million , respectively. We temporarily suspended or limited production at certain manufacturing facilities, resulting in us immediately expensing$67.6 million in the three and six-month periods endedJune 30, 2020 that related 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 six-month period endedJune 30, 2020 , we recognized litigation-related charges of$81.1 million compared to net litigation gains of$18.3 million in the same prior year period. Results of Operations We analyze sales by three geographies, theAmericas , EMEA andAsia 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 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. 30
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The following tables present our net sales by geography and the components of the percentage changes (dollars in millions):
Three Months Ended
June 30, Volume / Foreign
2020 2019 % (Dec) Mix Price Exchange
Americas $ 733.7 $ 1,214.3 (39.6 ) % (36.9 ) % (2.6 ) % (0.1 ) %
EMEA 218.7 438.0 (50.1 ) (48.7 ) (0.3 ) (1.1 )
Asia Pacific 273.7 336.3 (18.6 ) (17.2 ) (1.0 ) (0.4 )
Total $ 1,226.1 $ 1,988.6 (38.3 ) (36.2 ) (1.8 ) (0.3 )
Six Months Ended
June 30, Volume /
Foreign
2020 2019 % (Dec) Mix Price Exchange
Americas $ 1,835.0 $ 2,408.4 (23.8 ) % (21.0 ) % (2.7 ) % (0.1 ) %
EMEA 616.8 901.9 (31.6 ) (28.5 ) (1.3 ) (1.8 )
Asia Pacific 558.1 653.8 (14.6 ) (13.0 ) (1.0 ) (0.6 )
Total $ 3,009.9 $ 3,964.1 (24.1 ) (21.4 ) (2.1 ) (0.6 )
"Foreign Exchange," as used in the tables in this report, represents the effect of changes in foreign currency exchange rates on sales.
The following tables present our net sales by product category and the components of the percentage changes (dollars in millions):
Three Months Ended
June 30, Volume / Foreign
2020 2019 % (Dec) Mix Price Exchange
Knees $ 374.2 $ 703.5 (46.8 ) % (44.2 ) % (2.3 ) % (0.3 ) %
Hips 329.7 478.5 (31.1 ) (28.5 ) (2.2 ) (0.4 )
S.E.T. 252.6 357.0 (29.2 ) (26.0 ) (2.7 ) (0.5 )
Dental, Spine & CMFT 182.5 292.4 (37.6 ) (38.1 ) 0.7 (0.2 )
Other 87.1 157.2 (44.5 ) (42.9 ) (1.4 ) (0.2 )
Total $ 1,226.1 $ 1,988.6 (38.3 ) (36.2 ) (1.8 ) (0.3 )
Six Months Ended
June 30, Volume / Foreign
2020 2019 % (Dec) Mix Price Exchange
Knees $ 1,004.0 $ 1,397.6 (28.2 ) % (25.2 ) % (2.3 ) % (0.7 ) %
Hips 762.3 961.9 (20.8 ) (17.5 ) (2.6 ) (0.7 )
S.E.T. 586.2 713.8 (17.9 ) (15.1 ) (2.2 ) (0.6 )
Dental, Spine & CMFT 434.2 579.7 (25.1 ) (24.1 ) (0.6 ) (0.4 )
Other 223.2 311.1 (28.2 ) (25.9 ) (1.9 ) (0.4 )
Total $ 3,009.9 $ 3,964.1 (24.1 ) (21.4 ) (2.1 ) (0.6 )
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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 June 30 ,
Six Months Ended
2020 2019 % (Dec) 2020 2019 % (Dec)
Knees
Americas $ 221.0 $ 414.5 (46.7 ) % $ 601.3 $ 823.7 (27.0 ) %
EMEA 65.2 163.4 (60.1 ) 217.9 339.1 (35.7 )
Asia Pacific 88.0 125.6 (29.9 ) 184.8 234.8 (21.3 )
Total $ 374.2 $ 703.5 (46.8 ) $ 1,004.0 $ 1,397.6 (28.2 )
Hips
Americas $ 170.7 $ 253.3 (32.6 ) % $ 403.2 $ 500.4 (19.4 ) %
EMEA 70.8 125.9 (43.7 ) 182.2 259.0 (29.7 )
Asia Pacific 88.2 99.3 (11.3 ) 176.9 202.5 (12.7 )
Total $ 329.7 $ 478.5 (31.1 ) $ 762.3 $ 961.9 (20.8 )
Demand (Volume and Mix) Trends
Declines in volume and changes in the mix of product sales had a negative effect of 36.2 percent and 21.4 percent on year-over-year sales during the three and six-month periods endedJune 30, 2020 , respectively. Volumes declined from the deferral of many elective surgical procedures due to COVID-19. Based on current indications, we expect to see sequential improvement to these negative trends through the third and fourth quarters, but possibly at a more modest pace than occurred from April to June. Based upon country dynamics, volume declines varied by region. InAsia Pacific ,Japan is our largest market and did not experience as much of an impact from COVID-19 as other countries. Additionally, inChina the volume declines started to occur in February, allowing time for better sequential improvement in the second quarter. In theAmericas , we saw stronger than expected recovery in May and June. In theU.S. , we are seeing second waves of steep infection growth. However, we clearly see that healthcare systems, in general, are better equipped to address the pandemic such that we are not seeing an erosion of elective procedures at the same levels as observed in April. In EMEA, the return to elective surgical procedures was slower than other regions, but continued to improve throughout the quarter in our major markets.
