The following discussion and analysis should be read in conjunction with the interim condensed consolidated financial statements and corresponding notes included elsewhere in this Form 10-Q. Certain percentages presented in this discussion and analysis are calculated from the underlying whole-dollar amounts and, therefore, may not recalculate from the rounded numbers used for disclosure purposes. Executive Level Overview
Impact of the COVID-19 Global Pandemic
Our results have been and may continue to be significantly impacted by the COVID-19 global pandemic. The vast majority of our net sales are derived from products used in elective surgical procedures. As COVID-19 rapidly started to spread throughout the world in early 2020, our net sales decreased dramatically as countries took precautions to prevent the spread of the virus with lockdowns and stay-at-home measures and as hospitals deferred elective surgical procedures. In the third quarter of 2020, various levels of recovery of elective surgical procedures resulted in net sales growth of 2.0 percent when compared to the same prior year period. This was significantly improved from the first and second quarters of 2020 when our net sales declined by 9.7 percent and 38.3 percent, respectively, when compared to the same prior year periods. The consequences of COVID-19 continue to be extremely fluid and there are many market dynamics and impacts that we are unable to identify or quantify at this time. We were encouraged by certain developments in the third quarter, but COVID-19 continues to bring near-term uncertainty. For example, despite net sales growth of 2.0 percent in the third quarter of 2020, we saw the recovery curve flatten in the latter part of the third quarter. There are many variables and uncertainties that could impact our near-term performance, including a resurgence of the virus, policy actions, patient fear and economic downturn. With the deferral of elective surgical procedures, we have taken prudent measures in an effort to maintain an adequate financial profile to have access to capital to fund the business during these unprecedented times. In response to the COVID-19 pandemic, we have temporarily reduced discretionary spending such as travel, meetings and other project spend that can be delayed with limited long-term detriment to the business, and we temporarily suspended or limited production at certain manufacturing facilities. However, we have not experienced significant disruptions in our supply chain, or in our ability to meet our customer demands.
Results for the Three and Nine-Month Periods ended
Our net sales increased by 2.0 percent in the three-month period endedSeptember 30, 2020 compared to the same prior year period. As discussed previously, we saw a recovery in elective surgical procedures, especially in theU.S. and certain parts ofAsia Pacific , that drove net sales growth in the third quarter of 2020. However, in the nine-month period endedSeptember 30, 2020 our net sales decreased by 15.7 percent due to the significant deferral of elective surgical procedures in the first and second quarters. While we recognized net income of$242.5 million in the three-month period endedSeptember 30, 2020 , we had a net loss of$472.6 million in the nine-month period endedSeptember 30, 2020 . In the three-month period, net income was lower than in the prior year primarily due to a provisional net tax benefit of$263.8 million related toSwitzerland tax reform recorded in the 2019 period. This unfavorable headwind was partially offset by lower expenses from specific cost reductions taken due to COVID-19, such as lower travel and entertainment expenses, the continued impact of the 2019 Restructuring Plan, lower litigation-related charges and lower charges related to our compliance with the DPA. Our net loss in the nine-month period endedSeptember 30, 2020 was largely attributable to$645.0 million of goodwill and intangible asset impairment charges. Additionally, our results declined in the nine-month period endedSeptember 30, 2020 resulting from lower sales due to the COVID-19 pandemic. We have also temporarily suspended or limited production at certain manufacturing facilities, resulting in higher costs of products sold that relate to certain fixed overhead costs and hourly production worker labor expenses that are included in the cost of inventory when these facilities are operating at normal capacity. We also incurred higher restructuring and other cost reduction initiative expenses in the 2020 periods when compared to the same prior year periods. Lastly, in the nine-month period endedSeptember 30, 2020 , we recognized litigation-related charges of$100.4 million compared to net litigation-related charges of$24.5 million in the same prior year period.
Results of Operations
We analyze sales by three geographies, theAmericas , EMEA andAsia Pacific , and by the following product categories: Knees; Hips; S.E.T.; Dental, Spine & CMFT; and Other. This sales analysis differs from our reportable operating segments, which are based upon our senior management organizational structure and how we allocate resources toward achieving operating profit goals. We analyze sales by geography because the underlying market trends in any particular geography tend to be similar across product categories and because we primarily sell the same products in all geographies. Our business is seasonal in nature to some extent, as many of our products are used in elective surgical procedures, which typically decline during the summer months and can increase at 31
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the end of the year once annual deductibles have been met on health insurance plans. In 2020, it is uncertain if this seasonal pattern will be similar to previous years due to COVID-19 and its related impacts.
