filings.toolsItem 8. Financial Statements and Supplementary Data
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Item 8. Financial Statements and Supplementary Data
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Zimmer Biomet Holdings, Inc.
Index to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Zimmer Biomet Holdings, Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Zimmer Biomet Holdings, Inc. and its subsidiaries (the “Company) as of December 31, 2019 and 2018, and the related consolidated statements of earnings, comprehensive income (loss), stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2019, including the related notes and schedule of valuation and qualifying accounts for each of the three years in the period ended December 31, 2019 appearing under Item 15(a)(2), (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018**,** and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Annual Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (i) relate to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Goodwill Impairment Assessment – EMEA and Dental Reporting Units
As described in Notes 2 and 10 to the consolidated financial statements, the Company’s consolidated goodwill balance was $9,599.7 million as of December 31, 2019, and the goodwill associated with the EMEA reporting unit and the Dental reporting unit was $749.8 million and $397.7 million, respectively. Management conducts an impairment test in the fourth quarter of each year or whenever events or changes in circumstances indicate that the carrying value of the reporting unit’s assets may not be recoverable. Potential impairment of a reporting unit is identified by comparing the reporting unit’s estimated fair value to its carrying amount. The Company estimated the fair value of the Dental and EMEA reporting units based on income and market approaches. As disclosed by management, fair value under the income approach was determined by discounting to present value the estimated future cash flows of the reporting unit. Fair value under the market approach utilized the guideline public company methodology, which uses valuation indicators from other businesses that are similar to the EMEA and Dental reporting units. Significant assumptions are incorporated into the discounted cash flow analysis such as estimated growth rates and risk-adjusted discount rates.
The principal considerations for our determination that performing procedures relating to the goodwill impairment assessment of the EMEA and Dental reporting units is a critical audit matter are there was significant judgment by management when developing the fair value measurement of the reporting units. This in turn led to a high degree of auditor judgment, subjectivity, and effort in performing procedures and in evaluating management’s discounted cash flow analysis and significant assumptions, including estimated growth rates and risk-adjusted discount rates. In addition, the audit effort involved the use of professionals with specialized skill and knowledge to assist in performing these procedures and evaluating the audit evidence obtained.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to management’s goodwill impairment assessment, including controls over the valuation of the Company’s reporting units. These procedures also included, among others, (i) testing management’s process for developing the fair value estimate, (ii) evaluating the appropriateness of management’s fair value approaches, (iii) testing the completeness, accuracy and relevance of the underlying data used in the approaches, and (iv) evaluating significant assumptions used by management in the discounted cash flow analysis, including the revenue growth rates and the risk-adjusted discount rate. Evaluating management’s assumptions related to revenue growth rates involved evaluating whether the assumptions used by management were reasonable considering the past performance of the reporting units, the consistency with external data from other sources, and whether these assumptions were consistent with evidence obtained in other areas of the audit. Professionals with specialized skill and knowledge were used to assist in the evaluation of the Company’s discounted cash flow analysis and certain significant assumptions, including the risk-adjusted discount rate.
Tax Liabilities for Unrecognized Tax Benefits
As described in Notes 2 and 16 to the consolidated financial statements, the Company has recorded tax liabilities for unrecognized tax benefits of $741.8 million as of December 31, 2019. The calculation of the Company’s estimated tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a
multitude of jurisdictions across the Company’s global operations. The Company’s income tax filings are regularly under audit in multiple federal, state and foreign jurisdictions. Income tax audits may require an extended period of time to reach resolution and may result in significant income tax adjustments when interpretation of tax laws or allocation of company profits is disputed.
The principal considerations for our determination that performing procedures relating to tax liabilities for unrecognized tax benefits is a critical audit matter are that there was significant judgment by management when determining the tax liabilities, including a high degree of estimation uncertainty relative to the numerous and complex tax laws and regulations, frequency of income tax audits, and potential for significant adjustments as a result of such audits. This in turn led to a high degree of auditor judgment, subjectivity, and effort in performing procedures to evaluate the timely identification and accurate measurement of tax liabilities for unrecognized tax benefits. Also, the evaluation of audit evidence available to support the estimates is complex and required significant auditor judgment as the nature of the evidence is often highly subjective, and the audit effort involved the use of professionals with specialized skill and knowledge to assist in performing these procedures and evaluating the audit evidence obtained.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the identification, accurate measurement, and recognition of tax liabilities for unrecognized tax benefits, including controls addressing completeness of the tax liabilities. These procedures also included, among others, (i) testing certain information used in the calculation of tax liabilities for unrecognized tax benefits by jurisdiction on a sample basis, (ii) assessing the completeness of the Company’s identification of tax liabilities for unrecognized tax benefits and possible outcomes for each unrecognized tax benefit, and (iii) evaluating the status and results of income tax audits with the relevant tax authorities. Professionals with specialized skill and knowledge were used to assist in the evaluation of the Company’s interpretation and application of relevant tax laws and regulations in various jurisdictions and assessing the reasonableness of the Company’s tax positions.
/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
February 21, 2020
We have served as the Company’s auditor since 2000.
ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(in millions, except per share amounts)
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | 2017 | ||||||||||
| Net Sales | $ | 7,982.2 | $ | 7,932.9 | $ | 7,803.3 | ||||||
| Cost of products sold, excluding intangible asset amortization | 2,252.6 | 2,271.9 | 2,132.9 | |||||||||
| Intangible asset amortization | 584.3 | 595.9 | 603.9 | |||||||||
| Research and development | 449.3 | 391.7 | 369.9 | |||||||||
| Selling, general and administrative | 3,343.8 | 3,379.3 | 3,104.7 | |||||||||
| Goodwill and intangible asset impairment | 70.1 | 979.7 | 331.5 | |||||||||
| Quality remediation | 82.4 | 146.9 | 181.3 | |||||||||
| Restructuring and other cost reduction initiatives | 50.0 | 34.2 | 17.6 | |||||||||
| Acquisition, integration and related | 12.2 | 99.5 | 262.2 | |||||||||
| Operating expenses | 6,844.7 | 7,899.1 | 7,004.0 | |||||||||
| Operating Profit | 1,137.5 | 33.8 | 799.3 | |||||||||
| Other expense, net | (4.8 | ) | (15.6 | ) | (9.4 | ) | ||||||
| Interest expense, net | (226.9 | ) | (289.3 | ) | (325.3 | ) | ||||||
| Earnings (loss) before income taxes | 905.8 | (271.1 | ) | 464.6 | ||||||||
| (Benefit) provision for income taxes | (225.7 | ) | 108.2 | (1,348.8 | ) | |||||||
| Net Earnings (Loss) | 1,131.5 | (379.3 | ) | 1,813.4 | ||||||||
| Less: Net loss attributable to noncontrolling interest | (0.1 | ) | (0.1 | ) | (0.4 | ) | ||||||
| Net Earnings (Loss) of Zimmer Biomet Holdings, Inc. | $ | 1,131.6 | $ | (379.2 | ) | $ | 1,813.8 | |||||
| Earnings (Loss) Per Common Share - Basic | $ | 5.52 | $ | (1.86 | ) | $ | 8.98 | |||||
| Earnings (Loss) Per Common Share - Diluted | $ | 5.47 | $ | (1.86 | ) | $ | 8.90 | |||||
| Weighted Average Common Shares Outstanding | ||||||||||||
| Basic | 205.1 | 203.5 | 201.9 | |||||||||
| Diluted | 206.7 | 203.5 | 203.7 |
The accompanying notes are an integral part of these consolidated financial statements.
ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in millions)
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | 2017 | ||||||||||
| Net Earnings (Loss) | $ | 1,131.5 | $ | (379.3 | ) | $ | 1,813.4 | |||||
| Other Comprehensive (Loss) Income: | ||||||||||||
| Foreign currency cumulative translation adjustments, net of tax | (1.5 | ) | (135.4 | ) | 445.0 | |||||||
| Unrealized cash flow hedge gains/(losses), net of tax | 30.6 | 68.2 | (95.0 | ) | ||||||||
| Reclassification adjustments on cash flow hedges, net of tax | (35.1 | ) | 23.6 | (3.8 | ) | |||||||
| Adjustments to prior service cost and unrecognized actuarial assumptions, net of tax | (48.5 | ) | (17.7 | ) | 4.6 | |||||||
| Total Other Comprehensive (Loss) Income | (54.5 | ) | (61.3 | ) | 350.8 | |||||||
| Comprehensive Income (Loss) | 1,077.0 | (440.6 | ) | 2,164.2 | ||||||||
| Comprehensive Loss Attributable to Noncontrolling Interest | (0.1 | ) | (0.1 | ) | (1.3 | ) | ||||||
| Comprehensive Income (Loss) Attributable to Zimmer Biomet Holdings, Inc. | $ | 1,077.1 | $ | (440.5 | ) | $ | 2,165.5 |
The accompanying notes are an integral part of these consolidated financial statements.
ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in millions, except share amounts)
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | |||||||
| ASSETS | ||||||||
| Current Assets: | ||||||||
| Cash and cash equivalents | $ | 617.9 | $ | 542.8 | ||||
| Accounts receivable, less allowance for doubtful accounts | 1,363.9 | 1,275.8 | ||||||
| Inventories | 2,385.0 | 2,256.5 | ||||||
| Prepaid expenses and other current assets | 357.1 | 352.3 | ||||||
| Total Current Assets | 4,723.9 | 4,427.4 | ||||||
| Property, plant and equipment, net | 2,077.4 | 2,015.4 | ||||||
| Goodwill | 9,599.7 | 9,594.4 | ||||||
| Intangible assets, net | 7,257.6 | 7,684.6 | ||||||
| Other assets | 980.1 | 405.0 | ||||||
| Total Assets | $ | 24,638.7 | $ | 24,126.8 | ||||
| LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||
| Current Liabilities: | ||||||||
| Accounts payable | $ | 400.9 | $ | 362.6 | ||||
| Income taxes payable | 126.7 | 142.4 | ||||||
| Other current liabilities | 1,413.9 | 1,391.3 | ||||||
| Current portion of long-term debt | 1,500.0 | 525.0 | ||||||
| Total Current Liabilities | 3,441.5 | 2,421.3 | ||||||
| Deferred income taxes, net | 840.1 | 999.5 | ||||||
| Long-term income tax payable | 685.1 | 666.2 | ||||||
| Other long-term liabilities | 557.8 | 350.0 | ||||||
| Long-term debt | 6,721.4 | 8,413.7 | ||||||
| Total Liabilities | 12,245.9 | 12,850.7 | ||||||
| Commitments and Contingencies (Note 20) | ||||||||
| Stockholders' Equity: | ||||||||
| Common stock, $0.01 par value, one billion shares authorized, 309.9 million (307.9 million in 2018) issued | 3.1 | 3.1 | ||||||
| Paid-in capital | 8,920.1 | 8,686.1 | ||||||
| Retained earnings | 10,427.3 | 9,491.2 | ||||||
| Accumulated other comprehensive loss | (241.9 | ) | (187.4 | ) | ||||
| Treasury stock, 103.9 million shares (103.9 million shares in 2018) | (6,720.5 | ) | (6,721.7 | ) | ||||
| Total Zimmer Biomet Holdings, Inc. stockholders' equity | 12,388.1 | 11,271.3 | ||||||
| Noncontrolling interest | 4.7 | 4.8 | ||||||
| Total Stockholders' Equity | 12,392.8 | 11,276.1 | ||||||
| Total Liabilities and Stockholders' Equity | $ | 24,638.7 | $ | 24,126.8 |
The accompanying notes are an integral part of these consolidated financial statements.
ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in millions)
| Zimmer Biomet Holdings, Inc. Stockholders | ||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Accumulated | ||||||||||||||||||||||||||||||||||||
| Other | Total | |||||||||||||||||||||||||||||||||||
| Common Shares | Paid-in | Retained | Comprehensive | Treasury Shares | Noncontrolling | Stockholders' | ||||||||||||||||||||||||||||||
| Number | Amount | Capital | Earnings | (Loss) Income | Number | Amount | Interest | Equity | ||||||||||||||||||||||||||||
| Balance January 1, 2017 | 304.7 | $ | 3.1 | $ | 8,368.5 | $ | 8,467.1 | $ | (434.0 | ) | (104.1 | ) | $ | (6,735.8 | ) | $ | 1.0 | $ | 9,669.9 | |||||||||||||||||
| Net earnings | - | - | - | 1,813.8 | - | - | - | (0.4 | ) | 1,813.4 | ||||||||||||||||||||||||||
| Other comprehensive income | - | - | - | - | 350.8 | - | - | (0.9 | ) | 349.9 | ||||||||||||||||||||||||||
| Cash dividends declared ($0.96 per share) | - | - | - | (194.1 | ) | - | - | - | - | (194.1 | ) | |||||||||||||||||||||||||
| Retrospective adoption of new accounting standard | - | - | - | (77.8 | ) | - | - | - | - | (77.8 | ) | |||||||||||||||||||||||||
| Stock compensation plans | 1.8 | - | 146.4 | 13.8 | - | 0.2 | 14.0 | - | 174.2 | |||||||||||||||||||||||||||
| Balance December 31, 2017 | 306.5 | 3.1 | 8,514.9 | 10,022.8 | (83.2 | ) | (103.9 | ) | (6,721.8 | ) | (0.3 | ) | 11,735.5 | |||||||||||||||||||||||
| Net loss | - | - | - | (379.2 | ) | - | - | - | (0.1 | ) | (379.3 | ) | ||||||||||||||||||||||||
| Other comprehensive loss | - | - | - | - | (61.3 | ) | - | - | - | (61.3 | ) | |||||||||||||||||||||||||
| Cash dividends declared ($0.96 per share) | - | - | - | (195.5 | ) | - | - | - | - | (195.5 | ) | |||||||||||||||||||||||||
| Adoption of new accounting standard | - | - | - | 42.9 | (42.9 | ) | - | - | - | - | ||||||||||||||||||||||||||
| Sale of shares in a subsidiary without loss of control | - | - | - | - | - | - | - | 5.2 | 5.2 | |||||||||||||||||||||||||||
| Stock compensation plans | 1.4 | - | 171.2 | 0.2 | - | - | 0.1 | - | 171.5 | |||||||||||||||||||||||||||
| Balance December 31, 2018 | 307.9 | 3.1 | 8,686.1 | 9,491.2 | (187.4 | ) | (103.9 | ) | (6,721.7 | ) | 4.8 | 11,276.1 | ||||||||||||||||||||||||
| Net earnings | - | - | - | 1,131.6 | - | - | - | (0.1 | ) | 1,131.5 | ||||||||||||||||||||||||||
| Other comprehensive loss | - | - | - | - | (54.5 | ) | - | - | - | (54.5 | ) | |||||||||||||||||||||||||
| Cash dividends declared ($0.96 per share) | - | - | - | (197.2 | ) | - | - | - | - | (197.2 | ) | |||||||||||||||||||||||||
| Stock compensation plans | 2.0 | - | 234.0 | 1.7 | - | - | 1.2 | - | 236.9 | |||||||||||||||||||||||||||
| Balance December 31, 2019 | 309.9 | $ | 3.1 | $ | 8,920.1 | $ | 10,427.3 | $ | (241.9 | ) | (103.9 | ) | $ | (6,720.5 | ) | $ | 4.7 | $ | 12,392.8 |
The accompanying notes are an integral part of these consolidated financial statements.
ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | 2017 | ||||||||||
| Cash flows provided by (used in) operating activities: | ||||||||||||
| Net earnings (loss) | $ | 1,131.5 | $ | (379.3 | ) | $ | 1,813.4 | |||||
| Adjustments to reconcile net earnings to net cash provided by operating activities: | ||||||||||||
| Depreciation and amortization | 1,006.1 | 1,040.5 | 1,062.7 | |||||||||
| Share-based compensation | 84.3 | 65.5 | 53.7 | |||||||||
| Goodwill and intangible asset impairment | 70.1 | 979.7 | 331.5 | |||||||||
| Inventory step-up | - | - | 32.8 | |||||||||
| Deferred income tax benefit (provision) | (538.7 | ) | 13.4 | (1,776.0 | ) | |||||||
| Changes in operating assets and liabilities, net of | ||||||||||||
| acquired assets and liabilities | ||||||||||||
| Income taxes | 111.4 | (150.8 | ) | 150.2 | ||||||||
| Receivables | (93.8 | ) | 213.6 | 161.7 | ||||||||
| Inventories | (125.2 | ) | (199.5 | ) | (120.1 | ) | ||||||
| Accounts payable and accrued liabilities | (42.0 | ) | 155.9 | (133.3 | ) | |||||||
| Other assets and liabilities | (17.9 | ) | 8.4 | 5.7 | ||||||||
| Net cash provided by operating activities | 1,585.8 | 1,747.4 | 1,582.3 | |||||||||
| Cash flows provided by (used in) investing activities: | ||||||||||||
| Additions to instruments | (315.9 | ) | (276.3 | ) | (337.0 | ) | ||||||
| Additions to other property, plant and equipment | (207.1 | ) | (162.7 | ) | (156.0 | ) | ||||||
| Net investment hedge settlements | 48.1 | 69.2 | - | |||||||||
| Acquisition of intellectual property rights | (197.6 | ) | - | - | ||||||||
| Business combination investments, net of acquired cash | (37.1 | ) | (15.3 | ) | (4.0 | ) | ||||||
| Investments in other assets | (19.7 | ) | (31.5 | ) | (13.8 | ) | ||||||
| Net cash used in investing activities | (729.3 | ) | (416.6 | ) | (510.8 | ) | ||||||
| Cash flows provided by (used in) financing activities: | ||||||||||||
| Proceeds from senior notes | 549.2 | 749.5 | - | |||||||||
| Proceeds from multicurrency revolving facility | - | 400.0 | 400.0 | |||||||||
| Payments on multicurrency revolving facility | - | (400.0 | ) | (400.0 | ) | |||||||
| Redemption of senior notes | (500.0 | ) | (1,150.0 | ) | (500.0 | ) | ||||||
| Proceeds from term loans | 200.0 | 675.0 | 192.7 | |||||||||
| Payments on term loans | (960.0 | ) | (1,425.0 | ) | (940.0 | ) | ||||||
| Net payments on other debt | (5.3 | ) | (3.9 | ) | (0.9 | ) | ||||||
| Dividends paid to stockholders | (196.7 | ) | (195.2 | ) | (193.6 | ) | ||||||
| Proceeds from employee stock compensation plans | 158.2 | 107.9 | 145.5 | |||||||||
| Net cash flows from unremitted collections from factoring programs | (12.2 | ) | (36.7 | ) | 103.5 | |||||||
| Business combination contingent consideration payments | (2.9 | ) | (19.8 | ) | (9.1 | ) | ||||||
| Other financing activities | (10.2 | ) | (4.0 | ) | (8.6 | ) | ||||||
| Net cash used in financing activities | (779.9 | ) | (1,302.2 | ) | (1,210.5 | ) | ||||||
| Effect of exchange rates on cash and cash equivalents | (1.5 | ) | (10.2 | ) | 29.3 | |||||||
| Increase (decrease) in cash and cash equivalents | 75.1 | 18.4 | (109.7 | ) | ||||||||
| Cash and cash equivalents, beginning of year | 542.8 | 524.4 | 634.1 | |||||||||
| Cash and cash equivalents, end of period | $ | 617.9 | $ | 542.8 | $ | 524.4 |
The accompanying notes are an integral part of these consolidated financial statements.
ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| 1. | Business |
|---|
We design, manufacture and market orthopedic reconstructive products; sports medicine, biologics, extremities and trauma products; office based technologies; spine, craniomaxillofacial and thoracic products; dental implants; and related surgical products. We collaborate with healthcare professionals around the globe to advance the pace of innovation. Our products and solutions help treat patients suffering from disorders of, or injuries to, bones, joints or supporting soft tissues. Together with healthcare professionals, we help millions of people live better lives.
