ZIMMER BIOMET HOLDINGS, INC. The following discussion and analysis should be read in conjunction with the consolidated financial statements and the corresponding notes included elsewhere in this Annual Report on Form 10-K. 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. Certain amounts in the 2018 and 2017 consolidated financial statements have been reclassified to conform to the 2019 presentation. The following discussion, analysis and comparisons generally focus on the operating results for the years endedDecember 31, 2019 and 2018. Discussion, analysis and comparisons of the years endedDecember 31, 2018 and 2017 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the year endedDecember 31, 2018 .
EXECUTIVE LEVEL OVERVIEW
2019 Financial Highlights
In 2019, our net sales increased by 0.6 percent compared to 2018. We estimate changes in volume/mix of our products and pricing had a positive effect of 2.2 percent on our 2019 sales while changes in foreign currency exchange rates had a negative effect of 1.6 percent. Notably, our sales growth was higher in the second half of the year compared to the first half of the year primarily due to various product launches in our Knees product category, which drove improved commercial execution. The improved second half performance was present in all of our product categories and geographic regions. Additionally, the negative impact of changes in foreign currency exchange rates was less in the second half of 2019 compared to the first half. Our net earnings increased by more than$1.5 billion in 2019 from 2018. We had significant goodwill and intangible asset impairments and litigation-related charges in 2018, which contributed to a net loss that year. In 2019, expenses related to quality remediation, as well as acquisition and integration, declined due to the continued progress in completing those projects. Higher sales, lower interest expense and the recognition of a deferred tax benefit related toSwitzerland tax reform resulted in the significant increase in earnings in 2019 compared to 2018. 2020 Outlook We believe that the improved sales performance in the second half of 2019 will continue into 2020. We estimate sales growth in 2020 compared to 2019 will be in a range of 2.5 percent to 3.5 percent. We anticipate the impact from changes in foreign currency exchange rates will be minimal for 2020. We expect to be able to leverage the sales growth into higher operating profits. Additionally, we expect reductions in quality remediation costs, as well as other various project costs, as we complete these initiatives. We have recently initiated restructuring activities designed to reduce our operating costs in the long-term. These activities are expected to result in expenses of approximately$350 million to$400 million through the end of 2023, with slightly more than half of that expected to be incurred in 2020. Further, we expect interest expense, net, will continue to decline in 2020 due to lower average outstanding debt balances. Our 2020 outlook does not consider any impacts from the recent outbreak of the coronavirus. While there could be a near-term effect on our operating results, it is difficult to assess or predict how material the impact will be and what long-term effects the outbreak may have.
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 & CMF and Other. This sales analysis differs from our reportable operating segments, which are based upon our senior management organizational structure and how we allocate resources towards achieving operating profit goals. We analyze sales by geography because the underlying market trends in any particular geography tend to be similar across product categories and because we primarily sell the same products in all geographies. 30
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The following tables present net sales by geography and the components of the percentage changes (dollars in millions):
Year Ended December 31, Volume/ Foreign
2019 2018 % Inc/(Dec) Mix Price Exchange
Americas $ 4,875.8 $ 4,837.2 0.8 % 4.0 % (3.0 ) % (0.2 ) %
EMEA 1,746.9 1,801.9 (3.1 ) 4.3 (2.1 ) (5.3 )
Asia Pacific 1,359.5 1,293.8 5.1 9.1 (2.2 ) (1.8 )
Total $ 7,982.2 $ 7,932.9 0.6 4.9 (2.7 ) (1.6 )
Year Ended December 31, Volume/ Foreign
2018 2017 % Inc/(Dec) Mix Price Exchange
Americas $ 4,837.2 $ 4,844.8 (0.2 ) % 2.3 % (2.4 ) % (0.1 ) %
EMEA 1,801.9 1,745.2 3.2 1.7 (1.6 ) 3.1
Asia Pacific 1,293.8 1,213.3 6.6 9.2 (3.5 ) 0.9
Total $ 7,932.9 $ 7,803.3 1.7 3.2 (2.4 ) 0.9
"Foreign Exchange" used in the tables in this report represents the effect of changes in foreign currency exchange rates on sales.