The following tables present our net sales by geography and the components of the percentage changes (dollars in millions):
Three Months Ended September 30, Volume / Foreign 2020 2019 % Inc / (Dec) Mix Price Exchange Americas$ 1,216.5 $ 1,179.2 3.2 % 6.7 % (3.4 ) % (0.1 ) % EMEA 366.2 374.6 (2.3 ) (4.8 ) (0.9 ) 3.4 Asia Pacific 346.6 338.6 2.3 2.1 (1.4 ) 1.6 Total$ 1,929.3 $ 1,892.4 2.0 3.7 (2.6 ) 0.9 Nine Months Ended September 30, Volume / Foreign 2020 2019 % (Dec) Mix Price Exchange Americas$ 3,051.5 $ 3,587.6 (14.9 ) % (11.9 ) % (2.9 ) % (0.1 ) % EMEA 983.0 1,276.5 (23.0 ) (21.5 ) (1.2 ) (0.3 ) Asia Pacific 904.7 992.4 (8.8 ) (7.8 ) (1.2 ) 0.2 Total$ 4,939.2 $ 5,856.5 (15.7 ) (13.4 ) (2.2 ) (0.1 )
"Foreign Exchange," as used in the tables in this report, represents the effect of changes in foreign currency exchange rates on sales.
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The following tables present our net sales by product category and the components of the percentage changes (dollars in millions):
Three Months Ended September 30, Volume / Foreign 2020 2019 % Inc / (Dec) Mix Price Exchange Knees$ 648.7 $ 651.9 (0.5 ) % 1.4 % (2.8 ) % 0.9 % Hips 484.1 459.2 5.4 7.3 (2.9 ) 1.0 S.E.T. 359.9 348.5 3.3 4.9 (2.4 ) 0.8 Dental, Spine & CMFT 295.5 275.5 7.3 9.0 (2.5 ) 0.8 Other 141.1 157.3 (10.3 ) (10.1 ) (1.0 ) 0.8 Total$ 1,929.3 $ 1,892.4 2.0 3.7 (2.6 ) 0.9 Nine Months Ended September 30, Volume / Foreign 2020 2019 % (Dec) Mix Price Exchange Knees$ 1,652.7 $ 2,049.5 (19.4 ) % (16.7 ) % (2.5 ) % (0.2 ) % Hips 1,246.4 1,421.1 (12.3 ) (9.5 ) (2.7 ) (0.1 ) S.E.T. 946.1 1,062.3 (10.9 ) (8.5 ) (2.3 ) (0.1 ) Dental, Spine & CMFT 729.7 855.2 (14.7 ) (13.5 ) (1.2 ) - Other 364.3 468.4 (22.2 ) (20.6 ) (1.6 ) - Total$ 4,939.2 $ 5,856.5 (15.7 ) (13.4 ) (2.2 ) (0.1 )
The following table presents our net sales by geography for our Knees and Hips product categories, which represent our most significant product categories (dollars in millions):
Three Months Ended September 30, Nine Months Ended September 30, % Inc / 2020 2019 (Dec) 2020 2019 % (Dec) Knees Americas $ 402.6 $ 399.2 0.9 %$ 1,003.9 $ 1,222.9 (17.9 ) % EMEA 126.6 135.3 (6.4 ) 344.5 474.4 (27.4 ) Asia Pacific 119.5 117.4 1.7 304.3 352.2 (13.6 ) Total $ 648.7 $ 651.9 (0.5 )$ 1,652.7 $ 2,049.5 (19.4 ) Hips Americas $ 268.6 $ 249.0 7.9 % $ 671.8 $ 749.4 (10.3 ) % EMEA 109.7 108.8 0.8 291.9 367.8 (20.6 ) Asia Pacific 105.8 101.4 4.4 282.7 303.9 (7.0 ) Total $ 484.1 $ 459.2 5.4$ 1,246.4 $ 1,421.1 (12.3 ) 33
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Demand (Volume and Mix) Trends
Changes in volume and mix of product sales had a positive effect of 3.7 percent and negative effect of 13.4 percent on year-over-year sales during the three and nine-month periods endedSeptember 30, 2020 , respectively. In the three-month period endedSeptember 30, 2020 we saw various levels of recovery in elective surgical procedures. However, that recovery occurred primarily in July with the recovery curve flattening in the latter part of the third quarter. Due to multiple variables and uncertainties, we cannot predict whether there will be further recovery, continued flattening or a contraction in the fourth quarter. Based upon country dynamics, volume changes varied by region. In theAmericas , we saw stronger than expected recovery in theU.S. during the quarter, but the other countries in theAmericas mostly experienced net sales declines. In EMEA, the return to elective surgical procedures was slower than in other regions. While there was continued recovery in EMEA through the quarter, there was a slowing of the recovery in September, which continues with the recent COVID-19 surges and corresponding governmental policy actions in the region. Developed countries excluding theUnited Kingdom showed the strongest