The words “Zimmer Biomet,” “we,” “us,” “our,” “the Company” and similar words refer to Zimmer Biomet Holdings, Inc. and its subsidiaries. “Zimmer Biomet Holdings” refers to the parent company only. In 2015, we completed our merger with LVB Acquisition, Inc., the parent company of Biomet, Inc. (“Biomet”) (which merger is sometimes referred to herein as the “Biomet merger”).
| 2. | Significant Accounting Policies |
|---|
Basis of Presentation - The consolidated financial statements include the accounts of Zimmer Biomet Holdings and its subsidiaries in which it holds a controlling financial interest. All significant intercompany accounts and transactions are eliminated.
Use of Estimates - The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the U.S. which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Foreign Currency Translation - The financial statements of our foreign subsidiaries are translated into U.S. Dollars using period-end exchange rates for assets and liabilities and average exchange rates for operating results. Unrealized translation gains and losses are included in accumulated other comprehensive loss (income) in stockholders’ equity. When a transaction is denominated in a currency other than the subsidiary’s functional currency, we recognize a transaction gain or loss when the transaction is settled.
Shipping and Handling - Amounts billed to customers for shipping and handling of products are reflected in net sales and are not significant. Expenses incurred related to shipping and handling of products are reflected in selling, general and administrative (“SG&A”) expenses and were $292.7 million, $290.2 million and $263.6 million for the years ended December 31, 2019, 2018 and 2017, respectively.
Research and Development - We expense all research and development (“R&D”) costs as incurred except when there is an alternative future use for the R&D. R&D costs include salaries, prototypes, depreciation of equipment used in R&D, consultant fees and service fees paid to collaborative partners. Where contingent milestone payments are due to third parties under R&D arrangements, we expense the milestone payment obligations when it is probable that the milestone results will be achieved.
Litigation - We record a liability for contingent losses, including future legal costs, settlements and judgments, when we consider it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated.
Quality remediation - We use the financial statement line item “Quality remediation” to recognize expenses related to addressing inspectional observations on Form 483 and a warning letter issued by the FDA following its inspections of our Warsaw North Campus facility, among other matters. See Note 20 for additional information about the Form 483 and warning letter. The majority of these expenses are related to consultants who are helping us to update previous documents and redesign certain processes.
Restructuring and other cost reduction initiatives - A restructuring is defined as a program that is planned and controlled by management, and materially changes either the scope of a business undertaken by an entity, or the manner in which that business is conducted. Restructuring charges include (i) termination benefits related to employee terminations, (ii) contract termination costs and (iii) other related costs associated with exit or disposal activities.
In December 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. We have reclassified $34.2 million and $17.6 million in the years ended December 31, 2018 and 2017, respectively, from the “Acquisition, integration and related” line item to the “Restructuring and other cost reduction initiatives” line item, which amounts were primarily attributable to project costs related to our supply chain optimization initiative.
Acquisition, integration and related – We use the financial statement line item, “Acquisition, integration and related” to recognize expenses resulting from the consummation of business mergers and acquisitions and the related integration of those businesses. Acquisition, integration and related gains and expenses are primarily composed of:
| • | 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. |
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| • | 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. |
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| • | Contract termination expenses related to terminated contracts, primarily with sales agents and distribution agreements. |
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| • | Other various expenses to relocate facilities, integrate information technology, losses incurred on assets resulting from the applicable acquisition, and other various expenses. |
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We have reclassified $34.2 million and $17.6 million in the years ended December 31, 2018 and 2017, respectively, from the “Acquisition, integration and related” line item to the “Restructuring and other cost reduction initiatives” line item, which amounts were primarily attributable to project costs related to our supply chain optimization initiative.
Cash and Cash Equivalents - We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. The carrying amounts reported in the balance sheet for cash and cash equivalents are valued at cost, which approximates their fair value.
Accounts Receivable - Accounts receivable consists of trade and other miscellaneous receivables. We grant credit to customers in the normal course of business and maintain an allowance for doubtful accounts for potential credit losses. We determine the allowance for doubtful accounts by geographic market and take into consideration historical credit experience, creditworthiness of the customer and other pertinent information. We make concerted efforts to collect all accounts receivable, but sometimes we have to write-off the account against the allowance when we determine the account is uncollectible. The allowance for doubtful accounts was $65.0 million and $65.7 million as of December 31, 2019 and 2018, respectively.
We also have receivables purchase arrangements with unrelated third parties to transfer portions of our trade accounts receivable balance. Funds received from the transfers are recorded as an increase to cash and a reduction to accounts receivable outstanding in our consolidated balance sheets. We report the cash flows attributable to the sale of receivables to third parties in cash flows from operating activities in our consolidated statements of cash flows. Net expenses resulting from the sales of receivables are recognized in SG&A expense. Net expenses include any resulting gains or losses from the sales of receivables, credit insurance and factoring fees. Any collections that we make that are unremitted to the third parties are recognized on our consolidated balance sheets under other current liabilities and in our consolidated statements of cash flows in financing activities.
Inventories - Inventories are stated at the lower of cost and net realizable value, with cost determined on a first-in first-out basis.
Property, Plant and Equipment - Property, plant and equipment is carried at cost less accumulated depreciation. Depreciation is computed using the straight-line method based on estimated useful lives of ten to forty years for buildings and improvements and three to eight years for machinery and equipment. Maintenance and repairs are expensed as incurred. We review property, plant and equipment for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. An impairment loss would be recognized when estimated future undiscounted cash flows relating to the asset are less than its carrying amount. An impairment loss is measured as the amount by which the carrying amount of an asset exceeds its fair value.
Software Costs - We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use when both the preliminary project stage is completed and it is probable that the software will be used as intended. Capitalized software costs generally include external direct costs of materials and services utilized in developing or obtaining computer software and compensation and related benefits for employees who are directly associated with the software project. Capitalized software costs are included in property, plant and equipment on our balance sheet and amortized on a straight-line or weighted average estimated user basis when the software is ready for its intended use over the estimated useful lives of the software, which approximate three to fifteen years.
Instruments - Instruments are hand-held devices used by surgeons during total joint replacement and other surgical procedures. Instruments are recognized as long-lived assets and are included in property, plant and equipment. Undeployed instruments are carried at cost or realizable value. Instruments that have been deployed to be used in surgeries are carried at cost less accumulated depreciation. Depreciation is computed using the straight-line method based on average estimated useful lives, determined principally in reference to associated product life cycles, primarily five years. We review instruments for impairment whenever events or changes in circumstances indicate that the carrying value of an instrument may not be recoverable. Depreciation of instruments is recognized as SG&A expense.
Goodwill - Goodwill is not amortized but is subject to annual impairment tests. Goodwill has been assigned to reporting units. We perform annual impairment tests by either comparing a reporting unit’s estimated fair value to its carrying amount or doing a qualitative assessment of a reporting unit’s fair value from the last quantitative assessment to determine if there is potential impairment. We may do a qualitative assessment when the results of the previous quantitative test indicated the reporting unit’s estimated fair value was significantly in excess of the carrying value of its net assets and we do not believe there have been significant changes in the reporting unit’s operations that would significantly decrease its estimated fair value or significantly increase its net assets. If a quantitative assessment is performed, the fair value of the reporting unit and the fair value of goodwill are determined based upon a discounted cash flow analysis and/or use of a market approach by looking at market values of comparable companies. Significant assumptions are incorporated into our discounted cash flow analyses such as estimated growth rates and risk-adjusted discount rates. We perform this test in the fourth quarter of the year or whenever events or changes in circumstances indicate that the carrying value of the reporting unit’s assets may not be recoverable. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded in the amount that the carrying value of the business unit exceeds the fair value. See Note 10 for more information regarding goodwill.
Intangible Assets - Intangible assets are initially measured at their fair value. We have determined the fair value of our intangible assets either by the fair value of the consideration exchanged for the intangible asset or the estimated after-tax discounted cash flows expected to be generated from the intangible asset. Intangible assets with an indefinite life, including certain trademarks and trade names and in-process research and development (“IPR&D”) projects, are not amortized. Indefinite life intangible assets are assessed annually to determine whether events and circumstances continue to support an indefinite life. Intangible assets with a finite life, including technology, certain trademarks and trade names, customer-related intangibles, intellectual property rights and patents and licenses are amortized on a straight-line basis over their estimated useful life or contractual life, which may range from less than one year to twenty years. Intangible assets with a finite life are tested for impairment whenever events or circumstances indicate that the carrying amount may not be recoverable.
Intangible assets with an indefinite life are tested for impairment annually or whenever events or circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognized if the carrying amount exceeds the estimated fair value of the asset. The amount of the impairment loss to be recorded would be determined based upon the excess of the asset’s carrying value over its fair value. The fair values of indefinite lived intangible assets are determined based upon a discounted cash flow analysis using the relief from royalty method or a qualitative assessment may be performed for any changes to the asset’s fair value from the last quantitative assessment. The relief from royalty method estimates the cost savings associated with owning, rather than licensing, assets. Significant assumptions are incorporated into these discounted cash flow analyses such as estimated growth rates, royalty rates and risk-adjusted discount rates. We may do a qualitative assessment when the results of the previous quantitative test indicated that the asset’s fair value was significantly in excess of its carrying value.
In determining the useful lives of intangible assets, we consider the expected use of the assets and the effects of obsolescence, demand, competition, anticipated technological advances, changes in surgical techniques, market influences and other economic factors. For technology-based intangible assets, we consider the expected life cycles of products, absent unforeseen technological advances, which incorporate the corresponding technology.
Trademarks and trade names that do not have a wasting characteristic (i.e., there are no legal, regulatory, contractual, competitive, economic or other factors which limit the useful life) are assigned an indefinite life. Trademarks and trade names that are related to products expected to be phased out are assigned lives consistent with the period in which the products bearing each brand are expected to be sold. For customer relationship intangible assets, we assign useful lives based upon historical levels of customer attrition. Intellectual property rights are assigned useful lives that approximate the contractual life of any related patent or the period for which we maintain exclusivity over the intellectual property.