The following tables present net sales by product category and the components of the percentage changes (dollars in millions):
Year Ended December 31, Volume/ Foreign
2019 2018 % Inc/(Dec) Mix Price Exchange
Knees $ 2,810.1 $ 2,773.7 1.3 % 6.2 % (3.0 ) % (1.9 ) %
Hips 1,935.1 1,921.4 0.7 5.5 (3.0 ) (1.8 )
S.E.T. 1,795.7 1,751.8 2.5 5.4 (1.6 ) (1.3 )
Spine & CMF 747.3 763.9 (2.2 ) 1.4 (2.6 ) (1.0 )
Dental 414.0 411.2 0.7 3.2 (0.9 ) (1.6 )
Other 280.0 310.9 (9.9 ) (2.1 ) (6.5 ) (1.3 )
Total $ 7,982.2 $ 7,932.9 0.6 4.9 (2.7 ) (1.6 )
Year Ended December 31, Volume/ Foreign
2018 2017 % Inc/(Dec) Mix Price Exchange
Knees $ 2,773.7 $ 2,734.0 1.5 % 3.6 % (2.9 ) % 0.8 %
Hips 1,921.4 1,871.8 2.6 4.3 (2.8 ) 1.1
S.E.T. 1,751.8 1,701.8 2.9 3.9 (1.8 ) 0.8
Spine & CMF 763.9 757.9 0.8 2.1 (1.7 ) 0.4
Dental 411.2 418.6 (1.8 ) (1.7 ) (1.5 ) 1.4
Other 310.9 319.2 (2.6 ) (1.7 ) (1.5 ) 0.6
Total $ 7,932.9 $ 7,803.3 1.7 3.2 (2.4 ) 0.9
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The following table presents net sales by product category by geography for our
Knees and Hips product categories, which represent our most significant product
categories (dollars in millions):
Year Ended December 31,
2019 vs. 2018 2018 vs. 2017
2019 2018 2017 % Inc/(Dec) % Inc/(Dec)
Knees
Americas $ 1,676.6 $ 1,642.7 $ 1,656.5 2.1 % (0.8 ) %
EMEA 654.1 672.3 644.4 (2.7 ) 4.4
Asia Pacific 479.4 458.7 433.1 4.5 5.9
Total $ 2,810.1 $ 2,773.7 $ 2,734.0 1.3 1.5
Hips
Americas $ 1,016.3 $ 996.3 $ 968.9 2.0 % 2.8 %
EMEA 499.8 519.9 518.4 (3.9 ) 0.3
Asia Pacific 419.0 405.2 384.5 3.4 5.4
Total $ 1,935.1 $ 1,921.4 $ 1,871.8 0.7 2.6
Demand (Volume/Mix) Trends
Increased volume and changes in the mix of product sales had a positive effect
of 4.9 percent on year-over-year sales during 2019. Volume/mix growth was driven
by recent product introductions, particularly in our Knees product category,
sales in key emerging markets and market growth. Market growth has generally
been influenced by an aging global population, obesity, new technologies,
advances in surgical techniques and more active lifestyles, among other
factors.
Pricing Trends
Global selling prices had a negative effect of 2.7 percent on year-over-year sales during 2019. In the majority of countries in which we operate, we continue to experience pricing pressure from governmental healthcare cost containment efforts and from local hospitals and health systems.
Foreign Currency Exchange Rates
In 2019, changes in foreign currency exchange rates had a negative effect of 1.6 percent on year-over-year sales. If foreign currency exchange rates remain at levels consistent with recent rates, we estimate they will have a minimal effect on sales in 2020 for the full year. However, we estimate sales will be negatively affected by foreign currency exchange rates in the first half of the year, but that impact will be offset by positive effects in the second half of the year.
Sales by Product Category
Knees
Knee sales increased by 1.3 percent in 2019 compared to 2018. Various product
launches resulted in improved volume/mix growth in the knee product category,
which was partially offset by price declines and changes in foreign currency
exchange rates. Knee sales growth was principally driven by increased demand for
Persona® The Personalized Knee System, the Oxford® Partial Knee and the ROSA®
Knee System.
Hips
Hip sales increased by 0.7 percent in 2019 compared to 2018. Volume/mix growth
in this product category was partially offset by price declines and changes in
foreign currency exchange rates. Hip sales growth was primarily attributable to
increased utilization of our Taperloc® Complete Hip System and G7® Acetabular
System.
S.E.T.
S.E.T. sales increased by 2.5 percent in 2019 compared to 2018 primarily due to
supply stability, salesforce specialization and new product launches, partially
offset by price declines and changes in foreign currency exchange rates.
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--------------------------------------------------------------------------------Spine & CMF
Spine and CMF sales decreased by 2.2 percent in 2019 compared to 2018 primarily due to ongoing sales channel consolidation in our Spine division, price declines and changes in foreign currency exchange rates. Demand for our thoracic products continued to positively contribute to sales.
Dental
Dental sales increased by 0.7 percent in 2019 compared to 2018. Volume/mix growth in our Dental product category improved primarily due to investment of resources in priority areas, as well as other operational improvements.