signs of recovery in the quarter. TheUnited Kingdom and emerging markets continue to be a significant drag on overall EMEA regional growth. InAsia Pacific , there was strong recovery inChina , and inJapan there was continued stability, but it was not yet back to pre-COVID-19 volumes.Australia continued to show progress, but was negatively impacted by surges late in the third quarter. Finally,India continued to vastly underperform the rest of theAsia Pacific region. Pricing Trends Global selling prices had a negative effect of 2.6 percent and 2.2 percent on year-over-year sales during the three and nine-month periods endedSeptember 30, 2020 , respectively. The majority of countries in which we operate continue to experience pricing pressure from governmental healthcare cost containment efforts and from local hospitals and health systems.
Foreign Currency Exchange Rates
For the three and nine-month periods endedSeptember 30, 2020 , changes in foreign currency exchange rates had a positive effect of 0.9 percent and a negative effect of 0.1 percent on year-over-year sales, respectively. If foreign currency exchange rates remain at levels consistent with recent rates, we estimate there will be a positive impact of less than 1 percent on full-year 2020 sales.
Expenses as a Percentage of
Three Months Ended Nine Months Ended September 30, % Inc / September 30, % Inc / 2020 2019 (Dec) 2020 2019 (Dec) Cost of products sold, excluding intangible asset amortization 29.5 % 28.3 % 1.2 % 30.0 % 28.5 % 1.5 % Intangible asset amortization 7.8 7.7 0.1 9.0 7.5 1.5 Research and development 4.5 6.0 (1.5 ) 5.5 5.6 (0.1 ) Selling, general and administrative 40.9 43.7 (2.8 ) 46.2 42.0 4.2Goodwill and intangible asset impairment - - - 13.1 1.2 11.9 Restructuring and other cost reduction initiatives 0.8 0.3 0.5 1.8 0.3 1.5 Quality remediation 0.5 1.1 (0.6 ) 0.7 1.1 (0.4 ) Acquisition, integration and related 0.5 (0.1 ) 0.6 0.3 0.1 0.2 Operating profit (loss) 15.5 13.0 2.5 (6.7 ) 13.7 (20.4 ) The increase in cost of products sold as a percentage of net sales for the three-month period endedSeptember 30, 2020 compared to the same prior year period was primarily due to temporarily suspended or limited production at certain manufacturing facilities, a refund forU.S. medical device excise taxes received in the 2019 period, and lower average selling prices. These unfavorable items were partially offset by a favorable geographic mix of sales in countries that have higher gross profit margins. The temporary suspension or limited production at certain manufacturing facilities resulted in us immediately expensing certain fixed overhead costs and hourly production worker labor expenses that are included in the cost of inventory when these facilities are operating at normal capacity. The refund of a portion of theU.S. medical device excise tax in 2019 was the result of a change in the methodology we used to calculate the constructive sales price upon which the taxes were paid. The increase in cost of products sold as a percentage of net sales for the nine-month period endedSeptember 30, 2020 compared to the same prior year period included the same factors as discussed for the three-month period endedSeptember 30 . In addition, excess and obsolete charges as a percentage of net sales increased in the nine-month period endedSeptember 30, 2020 as these charges did not decline ratably with the significant decline in our net sales. The nine-month period endedSeptember 30, 2019 34 -------------------------------------------------------------------------------- included a charge of$20.8 million to terminate a long-term raw material supply agreement. Therefore, the absence of this charge in the nine-month period endedSeptember 30, 2020 had a favorable effect on the year-over-year comparison.