Income Taxes - We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period the new tax rate is enacted.
We reduce our deferred tax assets by a valuation allowance if it is more likely than not that we will not realize some portion or all of the deferred tax assets. In making such determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations. In the event we were to determine that we would be able to realize our deferred income tax assets in the future in excess of their net recorded amount, we would make an adjustment to the valuation allowance which would reduce the provision for income taxes.
We operate on a global basis and are subject to numerous and complex tax laws and regulations. Our income tax filings are regularly under audit in multiple federal, state and foreign jurisdictions. Income tax audits may require an extended period of time to reach resolution and may result in significant income tax adjustments when interpretation of tax laws or allocation of company profits is disputed. Because income tax adjustments in certain jurisdictions can be significant, we record accruals representing management's best estimate of the probable resolution of these matters. To the extent additional information becomes available, such accruals are adjusted to reflect the revised estimated probable outcome.
Derivative Financial Instruments - We measure all derivative instruments at fair value and report them on our consolidated balance sheet as assets or liabilities. We maintain written policies and procedures that permit, under appropriate circumstances and subject to proper authorization, the use of derivative financial instruments solely for risk management purposes. The use of derivative financial instruments for trading or speculative purposes is prohibited by our policy. See Note 14 for more information regarding our derivative and hedging activities.
Accumulated Other Comprehensive (Loss) Income – Accumulated other comprehensive income (loss) (“AOCI”) refers to revenues, expenses, gains and losses that under generally accepted accounting principles are included in comprehensive income but are excluded from net earnings as these amounts are recorded directly as an adjustment to stockholders’ equity. Our AOCI is comprised of foreign currency translation adjustments, including unrealized gains and losses on net investments hedges, unrealized gains and losses on cash flow hedges and amortization of prior service costs and unrecognized gains and losses in actuarial assumptions.
Treasury Stock - We account for repurchases of common stock under the cost method and present treasury stock as a reduction of stockholders’ equity. We reissue common stock held in treasury only for limited purposes.
Noncontrolling Interest - We have investments in other companies in which we have a controlling financial interest, but not 100 percent of the equity. Further information related to the noncontrolling interests of those investments have not been provided as it is not significant to our consolidated financial statements.
Accounting Pronouncements Recently Adopted
In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2016-02 – Leases (Topic 842). This ASU requires lessees to recognize right-of-use assets and lease liabilities on the balance sheet. This ASU was effective for us as of January 1, 2019. This ASU required a modified retrospective transition method that could either be applied at the earliest comparative period in the financial statements or the period of adoption. We elected to use the period of adoption (January 1, 2019) transition method and therefore did not recast prior periods. This ASU allowed for certain practical expedients to make the adoption of the ASU less burdensome. We elected the practical expedients upon transition which permitted us to not reassess lease identification, classification, and initial direct costs under the new standard for leases that commenced prior to
the effective date. We also elected not to recognize a right-of-use asset nor a lease liability for leases with an initial term of twelve months or less. Finally, we elected not to separate non-lease components from the leased components in the valuation of our right-of-use asset and lease liability for all asset classes.
On January 1, 2019, we recognized a right-of-use asset of $274.7 million in other assets and lease liabilities of $62.2 million and $221.2 million in other current liabilities and other long-term liabilities, respectively. No cumulative adjustment to retained earnings was required upon adoption. We do not have any significant finance leases. See Note 19 for additional information.
Accounting Pronouncements Not Yet Adopted
In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326). The new guidance describes the current expected credit loss (“CECL”) model which requires an estimate of expected impairment on financial instruments over the lifetime of the assets at each reporting date. Financial instruments in scope of the guidance include financial assets measured at amortized cost. Current accounting guidance requires recognition of impairment when it is probable the loss has been incurred. Under the CECL model, lifetime expected credit losses are measured and recognized at each reporting date based on historical experience, current conditions and forecasted information. The standard is effective for interim and annual periods after December 15, 2019. Adoption of this standard requires a modified retrospective transition method, which will result in a cumulative-effect adjustment to retained earnings in the period of adoption. We will adopt this standard as of January 1, 2020. The standard will primarily impact our trade receivables. We are currently evaluating the impact the standard will have on our consolidated financial statements, but at this time we do not expect it to be significant.
There are no other recently issued accounting pronouncements that we have not yet adopted that are expected to have a material effect on our financial position, results of operations or cash flows.
| 3. | Revenue Recognition |
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We recognize revenue when our performance obligations under the terms of a contract with our customer are satisfied. This happens when we transfer control of our products to the customer, which generally occurs upon implantation or when title passes upon shipment. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring our product. Taxes collected from customers and remitted to governmental authorities are excluded from revenues.
We sell products through three principal channels: 1) direct to healthcare institutions, referred to as direct channel accounts; 2) through stocking distributors and healthcare dealers; and 3) directly to dental practices and dental laboratories. In direct channel accounts and with some healthcare dealers, inventory is generally consigned to sales agents or customers so that products are available when needed for surgical procedures. No revenue is recognized upon the placement of inventory into consignment, as we retain the ability to control the inventory. Upon implantation, we issue an invoice and revenue is recognized. Consignment sales represented approximately 80 percent of our net sales in 2019. Pricing for products is generally predetermined by contracts with customers, agents acting on behalf of customer groups or by government regulatory bodies, depending on the market. Price discounts under group purchasing contracts are generally linked to volume of implant purchases by customer healthcare institutions within a specified group. At negotiated thresholds within a contract buying period, price discounts may increase. Payment terms vary by customer, but are typically less than 90 days.
With sales to stocking distributors, some healthcare dealers, dental practices and dental laboratories, revenue is generally recognized when control of our product passes to the customer, which is typically upon shipment of the product. We estimate sales recognized in this manner represented approximately 20 percent of our net sales in 2019. These customers may purchase items in large quantities if incentives are offered or if there are new product offerings in a market, which could cause period-to-period differences in sales. It is our accounting policy to account for shipping and handling activities as a fulfillment cost rather than as an additional promised service. We have contracts with these customers or orders may be placed from available price lists. Payment terms vary by customer, but are typically less than 90 days.
We offer standard warranties to our customers that our products are not defective. These standard warranties are not considered separate performance obligations. In limited circumstances, we offer extended warranties that are separate performance obligations. We have very few contracts that have multiple performance obligations. Since we do not have significant multiple element arrangements and essentially all of our sales are recognized upon implantation of a product or when title passes, very little judgment is required to allocate the transaction price of a contract or determine when control has passed to a customer. Our costs to obtain contracts consist primarily of sales
commissions to employees or third party agents that are earned when control of our product passes to the customer. Therefore, sales commissions are expensed as part of SG&A expenses at the same time revenue is recognized. Accordingly, we do not have significant contract assets, liabilities or future performance obligations.
We offer volume-based discounts, rebates, prompt pay discounts, right of return and other various incentives which we account for under the variable consideration model. If sales incentives may be earned by a customer for purchasing a specified amount of our product, we estimate whether such incentives will be achieved and recognize these incentives as a reduction in revenue in the same period the underlying revenue transaction is recognized. We primarily use the expected value method to estimate incentives. Under the expected value method, we consider the historical experience of similar programs as well as review sales trends on a customer-by-customer basis to estimate what levels of incentives will be earned. Occasionally, products are returned and, accordingly, we maintain an estimated refund liability based upon the expected value method that is recorded as a reduction in revenue.
We analyze sales by three geographies, the Americas; Europe, Middle East and Africa (“EMEA”); and Asia Pacific; and by the following product categories: Knees; Hips; Surgical, Sports Medicine, Biologics, Foot and Ankle, Extremities and Trauma (“S.E.T.”); Spine & Craniomaxillofacial and Thoracic (“CMF”); Dental; and Other. As discussed in Note 18, we have seven operating segments that are based upon geography and product categories. The geographic segments include sales of all product categories exclusive of the specific product category operating segments. The geographic operating segments are the Americas, EMEA and Asia Pacific. These three operating segments are our reporting segments. The product category operating segments are Spine, less Asia Pacific; Office Based Technologies; CMF; and Dental. The product operating segments do not constitute a reporting segment because they are, individually and on a combined basis, insignificant to our consolidated results.
Our sales analysis differs from our reporting operating segments because the underlying market trends in any particular geography tend to be similar across product categories, we primarily sell the same products in all geographies and the product category operating segments are not individually significant to our consolidated results.
Net sales by geography are as follows (in millions):
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | 2017 | ||||||||||
| Americas | $ | 4,875.8 | $ | 4,837.2 | $ | 4,844.8 | ||||||
| EMEA | 1,746.9 | 1,801.9 | 1,745.2 | |||||||||
| Asia Pacific | 1,359.5 | 1,293.8 | 1,213.3 | |||||||||
| Total | $ | 7,982.2 | $ | 7,932.9 | $ | 7,803.3 |
Net sales by product category are as follows (in millions):
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | 2017 | ||||||||||
| Knees | $ | 2,810.1 | $ | 2,773.7 | $ | 2,734.0 | ||||||
| Hips | 1,935.1 | 1,921.4 | 1,871.8 | |||||||||
| S.E.T | 1,795.7 | 1,751.8 | 1,701.8 | |||||||||
| Spine & CMF | 747.3 | 763.9 | 757.9 | |||||||||
| Dental | 414.0 | 411.2 | 418.6 | |||||||||
| Other | 280.0 | 310.9 | 319.2 | |||||||||
| Total | $ | 7,982.2 | $ | 7,932.9 | $ | 7,803.3 |
| 4. | Restructuring |
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In December 2019, our Board of Directors approved, and we initiated, a new global restructuring program (the “2019 Restructuring Plan”) with an objective of reducing costs to allow us to further invest in higher priority growth opportunities. The 2019 Restructuring Plan is expected to result in total pre-tax restructuring charges of approximately $350 million to $400 million and reduce gross annual pre-tax operating expenses by approximately $200 million to $300 million by the end of 2023 as program benefits are realized. The pre-tax restructuring charges will consist of employee termination benefits; contract terminations for facilities and sales agents; and other charges, such as consulting fees, project management and relocation costs. The restructuring charges incurred in 2019
primarily relate to employee termination benefits, consulting and project management. The following table summarizes the liabilities recognized related to the 2019 Restructuring Plan (in millions):
| Employee | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Termination | ||||||||||||
| Benefits | Other | Total | ||||||||||
| Balance, December 31, 2018 | $ | - | $ | - | $ | - | ||||||
| Additions | 23.2 | 13.1 | 36.3 | |||||||||
| Cash payments | - | (9.0 | ) | (9.0 | ) | |||||||
| Balance, December 31, 2019 | $ | 23.2 | $ | 4.1 | $ | 27.3 |
We do not include restructuring charges in the operating profit of our reportable segments.