The following table presents estimated* 2019 global market information (dollars
in billions):
Global Global Zimmer Biomet
Market Market Market
Size % Growth** Position
Knees $ 8 Low-Single Digit 1
Hips 7 Low-Single Digit 1
S.E.T. 22 Mid-Single Digit 5
Spine & CMF 11 Low-Single Digit 5
Dental 5 Mid-Single Digit 4
* Estimates are not precise and are based on competitor annual filings, Wall
Street equity research and Company estimates
** Excludes the effect of changes in foreign currency exchange rates on sales
growth
Expenses as a Percent of
Year Ended December 31,
2019 vs. 2018 2018 vs. 2017
2019 2018 2017 Inc/(Dec) Inc/(Dec)
Cost of products sold, excluding
intangible asset amortization 28.2 % 28.6 % 27.3 % (0.4 ) % 1.3 %
Intangible asset amortization 7.3 7.5 7.7 (0.2 ) (0.2 )
Research and development 5.6 4.9 4.7 0.7 0.2
Selling, general and
administrative 41.9 42.6 39.8 (0.7 ) 2.8
Goodwill and intangible asset
impairment 0.9 12.3 4.2 (11.4 ) 8.1
Quality remediation 1.0 1.9 2.3 (0.9 ) (0.4 )
Restructuring and other cost
reduction initiatives 0.6 0.4 0.2 0.2 0.2
Acquisition, integration and
related 0.2 1.3 3.4 (1.1 ) (2.1 )
Operating Profit 14.2 0.4 10.2 13.8 (9.8 )
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Cost of Products Sold and Intangible Asset Amortization
We calculate gross profit as net sales minus cost of products sold and
intangible asset amortization. Our gross margin percentage is gross profit
divided by net sales. The following table sets forth the factors that
contributed to the gross margin changes in each of 2019 and 2018 compared to the
prior year:
Year Ended December 31,
2019 2018
Prior year gross margin 63.9 % 64.9 %
Lower average selling prices (0.7 ) (0.6 )
Average cost per unit (0.4 ) 0.8
Excess and obsolete inventory 0.1 (1.0 )
Discontinued products inventory charges - (0.1 )
Royalties 0.4 -
Impact of foreign currency hedges 0.8 (0.4 )
Inventory step-up - 0.4
U.S. medical device excise tax 0.2 (0.3 )
Intangible asset amortization 0.2 0.2
Current year gross margin 64.5 % 63.9 %
The increase in gross margin percentage in 2019 compared to 2018 was primarily
due to the effect of our hedging program, lower royalty expense, a refund
related to U.S. medical device excise taxes and lower intangible asset
amortization. We incurred hedge gains of $38.4 million in 2019 compared to hedge
losses of $26.2 million in 2018. For derivatives which qualify as hedges of
future cash flows, the effective portion of changes in fair value is temporarily
recorded in other comprehensive income and then recognized in cost of products
sold when the hedged items affect earnings. The refund of a portion of the U.S.
medical device excise tax was the result of a change in the methodology we used
to calculate the constructive sales price upon which the taxes were paid. On
July 1, 2019 the IRS approved and agreed to our change in methodology. The
reduction in royalty expense was partially the result of an agreement we entered
into on April 1, 2019 . Under the agreement, we paid $192.5 million to buy out
certain licensing arrangements from an unrelated third party. This new agreement
and the related payment replace the variable royalty payments that otherwise
would have been due under the terms of previous licensing arrangements through
2029. The payment was recorded as an intangible asset and will be amortized
through 2029. Intangible asset amortization expense declined in 2019 due to
certain intangible assets from past acquisitions being fully amortized,
partially offset by additional amortization from the agreement to buy out
certain licensing arrangements we entered into on April 1, 2019 . These favorable
items were partially offset by lower average selling prices and higher
manufacturing costs.
Operating Expenses
R&D expenses as a percentage of net sales increased in 2019 compared to 2018 primarily due to increased investment in our Knee product pipeline, costs associated with the EU MDR and patent licenses acquired for use in R&D activities that were expensed immediately.
Selling, general and administrative ("SG&A") expenses and SG&A expenses as a
percentage of sales decreased in 2019 compared to 2018 primarily due to lower
litigation-related charges. In 2018, we recognized a $168 million litigation
charge for a patent infringement lawsuit. The lower litigation-related charges
were partially offset by higher selling costs due to higher sales, investments
in preparation for new product launches, and higher expenses from legal entity,
distribution and manufacturing optimization, including distributor contract
terminations.