Intangible asset amortization expense increased minimally in the three and
nine-month periods ended
Research and development ("R&D") expenses decreased in both amount and as a percentage of net sales in the three and nine-month periods endedSeptember 30, 2020 compared to the same prior year periods. The decrease in expenses was primarily due to savings as a result of the 2019 Restructuring Plan and lower spending on travel and certain project costs due to COVID-19. In the nine-month period endedSeptember 30, 2020 , the decline in expenses as a percentage of net sales compared to the same prior year period is less significant than the three-month period endedSeptember 30, 2020 due to the lower year-over-year sales from the impact of COVID-19 in the nine-month period as compared to higher year-over-year sales in the three-month period. Selling, general and administrative ("SG&A") expenses and SG&A expenses as a percentage of net sales decreased in the three-month period endedSeptember 30, 2020 compared to the same prior year period primarily due to specific cost reductions taken due to COVID-19, such as lower travel and entertainment expenses, the continued impact of the 2019 Restructuring Plan, lower litigation-related charges and lower charges related to our compliance with the DPA. SG&A expenses decreased in the nine-month period endedSeptember 30, 2020 compared to the same prior year period, but increased as a percentage of net sales. SG&A expenses decreased due to lower variable selling expenses from the decline in our net sales, COVID-19 cost reductions, the impact from the 2019 Restructuring Plan and lower charges related our compliance with the DPA. However, since SG&A expenses include many fixed expenses, the decline in year-over-year sales in the nine-month period due to COVID-19 resulted in an increase in SG&A expenses as a percentage of net sales. In the nine-month period endedSeptember 30, 2020 , we recognized goodwill and intangible asset impairment charges of$645.0 million , including charges of$470.0 million and$142.0 million related to our EMEA and Dental reporting units, respectively, in the first quarter of 2020 and$33.0 of intangible asset impairment charges in the second quarter of 2020. In the nine-month period endedSeptember 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. InDecember 2019 , our Board of Directors approved, and we initiated, the 2019 Restructuring Plan with an overall objective of reducing costs to allow us to invest in higher priority growth opportunities. We recognized expenses of$16.2 million and$89.2 million in the three and nine-month periods endedSeptember 30, 2020 , respectively, attributable to restructuring and other cost reduction initiatives, primarily related to employee termination benefits, distributor contract terminations, consulting and project management expenses associated with the 2019 Restructuring Plan. For more information regarding these charges, see Note 4 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report. Our quality remediation expenses declined in the three and nine-month periods endedSeptember 30, 2020 compared to the same prior year periods, due to the natural regression of completing our remediation milestones. Acquisition, integration and related expenses increased in the three and nine-month periods endedSeptember 30, 2020 compared to the same prior year periods due to a small acquisition in the 2020 periods.
Other Income (Expense), Net, Interest Expense, Net, and Income Taxes
In the three and nine-month periods ended
Interest expense, net, decreased in the three and nine-month periods endedSeptember 30, 2020 , compared to the same prior year periods, due to lower average outstanding debt balances during the 2020 periods resulting from debt repayments throughout 2019 and Euro notes that were issued in the fourth quarter of 2019 that were used to refinance debt with higher interest rates. In the three and nine-month periods endedSeptember 30, 2020 , our effective tax rate ("ETR") was 3.8 percent and negative 0.3 percent, respectively. The 3.8 percent ETR in the three-month period endedSeptember 30, 2020 was the result of the mix of some of our jurisdictions recognizing earnings while others had losses. The negative 0.3 percent ETR in the nine-month period endedSeptember 30, 2020 was primarily due to the$612.0 million goodwill impairment charge, which resulted in a loss before taxes, but had no corresponding tax benefit, as well as the mix of earnings and losses among our jurisdictions. In the three and nine-month periods endedSeptember 30, 2019 , our ETR was negative 134.1 percent and negative 31.4 percent, respectively. We recognized net tax benefits in the three and nine-month periods endedSeptember 30, 2019 , primarily due toSwitzerland tax reform that resulted in us 35 -------------------------------------------------------------------------------- recognizing a provisional net tax benefit of$263.8 million . Absent discrete tax events, we expect our future ETR will be lower than theU.S. corporate income tax rate of 21.0 percent due to our mix of earnings betweenU.S. and foreign locations, which have lower corporate income tax rates. Our ETR in future periods could also potentially be impacted by: changes in our mix of pre-tax earnings; changes in tax rates, tax laws or their interpretation, including theEuropean Union rules on state aid; the outcome of various federal, state and foreign audits; and the expiration of certain statutes of limitations. Currently, we cannot reasonably estimate the impact of these items on our financial results.