In our consolidated statement of earnings, we report restructuring charges in our “Restructuring and other cost reduction initiatives” financial statement line item. We report the expenses for other cost reduction initiatives with restructuring expenses because these activities both have the goal of reducing costs across the organization. However, since the cost reduction initiative expenses are not considered restructuring, they have been excluded from the amounts presented in this note.
| 5. | Share-Based Compensation |
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Our share-based payments primarily consist of stock options and restricted stock units (“RSUs”). Share-based compensation expense was as follows (in millions):
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | 2017 | ||||||||||
| Total expense, pre-tax | $ | 84.3 | $ | 65.5 | $ | 53.7 | ||||||
| Tax benefit related to awards | 21.8 | 14.6 | 12.5 | |||||||||
| Total expense, net of tax | $ | 62.5 | $ | 50.9 | $ | 41.2 |
We had two equity compensation plans in effect at December 31, 2019: the 2009 Stock Incentive Plan (“2009 Plan”) and the Stock Plan for Non-Employee Directors. We have reserved the maximum number of shares of common stock available for awards under the terms of each of these plans. We have registered 71.6 million shares of common stock under these plans. The 2009 Plan provides for the grant of nonqualified stock options and incentive stock options, long-term performance awards in the form of performance shares or units, restricted stock, RSUs and stock appreciation rights. The Compensation and Management Development Committee of the Board of Directors determines the grant date for annual grants under our equity compensation plans. The date for annual grants under the 2009 Plan to our executive officers is expected to occur in the first quarter of each year following the earnings announcements for the previous quarter and full year. The Stock Plan for Non-Employee Directors provides for awards of stock options, restricted stock and RSUs to non-employee directors. It has been our practice to issue shares of common stock upon exercise of stock options from previously unissued shares, except in limited circumstances where they are issued from treasury stock. The total number of awards which may be granted in a given year and/or over the life of the plan under each of our equity compensation plans is limited. At December 31, 2019, an aggregate of 7.8 million shares were available for future grants and awards under these plans.
Stock Options
Stock options granted to date under our plans vest over two or four years and have a maximum contractual life of 10 years. As established under our equity compensation plans, vesting may accelerate upon retirement after the first anniversary date of the award if certain criteria are met. We recognize expense related to stock options on a straight-line basis over the requisite service period, less awards expected to be forfeited using estimated forfeiture rates. Due to the accelerated retirement provisions, the requisite service period of our stock options range from one to four years. Stock options are granted with an exercise price equal to the market price of our common stock on the date of grant, except in limited circumstances where local law may dictate otherwise.
A summary of stock option activity for the year ended December 31, 2019 is as follows (options in thousands):
| Stock Options | Weighted Average Exercise Price | Weighted Average Remaining Contractual Life | Intrinsic Value (in millions) | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Outstanding at January 1, 2019 | 7,763 | $ | 100.29 | |||||||||||||
| Options granted | 1,488 | 123.76 | ||||||||||||||
| Options exercised | (1,633 | ) | 85.97 | |||||||||||||
| Options forfeited | (303 | ) | 117.28 | |||||||||||||
| Options expired | (30 | ) | 115.12 | |||||||||||||
| Outstanding at December 31, 2019 | 7,285 | $ | 107.53 | 6.6 | $ | 307.1 | ||||||||||
| Vested or expected to vest as of December 31, 2019 | 7,057 | $ | 107.10 | 6.6 | $ | 300.5 | ||||||||||
| Exercisable at December 31, 2019 | 3,890 | $ | 97.15 | 5.1 | $ | 204.3 |
We use a Black-Scholes option-pricing model to determine the fair value of our stock options. Expected volatility was derived from a combination of historical volatility and implied volatility because the options that were actively traded around the grant date of our stock options did not have maturities of over one year. The expected term of the stock options has been derived from historical employee exercise behavior. The risk-free interest rate was determined using the implied yield currently available for zero-coupon U.S. government issues with a remaining term approximating the expected life of the options. The dividend yield was determined by using an estimated annual dividend and dividing it by the market price of our stock on the grant date.
The following table presents information regarding the weighted average fair value of stock options granted, the assumptions used to determine fair value, the intrinsic value of options exercised and the tax benefit of options exercised in the indicated year:
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | 2017 | ||||||||||
| Dividend yield | 0.8 | % | 0.8 | % | 0.8 | % | ||||||
| Volatility | 22.1 | % | 22.1 | % | 21.6 | % | ||||||
| Risk-free interest rate | 2.4 | % | 2.7 | % | 2.0 | % | ||||||
| Expected life (years) | 5.5 | 5.2 | 5.3 | |||||||||
| Weighted average fair value of options granted | $ | 28.68 | $ | 26.66 | $ | 26.09 | ||||||
| Intrinsic value of options exercised (in millions) | $ | 76.8 | $ | 46.6 | $ | 67.6 | ||||||
| Tax benefit of options exercised (in millions) | $ | 15.8 | $ | 6.8 | $ | 27.7 |
As of December 31, 2019, there was $48.6 million of unrecognized share-based payment expense related to nonvested stock options granted under our plans. That expense is expected to be recognized over a weighted average period of 2.5 years.
RSUs
We have awarded RSUs to certain of our employees. The terms of the awards have been from five months to four years. Some of the awards have only service conditions while some have performance and market conditions in addition to service conditions. Future service conditions may be waived if an employee retires after the first anniversary date of the award, but performance and market conditions continue to apply. Accordingly, the requisite service period used for share-based payment expense on our RSUs range from five months to four years.
A summary of nonvested RSU activity for the year ended December 31, 2019 is as follows (RSUs in thousands):
| Weighted Average | ||||||||
|---|---|---|---|---|---|---|---|---|
| Grant Date | ||||||||
| RSUs | Fair Value | |||||||
| Outstanding at January 1, 2019 | 1,347 | $ | 112.81 | |||||
| Granted | 508 | 132.69 | ||||||
| Vested | (210 | ) | 108.35 | |||||
| Forfeited | (417 | ) | 114.61 | |||||
| Outstanding at December 31, 2019 | 1,228 | 118.11 |
For the RSUs with service conditions only, the fair value of the awards was determined based upon the fair market value of our common stock on the date of grant. For the RSUs with market conditions, a Monte Carlo valuation technique was used to simulate the market conditions of the awards. The outcome of the simulation was used to determine the fair value of the awards.
We are required to estimate the number of RSUs that will vest and recognize share-based payment expense on a straight-line basis over the requisite service period. As of December 31, 2019, we estimate that approximately 777,336 outstanding RSUs will vest. If our estimate were to change in the future, the cumulative effect of the change in estimate will be recorded in that period. Based upon the number of RSUs that we expect to vest, the unrecognized share-based payment expense as of December 31, 2019 was $47.8 million and is expected to be recognized over a weighted-average period of 2.1 years. The fair value of RSUs that vested during the years ended December 31, 2019, 2018 and 2017 based upon our stock price on the date of vesting was $26.3 million, $18.7 million, and $31.2 million, respectively.
| 6. | Inventories |
|---|
Inventories consisted of the following (in millions):
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | |||||||
| Finished goods | $ | 1,875.4 | $ | 1,797.7 | ||||
| Work in progress | 231.0 | 230.4 | ||||||
| Raw materials | 278.6 | 228.4 | ||||||
| Inventories | $ | 2,385.0 | $ | 2,256.5 |
Amounts charged to the consolidated statements of earnings for excess and obsolete inventory, including certain product lines we intend to discontinue, in the years ended December 31, 2019, 2018 and 2017 were $221.4 million, $226.1 million and $128.4 million, respectively.
| 7. | Property, Plant and Equipment |
|---|
Property, plant and equipment consisted of the following (in millions):
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | |||||||
| Land | $ | 27.6 | $ | 28.0 | ||||
| Building and equipment | 2,007.0 | 1,885.6 | ||||||
| Capitalized software costs | 482.4 | 425.8 | ||||||
| Instruments | 3,250.5 | 2,950.5 | ||||||
| Construction in progress | 149.3 | 147.2 | ||||||
| 5,916.8 | 5,437.1 | |||||||
| Accumulated depreciation | (3,839.4 | ) | (3,421.7 | ) | ||||
| Property, plant and equipment, net | $ | 2,077.4 | $ | 2,015.4 |
Depreciation expense was $421.8 million, $442.6 million and $454.1 million for the years ended December 31, 2019, 2018 and 2017, respectively.
We had $39.8 million and $49.3 million of property, plant and equipment included in accounts payable as of December 31, 2019 and 2018, respectively.
| 8**.** | Transfers of Financial Assets |
|---|
We have receivables purchase arrangements with unrelated third parties to liquidate portions of our trade accounts receivable balance. The receivables relate to products sold to customers and are short-term in nature. The factorings were treated as sales of our accounts receivable. Proceeds from the transfers reflect either the face value of the accounts receivable or the face value less factoring fees.
In the U.S. and Japan, our programs are executed on a revolving basis with a maximum funding limit as of December 31, 2019 of $450 million combined. We act as the collection agent on behalf of the third party, but have no significant retained interests or servicing liabilities related to the accounts receivable sold. In order to mitigate credit risk, we purchased credit insurance for the factored accounts receivable. As a result, our risk of loss is limited to the factored accounts receivable not covered by the insurance. Additionally, we have provided guarantees for the factored accounts receivable. The maximum exposures to loss associated with these arrangements were $21.8 million and $33.0 million as of December 31, 2019 and 2018, respectively.