In 2019, we recognized a
Our quality remediation expenses continued to decline in 2019 due to the natural regression of completing our remediation milestones. Similarly, acquisition, integration and related expenses declined mainly due to the completion of certain integration efforts.
In
34
--------------------------------------------------------------------------------incurred related to a supply chain optimization initiative. The 2018 cost reduction expenses only included expenses related to the supply chain optimization initiative.
Other Expense, net, Interest Expense, net, and Income Taxes
Our other expense, net, primarily relates to certain components of pension expense, investment gains and losses and remeasurement gains and losses related to monetary assets and liabilities denominated in a foreign currency other than an entity's functional currency, partially offset by the impact of foreign currency forward exchange contracts we entered into to mitigate any gain or loss. The decline in other expense, net in 2019 was driven by higher pension-related gains.
Interest expense, net, declined in 2019 compared to 2018 primarily due to continued debt repayments and gains related to our cross-currency interest rate swaps.
Our effective tax rate ("ETR") on earnings (loss) before income taxes was
negative 24.9 percent (a tax benefit was recognized on earnings before income
taxes) and negative 39.9 percent (a tax provision was recognized on a loss
before income taxes) for the years ended December 31, 2019 and 2018,
respectively. In 2019, we recognized an overall tax benefit in the year due to a
$315.0 million benefit from Switzerland's Federal Act on Tax Reform and AHV
Financing ("TRAF") in addition to the tax impact of certain restructuring
transactions in Switzerland . The TRAF is 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.
In 2018, our negative ETR was primarily due to goodwill impairment that resulted
in us having a net loss before income taxes with no associated tax benefit
recognized for this charge. In 2018, we also recognized an additional $8.3
million of income tax provision as we completed our estimate of the effects of
the Tax Cuts and Jobs Act of 2017 ("2017 Tax Act").
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
Year Ended December 31, Year Ended December 31, Year Ended December 31,
(dollars
in
millions) 2019 2018 2017 2019 2018 2017 2019 2018 2017
Americas $ 3,978.1 $ 3,932.6 $ 3,928.9 $ 2,163.2 $ 2,084.4 $ 2,126.8 54.4 % 53.0 % 54.1 %
EMEA 1,538.6 1,576.1 1,523.4 477.1 479.3 478.1 31.0 30.4 31.4
Asia
Pacific 1,297.0 1,236.9 1,158.3 458.9 435.3 417.6 35.4 35.2 36.1
In the Americas , operating profit as a percentage of net sales increased in 2019
compared to 2018. The increase was primarily due to improved sales volume/mix
and controlled spending. In EMEA, operating profit as a percentage of net sales
increased in 2019 compared to 2018. The increase was primarily due to higher
sales volume/mix and gains recognized related to our hedging program. In Asia
Pacific , operating profit as a percentage of net sales increased in 2019
compared to 2018 primarily due to volume/mix net sales growth and gains
recognized related to our hedging program.
Non-GAAP Operating Performance Measures
We use financial measures that differ from financial measures determined in
accordance with
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measures exclude, as applicable, the impact of inventory step-up; certain
inventory and manufacturing-related charges including charges to discontinue
certain product lines; intangible asset amortization; goodwill and intangible
asset impairment; quality remediation expenses; restructuring and other cost
reduction initiatives; acquisition, integration and related expenses; certain
litigation gains and charges; expenses to comply with the EU MDR; other charges;
any related effects on our income tax provision associated with these items; the
effect of Switzerland tax reform; the effect of the 2017 Tax Act; 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.
Our non-GAAP adjusted net earnings used for internal management purposes for the
years ended December 31, 2019 , 2018 and 2017 were $1,626.4 million , $1,565.4
million and $1,636.4 million , respectively, and our non-GAAP adjusted diluted
earnings per share were $7.87 , $7.64 and $8.03 , respectively.