Pricing Trends
Global selling prices had a negative effect of 1.8 percent and 2.1 percent on year-over-year sales during the three and six-month periods endedJune 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 six-month periods endedJune 30, 2020 , changes in foreign currency exchange rates had a negative effect of 0.3 percent and 0.6 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 negative impact of less than 1 percent on full-year 2020 sales. 32
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Expenses as a Percentage of
Three Months Ended Six Months Ended
June 30, % Inc / June 30, % Inc /
2020 2019 (Dec) 2020 2019 (Dec)
Cost of products sold,
excluding intangible asset
amortization 34.6 % 29.2 % 5.4 % 30.3 % 28.6 % 1.7 %
Intangible asset amortization 12.0 7.4 4.6 9.8 7.3 2.5
Research and development 7.2 5.6 1.6 6.2 5.4 0.8
Selling, general and
administrative 54.2 42.2 12.0 49.6 41.3 8.3
Goodwill and intangible asset
impairment 2.7 3.5 (0.8 ) 21.4 1.8 19.6
Restructuring and other cost
reduction initiatives 2.3 0.3 2.0 2.4 0.3 2.1
Quality remediation 0.8 1.1 (0.3 ) 0.9 1.1 (0.2 )
Acquisition, integration and
related 0.2 0.3 (0.1 ) 0.2 0.3 (0.1 )
Operating (loss) profit (14.0 ) 10.3 (24.3 ) (20.9 ) 14.0 (34.9 )
The increase in cost of products sold as a percentage of net sales for the three
and six-month periods ended June 30, 2020 compared to the same prior year
periods was primarily due to temporarily suspended or limited production at
certain manufacturing facilities resulting in us immediately expensing $67.6
million that related 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. Additionally, excess and obsolete
charges as a percentage of net sales increased as these charges did not decline
ratably with the significant decline in our net sales. These unfavorable items
were partially offset by a charge of $20.8 million incurred in the three and
six-month periods ended June 30, 2019 to terminate a long-term raw material
supply agreement. Additionally, hedge gains on our hedging program were higher
in the 2020 periods than in the same prior year periods.
Intangible asset amortization expense increased minimally in the three and
six-month periods ended June 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, but R&D expenses as a
percentage of net sales increased, in the three and six-month periods ended
June 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. R&D expenses
as a percentage of net sales increased due to the lower sales from the impact of
COVID-19.
Selling, general and administrative ("SG&A") expenses decreased in the three and
six-month periods ended June 30, 2020 compared to the same prior year periods
primarily due to lower variable selling expenses from the significant decline in
our net sales, as well as specific cost reductions taken due to COVID-19 and the
continued early impact of the 2019 Restructuring Plan. In the six-month period
ended June 30, 2020 these lower variable selling expenses were partially offset
by higher litigation-related charges of $81.1 million compared to net litigation
gains of $18.3 million in the same prior year period. Since SG&A expenses
include many fixed expenses, the decline in sales due to COVID-19 resulted in an
increase in SG&A expenses as a percentage of net sales in the 2020 periods.