Segment Operating Profit
Operating Profit as a Net Sales Operating Profit Percentage of Net Sales Three Months Ended Three Months Ended Three Months Ended September 30, September 30, September 30,
(dollars in millions) 2020 2019 2020 2019 2020 2019Americas and Global Businesses$ 1,253.5 $ 1,212.3 $ 413.9 $ 394.3 33.0 % 32.5 % EMEA 339.7 351.8 84.6 93.7 24.9 26.6 Asia Pacific 336.1 328.3 113.4 109.6 33.7 33.4 Operating Profit as a Net Sales Operating Profit Percentage of Net Sales Nine Months Ended Nine Months Ended Nine Months Ended September 30, September 30, September 30, (dollars in millions) 2020 2019 2020 2019 2020 2019 Americas and Global Businesses$ 3,147.6 $ 3,703.0 $ 865.7 $ 1,211.5 27.5 % 32.7 % EMEA 915.1 1,186.5 213.4 350.4 23.3 29.5 Asia Pacific 876.5 967.0 284.4 341.1 32.4 35.3 In the three-month period endedSeptember 30, 2020 , theAmericas and Global Businesses andAsia Pacific operating profit as a percentage of net sales increased compared to the same prior year period due to increased net sales combined with the cost reductions taken due to COVID-19, such as lower travel and entertainment expenses, and the continued impact of the 2019 Restructuring Plan. In EMEA, the COVID-19 recovery has been slower than in other regions, resulting in lower net sales in the three-month period endedSeptember 30, 2020 when compared to the same prior year period. Due to fixed operating expenses that did not decline proportionally with the decrease in net sales, EMEA's operating profit as a percentage of net sales declined in the three-month period endedSeptember 30, 2020 when compared to the same prior year period.
In the nine-month period ended
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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 ; the effect ofSwitzerland tax reform; other certain tax adjustments; and, with respect to earnings per share information, provide for the effect of dilutive shares assuming net earnings in a period of a reported net loss. We use these non-GAAP financial measures internally to evaluate the performance of the business. Additionally, we believe these non-GAAP measures provide meaningful incremental information to investors to consider when evaluating our performance. We believe these measures offer the ability to make period-to-period comparisons that are not impacted by certain items that can cause dramatic changes in reported income but that do not impact the fundamentals of our operations. The non-GAAP measures enable the evaluation of operating results and trend analysis by allowing a reader to better identify operating trends that may otherwise be masked or distorted by these types of items that are excluded from the non-GAAP measures. In addition, adjusted diluted earnings per share is used as a performance metric in our incentive compensation programs. The following are reconciliations from our GAAP net earnings (loss) and diluted earnings (loss) per share to our non-GAAP adjusted net earnings and non-GAAP adjusted diluted earnings per share (in millions, except per share amounts): Three Months Ended Nine Months Ended September 30, September 30, 2020 2019 2020 2019 Net Earnings (Loss) of Zimmer Biomet Holdings, Inc.$ 242.5 $ 431.1 $ (472.6 ) $ 810.9 Inventory and manufacturing-related charges(1) 2.3 11.6 4.3 47.7 Intangible asset amortization(2) 149.7 146.6 445.0 436.9Goodwill and intangible asset impairment(3) - - 645.0 70.1 Restructuring and other cost reduction initiatives(4) 16.2 5.4 89.2 17.0 Quality remediation(5) 10.0 21.5 35.8 64.6 Acquisition, integration and related(6) 9.1 (2.6 ) 15.7 8.5 Litigation(7) 19.3 42.8 100.4 48.0 Litigation settlement gain(8) - - - (23.5 ) European Union Medical Device Regulation(9) 2.0 11.4 19.1 18.1 Other charges(10) (8.3 ) 18.4 5.6 81.8 Taxes on above items(11) (58.4 ) (54.8 ) (152.1 ) (155.4 ) Tax adjustments relating to the impacts of tax only amortization in Switzerland(12) 1.9 - 18.1 - Switzerland tax reform(13) (6.5 ) (263.8 ) (6.5 ) (263.8 ) Other certain tax adjustments(14) (3.0 ) (1.2 ) (6.1 ) (12.6 ) Adjusted Net Earnings$ 376.8 $ 366.4 $ 740.9 $ 1,148.3 37