The following are reconciliations from our GAAP net earnings and diluted
earnings per share to our non-GAAP adjusted net earnings and non-GAAP adjusted
diluted earnings per share used for internal management purposes (in millions,
except per share amounts):
Year ended December 31,
2019 2018 2017
Net Earnings (Loss) of Zimmer Biomet
Holdings, Inc. $ 1,131.6 $ (379.2 ) $ 1,813.8
Inventory step-up and other
inventory and
manufacturing related charges(1) 53.9 32.5 70.8
Intangible asset amortization(2) 584.3 595.9
603.9
Goodwill and intangible asset impairment(3) 70.1 979.7
331.5
Quality remediation(4) 87.6 165.4
195.1
Restructuring and other cost reduction initiatives(5) 50.0 34.2
17.6
Acquisition, integration and related(6) 12.2 99.5
262.2
Litigation(7) 65.0 186.0
104.0
Litigation settlement gain(8) (23.5 ) - - European Union Medical Device Regulation(9) 30.9 3.7 - Other charges(10) 119.2 82.8 43.8 Taxes on above items (11) (226.2 ) (239.6 ) (421.5 ) U.S. tax reform (12) - 8.3 (1,272.4 ) Switzerland tax reform (13) (315.0 ) - - Other certain tax adjustments (14) (13.7 ) (3.8 ) (112.4 ) Adjusted Net Earnings$ 1,626.4 $ 1,565.4 $ 1,636.4 36
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Year ended December 31,
2019 2018 2017
Diluted Earnings (Loss) per share $ 5.47 $ (1.86 ) $ 8.90
Inventory step-up and other inventory and
manufacturing related charges(1) 0.26 0.16 0.35
Intangible asset amortization(2) 2.83 2.93 2.96
Goodwill and intangible asset impairment(3) 0.34 4.81 1.63
Quality remediation(4) 0.42 0.81 0.96
Restructuring and other cost reduction initiatives(5) 0.24 0.17 0.09
Acquisition, integration and related(6) 0.06 0.49 1.28
Litigation(7) 0.31 0.91 0.51
Litigation settlement gain(8) (0.11 ) - -
European Union Medical Device Regulation(9) 0.15 0.02 -
Other charges(10) 0.58 0.41 0.22
Taxes on above items (11) (1.09 ) (1.18 ) (2.07 )
U.S. tax reform (12) - 0.04 (6.25 )
Switzerland tax reform (13) (1.52 ) - -
Other certain tax adjustments (14) (0.07 ) (0.02 ) (0.55 )
Effect of dilutive shares assuming net earnings(15) - (0.05 ) -
Adjusted Diluted EPS $ 7.87 $ 7.64 $ 8.03 (1) Inventory step-up and other inventory and manufacturing-related charges
relate to inventory step-up expense, excess and obsolete inventory charges
on certain product lines we intend to discontinue and other inventory and
manufacturing-related charges. The year ended
agreement. Inventory step-up expense represents the incremental expense of
inventory sold recognized at its fair value after business combination
accounting is applied versus the expense that would have been recognized if
sold at its cost to manufacture. Since only the inventory that existed at
the business combination date was stepped-up to fair value, we believe
excluding the incremental expense provides investors useful information as
to what our costs may have been if we had not been required to increase the
inventory's book value to fair value. The excess and obsolete inventory
charges on certain product lines are driven by acquisitions where there are
competing product lines and we have plans to discontinue one of the
competing product lines.
(2) We exclude intangible asset amortization from our non-GAAP financialmeasures 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 2019 and 2018, we recognized $70.1 and $3.8 million , respectively, of
intangible asset impairments from merger-related IPR&D intangible
assets. Also in 2018, we recognized a goodwill impairment charge of
million. The impairment was comprised of
reporting unit,
in an insignificant reporting unit. In 2017, we recognized
$8.0 million of intangible asset impairment from merger-related IPR&D and trademark intangible assets, respectively. Also in 2017, we recognized goodwill impairment charges of$32.7 million and$272.0 million on our Office Based Technologies and Spine reporting units, respectively.
(4) 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.
(5) In December 2019 , our Board of Directors approved, and we initiated, a newglobal restructuring program with an overall objective of reducing costs to
allow us to invest in higher priority growth opportunities. In 2019, the
expenses were primarily related to severance and our supply chain
optimization initiative. The 2018 and 2017 expenses were related to our
supply chain optimization initiative.
(6) The acquisition, integration and related gains and expenses we have excluded
from our non-GAAP financial measures resulted from various acquisitions. The
acquisition, integration and related gains and expenses include the
following types of gains and expenses:
• Consulting and professional fees related to third-party integration
consulting performed in a variety of areas, such as tax, compliance,
logistics and human resources, and legal fees related to the
consummation of mergers and acquisitions.
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• Employee termination benefits related to terminating employees with
overlapping responsibilities in various areas of our business.
• Dedicated project personnel expenses which include the salary, benefits,
travel expenses and other costs directly associated with employees who
are 100 percent dedicated to our integration of acquired businesses and
employees who have been notified of termination, but are continuing to
work on transferring their responsibilities.
• Contract termination expenses related to terminated contracts, primarily
with sales agents and distribution agreements.
• Other various expenses to relocate facilities, integrate information
technology, losses incurred on assets resulting from the applicable
acquisition, and other various expenses.
(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 outof court, and the other party agreed to pay us an upfront, lump-sum amount
for a non-exclusive license to the patent.