In the three and six-month periods ended June 30, 2020 , we recognized goodwill
and intangible asset impairment charges of $33.0 million and $645.0 million ,
respectively, 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. In the three and six-month periods ended June 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 $28.0
million and $73.0 million in the three and six-month periods ended June 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 six-month periods
ended June 30, 2020 compared to the same prior year periods, due to the natural
regression of completing our remediation milestones. Acquisition, integration
and related expenses declined in the three and six -month periods ended June 30,
2020 compared to the same prior year periods, mainly due to the completion of
certain integration efforts.
33
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Other Income (Expense), Net, Interest Expense, Net, and Income Taxes
In the three and six-month periods ended
Interest expense, net, decreased in the three and six-month periods endedJune 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 six-month periods endedJune 30, 2020 , our effective tax rate ("ETR") was 6.2 percent and 1.2 percent, respectively, compared to 6.0 percent and 12.5 percent in the three and six-month periods endedJune 30, 2019 , respectively. Our ETR in the 2020 and 2019 periods was below the typical statutory tax rate for various reasons. The 6.2 percent ETR in the three-month period endedJune 30, 2020 was the result of the mix of some of our jurisdictions recognizing earnings while others had losses. The 1.2 percent ETR in the six-month period endedJune 30, 2020 was primarily due to the$612.0 million goodwill impairment charge, which resulted in a loss before taxes, but has no corresponding tax benefit, as well as the mix of earnings and losses among our jurisdictions. The 6.0 percent ETR in the three-month period endedJune 30, 2019 was primarily due to the favorable resolution of certain tax audits. The 12.5 percent ETR in the six-month period endedJune 30, 2019 was primarily due to the favorable resolution of certain tax audits as well as a release of uncertain tax positions due to emerging foreign tax guidance in the first quarter. Absent discrete tax events, we expect our future ETR will be lower than theU.S. corporate income tax rate of 21.0 percent due to our mix of earnings betweenU.S. and foreign locations, which have lower corporate income tax rates. Our ETR in future periods could also potentially be impacted by: changes in our mix of pre-tax earnings; changes in tax rates, tax laws or their interpretation, including theEuropean Union rules on state aid; the outcome of various federal, state and foreign audits; and the expiration of certain statutes of limitations. Currently, we cannot reasonably estimate the impact of these items on our financial results.
Segment Operating Profit
Operating Profit as a
Net Sales Operating Profit Percentage of Net Sales
Three Months Ended Three Months Ended Three Months Ended
June 30, June 30, June 30,(dollars in millions) 2020 2019 2020 2019 2020 2019Americas and Global Businesses$ 757.5 $ 1,255.1 $ 83.0 $ 427.2 11.0 % 34.0 % EMEA 204.1 405.8 20.0 117.5 9.8 29.0 Asia Pacific 264.5 327.7 78.4 118.0 29.6 36.0 Operating Profit as a Net Sales Operating Profit Percentage of Net Sales Six Months Ended Six Months Ended Six Months Ended June 30, June 30, June 30, (dollars in millions) 2020 2019 2020 2019 2020 2019 Americas and Global Businesses$ 1,894.1 $ 2,490.7 $ 451.8 $ 817.2 23.9 % 32.8 % EMEA 575.4 834.7 128.8 256.7 22.4 30.8 Asia Pacific 540.4 638.7 171.0 231.5 31.6 36.2 Similar to our consolidated results, all of our segments were adversely affected by COVID-19. In each of our segments, operating profit as a percentage of net sales declined in the three and six-month periods endedJune 30, 2020 compared to the same prior year periods due to the effect of fixed operating expenses that did not decline proportionally with lower net sales. 34