In Europe, we sell to a third party and have no continuing involvement or significant risk with the factored accounts receivable.
Funds received from the transfers are recorded as an increase to cash and a reduction of accounts receivable outstanding in the consolidated balance sheets. We report the cash flows attributable to the sale of the receivables to third parties in cash flows from operating activities in our consolidated statements of cash flows. Net expenses resulting from the sales of receivables are recognized in SG&A expense. Net expenses included any resulting gains or losses from the sales of receivables, credit insurance and factoring fees.
For the years ended December 31, 2019, 2018 and 2017, we sold receivables having an aggregate face value of $3,116.2 million, $2,706.4 million and $1,456.9 million to third parties in exchange for cash proceeds of $3,113.9 million, $2,704.9 million and $1,455.6 million, respectively. Expenses recognized on these sales during the years ended December 31, 2019, 2018 and 2017 were not significant. For the years ended December 31, 2019, 2018 and 2017 under the U.S. and Japan programs, we collected $2,857.4 million, $2,273.5 million and $1,031.2 million, respectively, from our customers and remitted that amount to the third party, and we effectively repurchased $184.6 million, $208.9 million and $96.3 million, respectively, of previously sold accounts receivable from the third party due to the programs’ revolving nature. At December 31, 2019 and 2018, we had collected $54.6 million and $66.8 million, respectively, that were unremitted to the third party, which are reflected in our consolidated balance sheets under other current liabilities. The initial collection of cash from customers and its remittance to the third party is reflected in net cash provided by/(used in) financing activities in our consolidated statements of cash flows.
At December 31, 2019 and 2018, the outstanding principal amount of receivables that has been derecognized under the U.S. and Japan revolving arrangements combined amounted to $270.2 million and $365.9 million, respectively.
| 9**.** | Fair Value Measurements of Assets and Liabilities |
|---|
The following financial assets and liabilities are recorded at fair value on a recurring basis (in millions):
| As of December 31, 2019 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fair Value Measurements at Reporting Date Using: | ||||||||||||||||
| Description | Recorded Balance | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Assets | ||||||||||||||||
| Derivatives, current and long-term | ||||||||||||||||
| Foreign currency forward contracts | $ | 39.1 | $ | - | $ | 39.1 | $ | - | ||||||||
| Interest rate swaps | 60.5 | - | 60.5 | - | ||||||||||||
| Total Assets | $ | 99.6 | $ | - | $ | 99.6 | $ | - | ||||||||
| Liabilities | ||||||||||||||||
| Derivatives, current and long-term | ||||||||||||||||
| Foreign currency forward contracts | $ | 0.6 | $ | - | $ | 0.6 | $ | - | ||||||||
| Total Liabilities | $ | 0.6 | $ | - | $ | 0.6 | $ | - |
| As of December 31, 2018 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fair Value Measurements at Reporting Date Using: | ||||||||||||||||
| Description | Recorded Balance | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Assets | ||||||||||||||||
| Derivatives, current and long-term | ||||||||||||||||
| Foreign currency forward contracts | $ | 45.7 | $ | - | $ | 45.7 | $ | - | ||||||||
| Interest rate swaps | 17.9 | - | 17.9 | - | ||||||||||||
| Total Assets | $ | 63.6 | $ | - | $ | 63.6 | $ | - | ||||||||
| Liabilities | ||||||||||||||||
| Derivatives, current and long-term | ||||||||||||||||
| Foreign currency forward contracts | $ | 0.5 | $ | - | $ | 0.5 | $ | - | ||||||||
| Interest rate swaps | 2.5 | - | 2.5 | - | ||||||||||||
| Total Liabilities | $ | 3.0 | $ | - | $ | 3.0 | $ | - |
We value our foreign currency forward contracts using a market approach based on foreign currency exchange rates obtained from active markets, and we perform ongoing assessments of counterparty credit risk.
We value our interest rate swaps using a market approach based on publicly available market yield curves, foreign currency exchange rates and the terms of our swaps, and we perform ongoing assessments of counterparty credit risk.
| 10. | Goodwill and Other Intangible Assets |
|---|
The following table summarizes the changes in the carrying amount of goodwill (in millions):
| Americas | EMEA | Asia Pacific | Immaterial Product Category Operating Segments | Total | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Balance at January 1, 2018 | ||||||||||||||||||||
| Goodwill | $ | 7,724.8 | $ | 1,379.8 | $ | 500.5 | $ | 1,741.0 | $ | 11,346.1 | ||||||||||
| Accumulated impairment losses | - | - | - | (677.7 | ) | (677.7 | ) | |||||||||||||
| 7,724.8 | 1,379.8 | 500.5 | 1,063.3 | 10,668.4 | ||||||||||||||||
| Currency translation | (12.4 | ) | (57.6 | ) | 6.7 | (34.8 | ) | (98.1 | ) | |||||||||||
| Impairment | - | (567.0 | ) | - | (408.9 | ) | (975.9 | ) | ||||||||||||
| Balance at December 31, 2018 | ||||||||||||||||||||
| Goodwill | 7,712.4 | 1,322.2 | 507.2 | 1,706.2 | 11,248.0 | |||||||||||||||
| Accumulated impairment losses | - | (567.0 | ) | - | (1,086.6 | ) | (1,653.6 | ) | ||||||||||||
| 7,712.4 | 755.2 | 507.2 | 619.6 | 9,594.4 | ||||||||||||||||
| Other acquisitions | - | - | - | 25.0 | 25.0 | |||||||||||||||
| Currency translation | (12.6 | ) | (5.4 | ) | 0.2 | (1.9 | ) | (19.7 | ) | |||||||||||
| Balance at December 31, 2019 | ||||||||||||||||||||
| Goodwill | 7,699.8 | 1,316.8 | 507.4 | 1,729.3 | 11,253.3 | |||||||||||||||
| Accumulated impairment losses | - | (567.0 | ) | - | (1,086.6 | ) | (1,653.6 | ) | ||||||||||||
| $ | 7,699.8 | $ | 749.8 | $ | 507.4 | $ | 642.7 | $ | 9,599.7 |
We have five reporting units with goodwill assigned to them. We perform our annual test of goodwill impairment in the fourth quarter of every year. In 2019, we performed a qualitative test on our Americas and Asia Pacific reporting units and concluded it was more likely than not the fair value of these reporting units exceeded their carrying value. We estimated the fair value of our EMEA, Dental and CMF reporting units using the income and market approaches. The estimated fair value of our EMEA and Dental reporting units only exceeded their carrying values by less than 5 percent. The estimated fair value of our CMF reporting unit exceeded its carrying value by more than 25 percent.
We will continue to monitor the fair value of our EMEA and Dental reporting units as well as our other three reporting units in our interim and annual reporting periods. If our estimated cash flows for these reporting units decrease, we may have to record impairment charges in the future. Factors that could result in our cash flows being lower than our current estimates include: 1) decreased revenues caused by unforeseen changes in the healthcare market, or our inability to generate new product revenue from our research and development activities, and 2) our inability to achieve the estimated operating margins in our forecasts due to unforeseen factors. Additionally, changes in the broader economic environment could cause changes to our estimated discount rates, foreign currency exchange rates used to translate cash flows and comparable company valuation indicators, which may impact our estimated fair values.
As indicated in Note 18, our operating segments may change in 2020 which, under the applicable accounting rules, could cause us to change our reporting units to which goodwill is assigned and/or could cause the assets and related cash flows assigned to a reporting unit to change. A change in reporting units may lead us to perform interim impairment tests on the new reporting units. We may have long-lived assets that currently have a carrying value that is greater than their fair value, but are not impaired because the impairment test for long-lived assets compares the carrying value to undiscounted cash flows. If the carrying value of assets that are reallocated to a new reporting unit is greater than their estimated fair value (as measured by their discounted cash flows), we may need to record an impairment charge with respect to that reporting unit.
During the year ended December 31, 2018, we recorded goodwill impairment charges related to our Spine reporting unit, our EMEA reporting unit and an insignificant reporting unit of $401.2 million, $567.0 million and $7.7 million, respectively. During the year ended December 31, 2017, we recorded goodwill impairment charges related to our Office Based Technologies and Spine reporting units of $32.7 million and $272.0 million, respectively.
For more information on how the fair values of these reporting units were determined in the prior periods and the factors that led to impairment, please see our Annual Reports on Form 10-K for the years ended December 31, 2018 and 2017.
The components of identifiable intangible assets were as follows (in millions):
| Technology | Intellectual Property Rights | Trademarks and Trade Names | Customer Relationships | IPR&D | Other | Total | ||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of December 31, 2019: | ||||||||||||||||||||||||||||
| Intangible assets subject to amortization: | ||||||||||||||||||||||||||||
| Gross carrying amount | $ | 3,634.0 | $ | 378.3 | $ | 659.9 | $ | 5,375.0 | $ | - | $ | 165.4 | $ | 10,212.6 | ||||||||||||||
| Accumulated amortization | (1,487.6 | ) | (191.9 | ) | (207.6 | ) | (1,489.4 | ) | - | (95.3 | ) | (3,471.8 | ) | |||||||||||||||
| Intangible assets not subject to amortization: | ||||||||||||||||||||||||||||
| Gross carrying amount | - | - | 454.9 | - | 61.9 | - | 516.8 | |||||||||||||||||||||
| Total identifiable intangible assets | $ | 2,146.4 | $ | 186.4 | $ | 907.2 | $ | 3,885.6 | $ | 61.9 | $ | 70.1 | $ | 7,257.6 | ||||||||||||||
| As of December 31, 2018: | ||||||||||||||||||||||||||||
| Intangible assets subject to amortization: | ||||||||||||||||||||||||||||
| Gross carrying amount | $ | 3,638.5 | $ | 180.7 | $ | 664.2 | $ | 5,384.4 | $ | - | $ | 128.3 | $ | 9,996.1 | ||||||||||||||
| Accumulated amortization | (1,282.7 | ) | (177.6 | ) | (169.3 | ) | (1,194.5 | ) | - | (80.0 | ) | (2,904.1 | ) | |||||||||||||||
| Intangible assets not subject to amortization: | ||||||||||||||||||||||||||||
| Gross carrying amount | - | - | 457.1 | - | 135.5 | - | 592.6 | |||||||||||||||||||||
| Total identifiable intangible assets | $ | 2,355.8 | $ | 3.1 | $ | 952.0 | $ | 4,189.9 | $ | 135.5 | $ | 48.3 | $ | 7,684.6 |
In 2019, we entered into an agreement and paid $192.5 million to buy out certain licensing arrangements from an unrelated third party. This new agreement and the related payment replaced the variable royalty payments that otherwise would have been due under the terms of previous licensing arrangements through 2029. Under the new agreement, we maintain the rights to the counterparty’s intellectual property provided under the previous licensing arrangements. The $192.5 million payment was recognized as an intangible asset and will be amortized through 2029, which represents the useful life of the intellectual property.