(9) The EU MDR imposes significant additional premarket and postmarket
requirements. The new regulations provide a transition period until
for currently-approved medical devices to meet the additional
requirements. For certain devices, this transition period can be extended
until
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) The 2017 Tax Act resulted in a net favorable provisional adjustment due to
the reduction of deferred tax liabilities for unremitted earnings and
revaluation of deferred tax liabilities to a 21 percent rate, which was
partially offset by provisional tax charges related to the toll charge
provision of the 2017 Tax Act. In 2018, we finalized our estimates of the
effects of the 2017 Tax Act based upon final guidance issued by
authorities.
(13) We recognized a tax benefit related to TRAF in addition to an impact from
certain restructuring transactions in
(14) Other certain tax adjustments relate to various discrete tax period
adjustments, including changes in statutory tax rates, adjustments from
internal restructuring transactions that provide us access to offshore funds
in a tax efficient manner and resolutions of various tax matters.
(15) Diluted share count used in Adjusted Diluted EPS (in millions):
Year ended
December 31, 2018
Diluted shares 203.5
Dilutive shares assuming net earnings 1.5
Adjusted diluted shares 205.0
LIQUIDITY AND CAPITAL RESOURCES
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Cash flows provided by operating activities were $1,585.8 million in 2019
compared to $1,747.4 million and $1,582.3 million in 2018 and 2017,
respectively. The decrease in operating cash flows in 2019 compared to 2018 was
primarily due to a payment of approximately $168 million on a patent
infringement lawsuit. Additionally, in 2018 we expanded our sale of accounts
receivable in certain countries which provided additional cash inflows, compared
to 2019 when we sold fewer receivables at the end of the year which had a
negative effect on operating cash flows.
Cash flows used in investing activities were $729.3 million in 2019 compared to
$416.6 million and $510.8 million in 2018 and 2017, respectively. In 2019, we
paid $197.6 million to buy out certain licensing arrangements from unrelated
third parties. Instrument and property, plant and equipment additions reflected
ongoing investments in our product portfolio and optimization of our
manufacturing and logistics network, including investments in instruments in
2019 to support new product launches.
Cash flows used in financing activities were $779.9 million in 2019. Our primary
use of available cash in 2019 was for debt repayment. We received net proceeds
of $549.2 million from the issuance of additional Euro-denominated senior notes
which we used to repay $500.0 million of senior notes that became due on
November 30, 2019 . In January 2019 , we borrowed an additional $200.0 million
under a U.S. term loan ("U.S. Term Loan C") and used those proceeds, along with
cash on hand, to repay the remaining $225.0 million outstanding under the U.S.
term loan ("U.S. Term Loan B") provided for under our 2016 credit
agreement. During 2019 we also repaid the $735.0 million outstanding balance
under U.S. Term Loan C, with the remainder of the proceeds from the
Euro-denominated senior notes issuance and cash from operations. Overall, we had
approximately $710 million of net principal repayments on our senior notes and
term loans in 2019. In 2018, we received net proceeds of $749.5 million from the
issuance of additional senior notes and borrowed $400.0 million from our $1.5
billion multicurrency revolving facility provided for under our 2016 credit
agreement (the "2016 Multicurrency Revolving Facility") to repay $1,150.0
million of senior notes that became due on April 2, 2018 . We subsequently repaid
the $400.0 million of 2016 Multicurrency Revolving Facility borrowings in
2018. Also in 2018, we borrowed $675.0 million under U.S. Term Loan C and used
the cash proceeds along with cash generated from operations throughout the year
to repay an aggregate of $835.0 million on U.S. Term Loan A, $450.0 million on
U.S. Term Loan B, and we subsequently repaid $140.0 million on U.S. Term Loan
C. Overall , we had approximately $1,150 million of net principal repayments on
our senior notes and term loans in 2018.