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Three Months Ended Nine Months Ended September 30, September 30, 2020 2019 2020 2019 Diluted (Loss) Earnings Per Share$ 1.16 $ 2.08 $ (2.29 ) $ 3.93 Inventory and manufacturing-related charges(1) 0.01 0.06 0.02 0.23 Intangible asset amortization(2) 0.72 0.71 2.15 2.11Goodwill and intangible asset impairment(3) - - 3.12 0.34 Restructuring and other cost reduction initiatives(4) 0.08 0.03 0.43 0.08 Quality remediation(5) 0.05 0.10 0.17 0.31 Acquisition, integration and related(6) 0.04 (0.01 ) 0.08 0.04 Litigation(7) 0.09 0.21 0.49 0.23 Litigation settlement gain(8) - - - (0.11 ) European Union Medical Device Regulation(9) 0.01 0.05 0.09 0.09 Other charges(10) (0.04 ) 0.09 0.03 0.40 Taxes on above items(11) (0.28 ) (0.27 ) (0.74 ) (0.75 ) Tax adjustments relating to the impacts of tax only amortization in Switzerland(12) 0.01 - 0.09 - Switzerland tax reform(13) (0.03 ) (1.27 ) (0.03 ) (1.27 ) Other certain tax adjustments(14) (0.01 ) (0.01 ) (0.03 ) (0.06 ) Effect of dilutive shares assuming net earnings(15) - - (0.02 ) - Adjusted Diluted Earnings Per Share$ 1.81 $ 1.77 $ 3.56 $ 5.57
(1) Inventory and manufacturing-related charges include excess and obsolete
inventory charges on certain product lines we intend to discontinue and other
inventory and manufacturing-related charges. In the nine-month period ended
a
(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.
38 --------------------------------------------------------------------------------
(7) We are involved in routine patent litigation, product liability litigation,
commercial litigation and other various litigation matters. We review
litigation matters from both a qualitative and quantitative perspective to
determine if excluding the losses or gains will provide our investors with
useful incremental information. Litigation matters can vary in their
characteristics, frequency and significance to our operating results. The
litigation charges and gains excluded from our non-GAAP financial measures in
the periods presented relate to product liability matters where we have received numerous claims on specific products, patent litigation and commercial litigation related to a common matter in multiple jurisdictions. In regards to the product liability matters, due to the
complexities involved and claims filed in multiple districts, the expenses
associated with these matters are significant to our operating results. Once
the litigation matter has been excluded from our non-GAAP financial measures
in a particular period, any additional expenses or gains from changes in
estimates are also excluded, even if they are not significant, to ensure
consistency in our non-GAAP financial measures from period-to-period.
(8) In the first quarter of 2019, we settled a patent infringement lawsuit out of
court, and the other party agreed to pay us an upfront, lump-sum amount for a
non-exclusive license to the patent.
(9) The European Union Medical Device Regulation imposes significant additional
premarket and postmarket requirements. The new regulations provide a
transition period until
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, gains and losses from changes
in fair value on our equity investments, as well as our costs of complying
with our DPA with the
involving
subject to oversight by an independent compliance monitor, which monitorship
concluded in
against us in 2017 to be dismissed with prejudice inFebruary 2021 and the DPA to conclude at that time. The excluded costs include the fees paid to
the independent compliance monitor and to external legal counsel assisting
in the matter.
(11) Represents the tax effects on the previously specified items. The tax effect
for the
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 inSwitzerland .
(13)
of the TRAF were enacted in the third quarter of 2019, resulting in
provisional adjustments to our deferred taxes, generating a net tax benefit.
(14) Other certain tax adjustments relate to various discrete tax period
adjustments.