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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 inSwitzerland ; 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 (loss) earnings and diluted (loss) earnings per share to our non-GAAP adjusted net earnings and non-GAAP adjusted diluted earnings per share used for internal management purposes (in millions, except per share amounts): Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 Net (Loss) Earnings of Zimmer Biomet Holdings, Inc.$ (206.6 ) $ 133.7 $ (715.1 ) $ 379.8 Inventory and manufacturing-related charges(1) 1.4 34.1 2.0 36.1 Intangible asset amortization(2) 147.7 146.9 295.3 290.3Goodwill and intangible asset impairment(3) 33.0 70.1 645.0 70.1 Restructuring and other cost reduction initiatives(4) 28.0 6.9 73.0 11.6 Quality remediation(5) 9.9 23.4 25.8 43.1 Acquisition, integration and related(6) 2.2 5.1 6.6 11.1 Litigation(7) 1.3 7.0 81.1 5.2 Litigation settlement gain(8) - - - (23.5 ) European Union Medical Device Regulation(9) 6.1 5.1 17.1 6.7 Other charges(10) 7.3 41.3 13.9 63.4 Taxes on above items(11) (23.5 ) (69.8 ) (93.7 ) (100.6 ) Tax adjustments relating to the impacts of tax only amortization in Switzerland(12) (0.7 ) - 16.2 - Other certain tax adjustments(13) 4.1 (6.1 ) (3.1 ) (11.4 ) Adjusted Net Earnings$ 10.2 $ 397.7 $ 364.1 $ 781.9 35
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Three Months Ended Six Months Ended
June 30, June 30,
2020 2019 2020 2019
Diluted (Loss) Earnings Per
Share $ (1.00 ) $ 0.65 $ (3.46 ) $ 1.84
Inventory and
manufacturing-related
charges(1) 0.01 0.17 0.01 0.18
Intangible asset
amortization(2) 0.71 0.71 1.43 1.41
Goodwill and intangible asset
impairment(3) 0.16 0.34 3.12 0.34
Restructuring and other cost
reduction initiatives(4) 0.14 0.03 0.35 0.06
Quality remediation(5) 0.05 0.11 0.12 0.21
Acquisition, integration and
related(6) 0.01 0.02 0.03 0.05
Litigation(7) 0.01 0.03 0.39 0.03
Litigation settlement gain(8) - - - (0.11 )
European Union Medical Device
Regulation(9) 0.03 0.02 0.08 0.03
Other charges(10) 0.04 0.21 0.07 0.31
Taxes on above items(11) (0.13 ) (0.34 ) (0.44 ) (0.50 )
Tax adjustments relating to
the impacts of tax only
amortization in
Switzerland(12) - - 0.08 -
Other certain tax
adjustments(13) 0.02 (0.02 ) (0.02 ) (0.05 )
Effect of dilutive shares
assuming net earnings(14) - - (0.01 ) -
Adjusted Diluted Earnings Per
Share $ 0.05 $ 1.93 $ 1.75 $ 3.80 (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 2019 periods, inventory
and manufacturing-related charges also include 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
units, respectively. In the second quarters of 2020 and 2019, we recognized
development ("IPR&D") intangible asset impairments on certain IPR&D
projects.
(4) In
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
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.
36
--------------------------------------------------------------------------------(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 thecomplexities 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
meet the additional requirements. For certain devices, this transition period
can be extended until
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, as well as our costs of
complying with our Deferred Prosecution Agreement ("DPA") with the
government related to certain Foreign Corrupt Practices Act matters
involving
three-year term, we are subject to oversight by an independent compliance
monitor, which monitorship commenced in
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
considering federal and state taxes, as well as permanent items. For
jurisdictions outside 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) Other certain tax adjustments relate to various discrete tax period
adjustments.