In February, May, August and December 2019 , our Board of Directors declared cash
dividends 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
We will continue to exercise disciplined capital allocation designed to drive stockholder value creation. We intend to use available cash for debt repayment, reinvestment in the business and payment of dividends. If the right opportunities arise, we may also use available cash to pursue business development opportunities. As discussed in Note 4 to our consolidated financial statements, inDecember 2019 , our Board of Directors approved, and we initiated, a new global restructuring program with an objective of reducing costs to allow us to further invest in higher priority growth opportunities. The restructuring program is expected to result in total pre-tax restructuring charges of approximately$350 million to$400 million , with slightly more than half of that expected to be incurred in 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 are realized. As discussed in Note 16 to our consolidated financial statements, the Internal Revenue Service ("IRS") has issued proposed adjustments for years 2005 through 2012 reallocating profits between certain of ourU.S. and foreign subsidiaries. We have disputed these proposed adjustments and continue to pursue resolution with theIRS . Although the ultimate timing for resolution of the disputed tax issues is uncertain, future payments may be significant to our operating cash flows. As discussed in Note 20 to our consolidated financial statements, as ofDecember 31, 2019 , we have an estimated liability of$59.9 million related to Durom Cup product liability claims and a liability of$50.1 million related toBiomet metal-on-metal hip implant claims on our consolidated balance sheet. We expect to continue paying these claims over the next few years. 39 --------------------------------------------------------------------------------
At
Interest
Type Principal Currency Rate Maturity Date
Notes $ 1,500.0 U.S. Dollar 2.700 % April 1, 2020
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 106.9 Japanese Yen 0.635 September 27, 2022
Term 194.7 Japanese Yen 0.635 September 27, 2022
Notes 561.3 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 561.3 Euro 2.425 December 13, 2026
Notes 561.3 Euro 1.164 November 15, 2027
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
We have a five-year unsecured multicurrency revolving facility of $1.5 billion
(the "2019 Multicurrency Revolving Facility") that will mature on November 1,
2024 . There were no outstanding borrowings under this facility as of
December 31, 2019 . The 2019 Multicurrency Revolving Facility replaced the 2016
Multicurrency Revolving Facility, effective November 1, 2019 . We also had other
available uncommitted credit facilities totaling $45.3 million as of December
31, 2019 .
We have $1.5 billion principal amount of notes due April 1, 2020 . We believe we
can satisfy this debt obligation with cash generated from our operations, by
issuing new debt, and/or by borrowing on our 2019 Multicurrency Revolving
Facility. We believe that our earnings, balance sheet and cash flows will allow
us to obtain additional capital, if necessary, to satisfy this debt obligation.
For additional information on our debt, see Note 12 to our consolidated financial statements.
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 ofDecember 31, 2019 ,$373.4 million of our cash and cash equivalents were held in jurisdictions outside of theU.S. Of this amount,$102.1 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. In the future, we intend to repatriate at least$5.0 billion of unremitted earnings, of which the additional tax related to remitting earnings is deemed immaterial. Management believes that cash flows from operations and available borrowings under the 2019 Multicurrency Revolving Facility are sufficient to meet our working capital, capital expenditure and debt service needs, as well as return cash to stockholders in the form of dividends and share repurchases. Should additional investment opportunities arise, we believe that our earnings, balance sheet and cash flows will allow us to obtain additional capital, if necessary. 40 --------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS
We have entered into contracts with various third parties in the normal course
of business that will require future payments. The following table illustrates
our contractual obligations and certain other commitments (in millions):
2021 2023 2025
and and and
Contractual Obligations Total 2020 2022 2024 ThereafterLong-term debt$ 8,252.1 $ 1,500.0 $ 2,362.9 $ 300.0 $ 4,089.2 Interest payments 1,602.8 173.0 306.0 279.4 844.4 Operating leases 307.3 70.5 99.4 63.3 74.1 Purchase obligations 599.6 319.8 203.3 76.1 0.4 Toll charge tax liability 234.9 - 12.4 136.6 85.9 Other long-term liabilities 227.2 - 146.6 19.3 61.3
Total contractual obligations
$118.6 million of the other long-term liabilities on our balance sheet as ofDecember 31, 2019 are liabilities related to defined benefit pension plans. Defined benefit plan liabilities are based upon the underfunded status of the respective plans; they are not based upon future contributions. Due to uncertainties regarding future plan asset performance, changes in interest rates and our intentions with respect to voluntary contributions, we are unable to reasonably estimate future contributions beyond 2020. Therefore, this table does not include any amounts related to future contributions to our plans. See Note 15 to our consolidated financial statements for further information on our defined benefit plans. Under the 2017 Tax Act, we have a$234.9 million toll charge liability for the one-time deemed repatriation of unremitted foreign earnings. This amount was recorded in non-current income tax liabilities on our consolidated balance sheet as ofDecember 31, 2019 . We have elected to pay the toll charge in installments over eight years. Also included in long-term liabilities on our consolidated balance sheets are liabilities related to unrecognized tax benefits and corresponding interest and penalties thereon. Due to the uncertainties inherent in these liabilities, such as the ultimate timing and resolution of tax audits, we are unable to reasonably estimate the amount or period in which potential tax payments related to these positions will be made. Therefore, this table does not include any obligations related to unrecognized tax benefits. See Note 16 to our consolidated financial statements for further information on these tax-related accounts. We have entered into various agreements that may result in future payments dependent upon various events such as the achievement of certain product R&D milestones, sales milestones, or, at our discretion, maintenance of exclusive rights to distribute a product. Since there is uncertainty on the timing or whether such payments will have to be made, we have not included them in this table. These payments could range from$0 to$60 million .