We recognized intangible asset impairment charges of $70.1 million, $3.8 million and $26.8 million in the years ended December 31, 2019, 2018 and 2017, respectively, in “Goodwill and intangible asset impairment” on our consolidated statements of earnings. The impairment charges were primarily related to the abandonment of IPR&D projects that were recognized as part of the Biomet merger purchase accounting.
Estimated annual amortization expense based upon intangible assets recognized as of December 31, 2019 for the years ending December 31, 2020 through 2024 is (in millions):
| For the Years Ending December 31, | ||||
|---|---|---|---|---|
| 2020 | $ | 576.9 | ||
| 2021 | 562.8 | |||
| 2022 | 556.3 | |||
| 2023 | 551.6 | |||
| 2024 | 543.4 |
| 11. | Other Current Liabilities |
|---|
Other current liabilities consisted of the following (in millions):
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | |||||||
| Other current liabilities: | ||||||||
| License and service agreements | $ | 179.3 | $ | 181.8 | ||||
| Salaries, wages and benefits | 314.1 | 260.3 | ||||||
| Litigation and product liability | 142.4 | 278.6 | ||||||
| Accrued liabilities | 778.1 | 670.6 | ||||||
| Total other current liabilities | $ | 1,413.9 | $ | 1,391.3 |
| 12. | Debt |
|---|
Our debt consisted of the following (in millions):
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | |||||||
| Current portion of long-term debt | ||||||||
| 4.625% Senior Notes due 2019 | $ | - | $ | 500.0 | ||||
| 2.700% Senior Notes due 2020 | 1,500.0 | - | ||||||
| U.S. Term Loan B | - | 25.0 | ||||||
| Total short-term debt | $ | 1,500.0 | $ | 525.0 | ||||
| Long-term debt | ||||||||
| 2.700% Senior Notes due 2020 | $ | - | $ | 1,500.0 | ||||
| Floating Rate Notes due 2021 | 450.0 | 450.0 | ||||||
| 3.375% Senior Notes due 2021 | 300.0 | 300.0 | ||||||
| 3.150% Senior Notes due 2022 | 750.0 | 750.0 | ||||||
| 3.700% Senior Notes due 2023 | 300.0 | 300.0 | ||||||
| 3.550% Senior Notes due 2025 | 2,000.0 | 2,000.0 | ||||||
| 4.250% Senior Notes due 2035 | 253.4 | 253.4 | ||||||
| 5.750% Senior Notes due 2039 | 317.8 | 317.8 | ||||||
| 4.450% Senior Notes due 2045 | 395.4 | 395.4 | ||||||
| 1.414% Euro Notes due 2022 | 561.3 | 571.6 | ||||||
| 2.425% Euro Notes due 2026 | 561.3 | 571.6 | ||||||
| 1.164% Euro Notes due 2027 | 561.3 | - | ||||||
| U.S. Term Loan B | - | 200.0 | ||||||
| U.S. Term Loan C | - | 535.0 | ||||||
| Japan Term Loan A | 106.9 | 105.3 | ||||||
| Japan Term Loan B | 194.7 | 191.7 | ||||||
| Debt discount and issuance costs | (37.1 | ) | (42.7 | ) | ||||
| Adjustment related to interest rate swaps | 6.4 | 14.6 | ||||||
| Total long-term debt | $ | 6,721.4 | $ | 8,413.7 |
At December 31, 2019, our total current and non-current debt of $8.2 billion consisted of $8.0 billion aggregate principal amount of senior notes, which included $1.7 billion of Euro-denominated senior notes (“Euro notes”), an 11.7 billion Japanese Yen term loan agreement (“Japan Term Loan A”) and a 21.3 billion Japanese Yen term loan agreement (“Japan Term Loan B”) that each will mature on September 27, 2022, and other debt and fair value adjustments totaling $6.4 million, partially offset by debt discount and issuance costs of $37.1 million.
On November 15, 2019, we completed the offering of €500 million aggregate principal amount of our 1.164% Euro notes due November 15, 2027. Interest is payable on the 1.164% Euro notes on November 15 of each year until maturity. We received net proceeds of approximately $549.2 million from this offering, which were primarily used to repay the $500 million principal amount 4.625% Senior Notes due 2019 at maturity, and the remainder of which were used to repay a portion of a U.S. term loan (“U.S. Term Loan C”).
On November 1, 2019, we entered into a revolving credit agreement (the “2019 Credit Agreement”), which contains a five-year unsecured multicurrency revolving facility of $1.5 billion (the “2019 Multicurrency Revolving Facility”), which replaced the previous $1.5 billion multicurrency revolving credit facility (the “2016 Multicurrency Revolving Facility”) and a U.S. term loan (“U.S. Term Loan B”) under our credit agreement executed in September 2016 (as amended, the “2016 Credit Agreement”). As of the date we entered into the 2019 Credit Agreement, there were no borrowings outstanding under the 2016 Multicurrency Revolving Facility or U.S. Term Loan B. The 2019 Credit Agreement will mature on November 1, 2024, with two one-year extensions exercisable at our discretion and subject to required lender consent. As of December 31, 2019, there were no outstanding borrowings under the 2019 Multicurrency Revolving Facility.
On December 14, 2018, we entered into a credit agreement (the “2018 Credit Agreement”) that provides for U.S. Term Loan C, which is a two-year unsecured multi-draw term loan facility for the Company in the principal amount of $900.0 million, with a maturity date of December 14, 2020, and borrowed $675.0 million under that facility. In January 2019, we borrowed an additional $200.0 million under U.S. Term Loan C and used those proceeds, along
with cash on hand, to repay the remaining $225.0 million outstanding under U.S. Term Loan B issued under the 2016 Credit Agreement. Under the applicable accounting rules, since $200.0 million of U.S. Term Loan B was refinanced on a long-term basis before the issuance of our consolidated financial statements, we classified the refinanced portion of U.S. Term Loan B as long-term as of December 31, 2018.
We have repaid $735.0 million and $140.0 million in principal under U.S. Term Loan C during the years ended December 31, 2019 and 2018, respectively, primarily with cash from operations. As of December 31, 2019, we had no borrowings outstanding under U.S. Term Loan C, and since there are no more advances available under the 2018 Credit Agreement, the 2018 Credit Agreement and U.S. Term Loan C have terminated by their terms.
On March 19, 2018, we completed the offering of $450.0 million aggregate principal amount of our floating rate senior notes due March 19, 2021 and $300.0 million aggregate principal amount of our 3.700% senior notes due March 19, 2023. Interest on the floating rate senior notes is equal to three-month LIBOR plus 0.750% and is payable quarterly, commencing on June 19, 2018, until maturity. Interest is payable on the 3.700% senior notes semi-annually, commencing on September 19, 2018, until maturity. We received net proceeds of $749.5 million from this offering.
On September 22, 2017, we entered into a term loan agreement for the Japan Term Loan B, and an amended and restated term loan agreement, which amended and restated the Japan Term Loan A loan agreement dated as of May 24, 2012, as amended as of October 31, 2014. As described above, the term loans under both of these agreements will mature on September 27, 2022. Each of these term loans bears interest at a fixed rate of 0.635 percent per annum.
Borrowings under the 2019 Credit Agreement generally bear interest at floating rates. We pay a facility fee on the aggregate amount of the 2019 Multicurrency Revolving Facility. The 2019 Credit Agreement contains customary affirmative and negative covenants and events of default for unsecured financing arrangements, including among other things limitations on consolidations, mergers, and sales of assets. We were in compliance with all covenants under the 2019 Credit Agreement as of December 31, 2019.
We may, at our option, redeem our senior notes, in whole or in part, at any time upon payment of the principal, any applicable make-whole premium, and accrued and unpaid interest to the date of redemption, except that the Floating Rate Notes due 2021 do not have any applicable make-whole premium. In addition, we may redeem, at our option, the 3.375% Senior Notes due 2021, the 3.150% Senior Notes due 2022, the 1.414% Euro notes due 2022, the 3.700% Senior Notes due 2023, the 3.550% Senior Notes due 2025, the 2.425% Euro notes due 2026, the 1.164% Euro notes due 2027, the 4.250% Senior Notes due 2035 and the 4.450% Senior Notes due 2045 without any make-whole premium at specified dates ranging from one month to six months in advance of the scheduled maturity date.
The estimated fair value of our senior notes as of December 31, 2019, based on quoted prices for the specific securities from transactions in over-the-counter markets (Level 2), was $8,261.2 million. The estimated fair value of Japan Term Loan A and Japan Term Loan B, in the aggregate, as of December 31, 2019, based upon publicly available market yield curves and the terms of the debt (Level 2), was $300.1 million.