(15) Diluted share count used in Adjusted Diluted EPS:
Nine Months EndedSeptember 30, 2020 Diluted shares 206.8 Dilutive shares assuming net earnings 1.4 Adjusted diluted shares 208.2
Liquidity and Capital Resources
The COVID-19 pandemic has had an adverse effect on our liquidity and capital resource needs, primarily driven by the reduction in sales due to elective surgical procedure deferrals. We have taken prudent measures in an effort to maintain an adequate financial profile to have access to capital to fund the business during these unprecedented times, including reductions to discretionary spending 39
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such as travel, meetings and other project spend that can be delayed with
limited long-term detriment to the business. However, we continued to incur
fixed expenses that resulted in lower operating cash flows in the nine-month
period ended
As ofSeptember 30, 2020 , we had$967.3 million in cash and cash equivalents. In addition, we have$1.0 billion available to borrow under ourSeptember 2020 Credit Agreement that contains theSeptember 2020 Revolving Facility and matures onSeptember 17, 2021 , 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 theSeptember 2020 Revolving Facility (collectively, the "Revolving Facilities") are described further below and in Note 9 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report. Based on the actions described above, we believe that cash flows from operations, our cash and cash equivalents on hand, and available borrowings under our Revolving Facilities will be sufficient to meet our ongoing liquidity requirements for at least the next twelve months. At this time, we do not anticipate needing to borrow against our Revolving Facilities to fund our operations. However, due to the significant uncertainties of the COVID-19 pandemic, it is possible our needs may change. There can be no assurance that, if needed, we will be able to secure additional financing if recovery from the COVID-19 pandemic slows and has a sustained impact on our overall business and liquidity. Sources of Liquidity Cash flows provided by operating activities were$779.4 million in the nine-month period endedSeptember 30, 2020 , compared to$1,162.5 million in the same prior year period. The decline in cash flow from operating activities was primarily the result of COVID-19 reducing our cash inflows due to lower net sales while we continued to pay many fixed operating costs. Additionally, in the nine-month period endedSeptember 30, 2020 we sold fewer of our accounts receivables to a third party which we estimate negatively impacted operating cash flows by approximately$230 million . The 2019 period included a payment of approximately$168 million on a patent infringement lawsuit. Cash flows used in investing activities were$297.9 million in the nine-month period endedSeptember 30, 2020 , compared to$591.3 million in the same prior year period. Instrument and property, plant and equipment additions reflected ongoing investments in our product portfolio and optimization of our manufacturing and logistics network. In order to preserve cash, we are prioritizing investments which are reflected in the lower investments in property, plant and equipment of$89.8 million in the 2020 period when compared to$155.3 million in the 2019 period. In the 2019 period, we paid$197.6 million to buy out certain licensing arrangements from third parties. Cash flows used in financing activities were$135.5 million in the nine-month period endedSeptember 30, 2020 , compared to$597.2 million in the same prior year period. In the 2020 period, we issued senior notes and received$1,497.1 million in proceeds, which were used to pay our$1,500.0 million senior notes at maturity onApril 1, 2020 . In the 2019 period, we had$550.0 million in net repayments of term loans. 40
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At
Interest Type Principal Currency Rate Maturity Date Notes$ 450.0 U.S. Dollar Floating March 19, 2021 Notes300.0 U.S. Dollar 3.375 November 30, 2021 Notes750.0 U.S. Dollar 3.150 April 1, 2022 Term110.8 Japanese Yen 0.635 September 27, 2022 Term201.7 Japanese Yen 0.635 September 27, 2022 Notes586.3 Euro 1.414 December 13, 2022 Notes300.0 U.S. Dollar 3.700 March 19, 2023 Notes2,000.0 U.S. Dollar 3.550 April 1, 2025 Notes600.0 U.S. Dollar 3.050 January 15, 2026 Notes586.3 Euro 2.425 December 13, 2026 Notes586.3 Euro 1.164 November 15, 2027 Notes900.0 U.S. Dollar 3.550 March 20, 2030 Notes253.4 U.S. Dollar 4.250 August 15, 2035 Notes317.8 U.S. Dollar 5.750 November 30, 2039 Notes395.4 U.S. Dollar 4.450 August 15, 2045 The 2019 Multicurrency Revolving Facility will mature onNovember 1, 2024 . There were no outstanding borrowings under the 2019 Multicurrency Revolving Facility as ofSeptember 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 a credit agreement which contained an unsecured revolving credit facility of$1.0 billion . OnSeptember 18, 2020 , this credit agreement was terminated and we entered into theSeptember 2020 Credit Agreement, which contains theSeptember 2020 Revolving Facility, an unsecured revolving credit facility of$1.0 billion . TheSeptember 2020 Credit Agreement matures onSeptember 17, 2021 . We are currently in compliance with our covenants under theSeptember 2020 Revolving Facility. If we violate any covenants in the future, it is possible the lenders may terminate their commitments and require us to repay any outstanding borrowings immediately. There were no outstanding borrowings under theSeptember 2020 Revolving Facility as ofSeptember 30, 2020 , nor have we borrowed against it subsequent to then. As of the date of this filing, we do not expect to borrow under theSeptember 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 ofSeptember 30, 2020 ,$349.9 million of our cash and cash equivalents were held in jurisdictions outside of theU.S. Of this amount,$85.1 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. 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. 41