(14) Diluted share count used in Adjusted Diluted EPS:
Three Months Ended Six Months Ended
June 30, 2020 June 30, 2020
Diluted shares 206.8 206.6
Dilutive shares assuming net earnings 1.0 1.4
Adjusted diluted shares 207.8 208.0
Liquidity and Capital Resources
The COVID-19 pandemic has had, and will continue to have a significant, 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 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 negative operating cash flows of$52.8 million in the three-month period endedJune 30, 2020 . 37
-------------------------------------------------------------------------------- As ofJune 30, 2020 , we had$713.4 million in cash and cash equivalents. In addition, we have$1.0 billion available to borrow under our 2020 Credit Agreement that contains the 2020 Revolving Facility and matures onDecember 31, 2020 , and$1.5 billion available under our 2019 Multicurrency Revolving Facility that will mature onNovember 1, 2024 . The terms of the 2019 Multicurrency Revolving Facility and the 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$398.1 million in the six-month period endedJune 30, 2020 , compared to$584.6 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. However, we did take advantage of the CARES Act and deferred certain tax payments which we expect to mostly pay in the third quarter of 2020. The 2019 period included a payment of approximately$168 million on a patent infringement lawsuit. Cash flows used in investing activities were$206.5 million in the six-month period endedJune 30, 2020 , compared to$427.7 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 necessary investments which are reflected in the lower investments in property, plant and equipment of$59.2 million in the 2020 period when compared to$96.7 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$92.9 million in the six-month period endedJune 30, 2020 , compared to$298.8 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 onApril 1, 2020 . In the 2019 period, we had$225.0 million in net repayments of term loans.
At
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 108.6 Japanese Yen 0.635 September 27, 2022
Term 197.8 Japanese Yen 0.635 September 27, 2022
Notes 561.6 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 561.6 Euro 2.425 December 13, 2026
Notes 561.6 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
38
-------------------------------------------------------------------------------- The 2019 Multicurrency Revolving Facility will mature onNovember 1, 2024 . There were no outstanding borrowings under the 2019 Multicurrency Revolving Facility as ofJune 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, onApril 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. OnApril 23, 2020 , we entered into the 2020 Credit Agreement, which contains the 2020 Revolving Facility, an unsecured revolving credit facility of$1.0 billion . The 2020 Credit Agreement matures onDecember 31, 2020 . As of the date of this filing, we do not expect to borrow under the 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 ofJune 30, 2020 ,$216.3 million of our cash and cash equivalents were held in jurisdictions outside of theU.S. Of this amount,$64.2 million is denominated inU.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 theU.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. In February andMay 2020 , our Board of Directors declared a quarterly cash dividend of$0.24 per share. We have paid cash dividends on a quarterly basis for more than five years; however, future dividends are subject to approval of the Board of Directors and may be adjusted as business needs or market conditions change. Due to the decline in our cash flows as a result of the COVID-19 pandemic, our Board of Directors will continue to assess our cash requirements and determine if our quarterly dividends will be impacted in the future. InFebruary 2016 , our Board of Directors authorized a new$1.0 billion share repurchase program effectiveMarch 1, 2016 , with no expiration date. The previous program expired onFebruary 29, 2016 . As ofJune 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, inDecember 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$145 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, theIRS has issued proposed adjustments for years 2005 through 2012, as well as a draft NOPA for years 2013 through 2015, reallocating profits between certain of ourU.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. Also, 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. 39
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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
six-month periods ended
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;
• 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
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;
• the effect of mergers and acquisitions on our relationships with
customers, suppliers and lenders and on our operating results and
businesses generally;
• challenges relating to changes in and compliance with governmental laws
and regulations affecting our
regulations of the FDA and foreign government regulators, such as more
stringent requirements for regulatory clearance of products;
• the outcome of government investigations;
• competition;
• pricing pressures;
• changes in customer demand for our products and services caused by
demographic changes or other factors;
• the impact of healthcare reform measures;
• 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;
• shifts in the product category or regional sales mix of our products and
services;
• supply and prices of raw materials and products;
• control of costs and expenses;
• the ability to obtain and maintain adequate intellectual property protection;
• breaches or failures of our information technology systems or products,
including by cyber-attack, unauthorized access or theft;
• the ability to form and implement alliances;
• changes in tax obligations arising from tax reform measures, including
• product liability, intellectual property and commercial litigation losses;
• changes in general industry and market conditions, including domestic and
international growth rates;
• changes in general domestic and international economic conditions,
including interest rate and currency exchange rate fluctuations; and
• the impact of the ongoing financial and political uncertainty on countries
in the Euro zone on the ability to collect accounts receivable in affected
countries.
Our Annual Report on Form 10-K for the year endedDecember 31, 2019 , our Quarterly Report on Form 10-Q for the quarter endedMarch 31, 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 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.
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