CRITICAL ACCOUNTING ESTIMATES
Our financial results are affected by the selection and application of accounting policies and methods. Significant accounting policies which require management's judgment are discussed below.
Excess Inventory and Instruments - We must determine as of each balance sheet date how much, if any, of our inventory may ultimately prove to be unsaleable or unsaleable at our carrying cost. Similarly, we must also determine if instruments on hand will be put to productive use or remain undeployed as a result of excess supply. Accordingly, inventory and instruments are written down to their net realizable value. To determine the appropriate net realizable value, we evaluate current stock levels in relation to historical and expected patterns of demand for all of our products and instrument systems and components. The basis for the determination is generally the same for all inventory and instrument items and categories except for workinprocess inventory, which is recorded at cost. Obsolete or discontinued items are generally destroyed and completely written off. Management evaluates the need for changes to the net realizable values of inventory and instruments based on market conditions, competitive offerings and other factors on a regular basis. Income Taxes - Our income tax expense, deferred tax assets and liabilities and reserves for unrecognized tax benefits reflect management's best assessment of estimated future taxes to be paid. We are subject to income taxes in theU.S. and numerous foreign jurisdictions. Significant judgments and estimates are required in determining the consolidated income tax expense. 41 -------------------------------------------------------------------------------- We estimate income tax expense and income tax liabilities and assets by taxable jurisdiction. Realization of deferred tax assets in each taxable jurisdiction is dependent on our ability to generate future taxable income sufficient to realize the benefits. We evaluate deferred tax assets on an ongoing basis and provide valuation allowances unless we determine it is "more likely than not" that the deferred tax benefit will be realized. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our global operations. We are subject to regulatory review or audit in virtually all of those jurisdictions and those reviews and audits may require extended periods of time to resolve. We record our income tax provisions based on our knowledge of all relevant facts and circumstances, including existing tax laws, our experience with previous settlement agreements, the status of current examinations and our understanding of how the tax authorities view certain relevant industry and commercial matters. We recognize tax liabilities in accordance with theFinancial Accounting Standards Board ("FASB") guidance on income taxes and we adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which they are determined. Commitments and Contingencies - Accruals for product liability and other claims are established with the assistance of internal and external legal counsel based on current information and historical settlement information for claims, related legal fees and for claims incurred but not reported. We use an actuarial model to assist management in determining an appropriate level of accruals for product liability claims. Historical patterns of claim loss development over time are statistically analyzed to arrive at factors which are then applied to loss estimates in the actuarial model.Goodwill and Intangible Assets - We evaluate the carrying value of goodwill and indefinite life intangible assets annually, or whenever events or circumstances indicate the carrying value may not be recoverable. We evaluate the carrying value of finite life intangible assets whenever events or circumstances indicate the carrying value may not be recoverable. Significant assumptions are required to estimate the fair value of goodwill and intangible assets, most notably estimated future cash flows generated by these assets and risk-adjusted discount rates. As such, these fair value measurements use significant unobservable inputs. Changes to these assumptions could require us to record impairment charges on these assets. In our annual impairment test in the fourth quarter of 2019, we estimated the fair value of our EMEA and Dental reporting units only exceeded their carrying values by less than 5 percent. Fair value was determined using 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 units. Significant assumptions are incorporated into the income approach, such as estimated growth rates and risk-adjusted discount rates. Fair value under the market approach utilized the guideline public company methodology, which uses valuation indicators determined from other businesses that are similar to our EMEA and Dental reporting units. As ofDecember 31, 2019 , the remaining goodwill on the EMEA and Dental reporting units were$749.8 million and$397.7 million , respectively. Future impairment in the EMEA and Dental reporting units could occur if the estimates used in the income and market approaches change. If our estimates of profitability in the reporting unit decline, the fair value estimate under the income approach will decline. Additionally, changes in the broader economic environment could cause changes to our estimated discount rates, foreign currency exchange rates used to translate cash flows and comparable company valuation indicators, which may impact our estimated fair values. We have three other reporting units that have goodwill assigned to them. The fair value of each of these three reporting units is sufficiently in excess of its carrying value which leads us to believe only a significant, unforeseen event could cause impairment to any of these reporting units.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 2 to our consolidated financial statements for information on how recent accounting pronouncements have affected or may affect our financial position, results of operations or cash flows.
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