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In February, June and
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 ofSeptember 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$155 million of that total expected to be incurred by the end of 2020. We expect to reduce gross annual pre-tax operating expenses by approximately$200 million to$300 million by the end of 2023 as program benefits under the 2019 Restructuring Plan are realized. As discussed in Note 13 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report, theIRS has issued proposed adjustments for years 2010 through 2012, as well as a draft NOPA for years 2013 through 2015, reallocating profits between certain of 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. We do not expect the agreement reached with theIRS for tax years 2006-2012 related to the reallocation of profits between theU.S. andPuerto Rico as well as other miscellaneous adjustments to have a material impact on our operating cash flows.
As discussed in Note 16 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report, we are involved in various litigation matters with respect to which we expect to continue paying settlements over the next few years.
As discussed in Note 17 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report, we entered into stock purchase and merger agreements to acquire two companies. Subsequent toSeptember 30, 2020 , one of these transactions has closed while the other one is pending regulatory approval as of the date of this filing. There is no assurance that regulatory approval will be received, and if not received, the agreement will be terminated. Assuming we receive regulatory approval, these acquisitions will require initial aggregate consideration of approximately$225 million in the fourth quarter of 2020 and deferred payments totaling approximately$145 million in 2021.
Recent Accounting Pronouncements
Information pertaining to recent accounting pronouncements can be found in Note 2 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report. Critical Accounting Estimates
Our financial results are affected by the selection and application of
accounting policies and methods. There were no changes in the three and
nine-month periods ended
Cautionary Note Regarding Forward-Looking Statements and Factors That May Affect Future Results
This quarterly report contains certain statements that are forward-looking statements within the meaning of federal securities laws. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. When used in this report, the words "may," "will," "can," "should," "would," "could," "anticipate," "expect," "plan," "seek," "believe," "are confident that," "predict," "estimate," "potential," "project," "target," "forecast," "intend," "strategy," "future," "opportunity," "assume," "guide," "position," "continue" and similar expressions are intended to identify forward-looking statements. Forward-looking statements are based on current beliefs, expectations and assumptions that are subject to significant risks, uncertainties and changes in circumstances that could cause actual results to differ materially from such forward-looking statements. These risks, uncertainties and changes in circumstances include, but are not limited to:
• the effects of the COVID-19 global pandemic and other adverse public
health developments on the global economy, our business and operations and
the business and operations of our suppliers and customers, including the
deferral of elective surgical procedures and our ability to collect accounts receivable;
• the risks and uncertainties related to our ability to successfully execute
our restructuring plans; 42
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• 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;
• 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 Reports on Form 10-Q for the quarters endedMarch 31, 2020 andJune 30, 2020 and this report contain detailed discussions of these and other important factors under the heading "Risk Factors." You should understand that it is not possible to predict or identify all factors that could cause actual results to 43
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differ materially from forward-looking statements. Consequently, you should not consider any list or discussion of such factors to be a complete set of all potential risks or uncertainties.
Forward-looking statements speak only as of the date they are made and we expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Readers of this report are cautioned not to rely on these forward-looking statements since there can be no assurance that these forward-looking statements will prove to be accurate. This cautionary statement is applicable to all forward-looking statements contained in this report.
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