We entered into interest rate swap agreements which we designated as fair value hedges of underlying fixed-rate obligations on our senior notes due 2019 and 2021. These fair value hedges were settled in 2016. In 2016, we entered into various variable-to-fixed interest rate swap agreements that were accounted for as cash flow hedges of U.S. Term Loan B. These interest rate swaps were terminated concurrently with the repayment of the remaining balance of U.S. Term Loan B in 2019. In 2018 and 2019, we entered into cross-currency interest rate swaps that we designated as net investment hedges. The excluded component of these net investment hedges is recorded in interest expense, net. See Note 14 for additional information regarding our interest rate swap agreements.
We also have available uncommitted credit facilities totaling $45.3 million as of December 31, 2019.
At December 31, 2019 and 2018, the weighted average interest rate for our borrowings was 2.9 percent and 3.1 percent, respectively. We paid $226.9 million, $282.8 million, and $317.5 million in interest during 2019, 2018, and 2017, respectively.
| 13. | Accumulated Other Comprehensive Income |
|---|
AOCI refers to certain gains and losses that under GAAP are included in comprehensive income but are excluded from net earnings as these amounts are initially recorded as an adjustment to stockholders’ equity. Amounts in AOCI may be reclassified to net earnings upon the occurrence of certain events.
Our AOCI is comprised of foreign currency translation adjustments, unrealized gains and losses on cash flow hedges, and amortization of prior service costs and unrecognized gains and losses in actuarial assumptions on our defined benefit plans. Foreign currency translation adjustments are reclassified to net earnings upon sale or upon a complete or substantially complete liquidation of an investment in a foreign entity. Unrealized gains and losses on cash flow hedges are reclassified to net earnings when the hedged item affects net earnings. Amounts related to defined benefit plans that are in AOCI are reclassified over the service periods of employees in the plan. See Note 15 for more information on our defined benefit plans.
The following table shows the changes in the components of AOCI, net of tax (in millions):
| Foreign | Cash | Defined | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Currency | Flow | Benefit | Total | |||||||||||||
| Translation | Hedges | Plan Items | AOCI | |||||||||||||
| Balance December 31, 2018 | $ | (31.3 | ) | $ | 20.9 | $ | (177.0 | ) | $ | (187.4 | ) | |||||
| AOCI before reclassifications | (1.5 | ) | 30.6 | (53.5 | ) | (24.4 | ) | |||||||||
| Reclassifications to statements of earnings | - | (35.1 | ) | 5.0 | (30.1 | ) | ||||||||||
| Balance December 31, 2019 | $ | (32.8 | ) | $ | 16.4 | $ | (225.5 | ) | $ | (241.9 | ) |
The following table shows the reclassification adjustments from AOCI (in millions):
| Amount of Gain / (Loss) | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Reclassified from AOCI | ||||||||||||||
| For the Years Ended December 31, | Location on | |||||||||||||
| Component of AOCI | 2019 | 2018 | 2017 | Statements of Earnings | ||||||||||
| Cash flow hedges | ||||||||||||||
| Foreign exchange forward contracts | $ | 38.4 | $ | (26.2 | ) | $ | 5.1 | Cost of products sold | ||||||
| Interest rate swaps | 2.8 | - | - | Interest expense, net | ||||||||||
| Forward starting interest rate swaps | (0.6 | ) | (0.6 | ) | (0.5 | ) | Interest expense, net | |||||||
| 40.6 | (26.8 | ) | 4.6 | Total before tax | ||||||||||
| 5.5 | (3.2 | ) | 0.8 | (Benefit) provision for income taxes | ||||||||||
| $ | 35.1 | $ | (23.6 | ) | $ | 3.8 | Net of tax | |||||||
| Defined benefit plans | ||||||||||||||
| Prior service cost | $ | 7.3 | $ | 9.9 | $ | 10.3 | Other expense, net | |||||||
| Curtailment gain | 7.2 | - | - | Other expense, net | ||||||||||
| Unrecognized actuarial loss | (21.8 | ) | (26.2 | ) | (22.1 | ) | Other expense, net | |||||||
| (7.3 | ) | (16.3 | ) | (11.8 | ) | Total before tax | ||||||||
| (2.3 | ) | (4.3 | ) | (4.5 | ) | (Benefit) provision for income taxes | ||||||||
| $ | (5.0 | ) | $ | (12.0 | ) | $ | (7.3 | ) | Net of tax | |||||
| Total reclassifications | $ | 30.1 | $ | (35.6 | ) | $ | (3.5 | ) | Net of tax |
The following table shows the tax effects on each component of AOCI recognized in our consolidated statements of comprehensive income (loss) (in millions):
| For the Years Ended December 31, | ||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Before Tax | Tax | Net of Tax | ||||||||||||||||||||||||||||||||||
| 2019 | 2018 | 2017 | 2019 | 2018 | 2017 | 2019 | 2018 | 2017 | ||||||||||||||||||||||||||||
| Foreign currency cumulative translation adjustments | $ | 12.1 | $ | (148.7 | ) | $ | 396.8 | $ | 13.6 | $ | (13.3 | ) | $ | (48.2 | ) | $ | (1.5 | ) | $ | (135.4 | ) | $ | 445.0 | |||||||||||||
| Unrealized cash flow hedge gains (losses) | 34.6 | 81.1 | (116.0 | ) | 4.0 | 12.9 | (21.0 | ) | 30.6 | 68.2 | (95.0 | ) | ||||||||||||||||||||||||
| Reclassification adjustments on cash flow hedges | (40.6 | ) | 26.8 | (4.6 | ) | (5.5 | ) | 3.2 | (0.8 | ) | (35.1 | ) | 23.6 | (3.8 | ) | |||||||||||||||||||||
| Adjustments to prior service cost and unrecognized actuarial assumptions | (56.4 | ) | (22.7 | ) | 6.6 | (7.9 | ) | (5.0 | ) | 2.0 | (48.5 | ) | (17.7 | ) | 4.6 | |||||||||||||||||||||
| Total Other Comprehensive (Loss) Income | $ | (50.3 | ) | $ | (63.5 | ) | $ | 282.8 | $ | 4.2 | $ | (2.2 | ) | $ | (68.0 | ) | $ | (54.5 | ) | $ | (61.3 | ) | $ | 350.8 |
| 14. | Derivative Instruments and Hedging Activities |
|---|
We are exposed to certain market risks relating to our ongoing business operations, including foreign currency exchange rate risk, commodity price risk, interest rate risk and credit risk. We manage our exposure to these and other market risks through regular operating and financing activities. Currently, the only risks that we manage through the use of derivative instruments are interest rate risk and foreign currency exchange rate risk.
Interest Rate Risk
Derivatives Designated as Fair Value Hedges
In prior years, we entered into various fixed-to-variable interest rate swap agreements that were accounted for as fair value hedges of a portion of our 4.625% Senior Notes due in 2019 and all of our 3.375% Senior Notes due 2021. In August 2016, we received cash for these interest rate swap assets by terminating the hedging instruments with the counterparties. The 4.625% Senior Notes were repaid at maturity in 2019. The remaining unamortized balance related to the 3.375% Senior Notes as of December 31, 2019 was $6.4 million, which will be recognized using the effective interest rate method over the remaining maturity period of the 3.375% Senior Notes. As of December 31, 2019 and 2018, the following amounts were recorded on our consolidated balance sheets related to cumulative basis adjustments for fair value hedges (in millions):
| Carrying Amount of the Hedged Liabilities | Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Liabilities | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Balance Sheet Line Item | December 31, 2019 | December 31, 2018 | December 31, 2019 | December 31, 2018 | |||||||||||||
| Long-term debt | $ | 306.2 | $ | 564.4 | $ | 6.4 | $ | 14.6 |
Derivatives Designated as Cash Flow Hedges
In 2014, we entered into forward starting interest rate swaps that were designated as cash flow hedges of our thirty-year tranche of senior notes (the 4.450% Senior Notes due 2045) we expected to issue in 2015. The forward starting interest rate swaps mitigated the risk of changes in interest rates prior to the completion of the notes offering. The interest rate swaps were settled, and the remaining loss to be recognized at December 31, 2019 was $26.5 million, which will be recognized using the effective interest rate method over the remaining maturity period of the hedged notes.
In September 2016, we entered into various variable-to-fixed interest rate swap agreements with a notional amount of $375 million that were accounted for as cash flow hedges of U.S. Term Loan B. The interest rate swaps minimized the exposure to changes in the LIBOR interest rates while the variable-rate debt was outstanding. In the first quarter of 2019, we terminated these interest rate swaps concurrently with the repayment of the remaining
balance of U.S Term Loan B, and we recognized proceeds and interest income of $2.8 million related to the termination.
Foreign Currency Exchange Rate Risk
We operate on a global basis and are exposed to the risk that our financial condition, results of operations and cash flows could be adversely affected by changes in foreign currency exchange rates. To reduce the potential effects of foreign currency exchange rate movements on net earnings, we enter into derivative financial instruments in the form of foreign currency exchange forward contracts with major financial institutions. We also designated our Euro notes and other foreign currency exchange forward contracts as net investment hedges of investments in foreign subsidiaries. We are primarily exposed to foreign currency exchange rate risk with respect to transactions and net assets denominated in Euros, Swiss Francs, Japanese Yen, British Pounds, Canadian Dollars, Australian Dollars, Korean Won, Swedish Krona, Czech Koruna, Thai Baht, Taiwan Dollars, South African Rand, Russian Rubles, Indian Rupees, Turkish Lira, Polish Zloty, Danish Krone, and Norwegian Krone. We do not use derivative financial instruments for trading or speculative purposes.
Derivatives Designated as Net Investment Hedges
We are exposed to the impact of foreign exchange rate fluctuations in the investments in our wholly-owned foreign subsidiaries that are denominated in currencies other than the U.S. Dollar. In order to mitigate the volatility in foreign exchange rates, we issued Euro notes in December 2016 and November 2019, as discussed in Note 12, and designated 100 percent of the Euro notes to hedge our net investment in certain wholly-owned foreign subsidiaries that have a functional currency of Euro. All changes in the fair value of the hedging instrument designated as a net investment hedge are recorded as a component of AOCI in our consolidated balance sheets.
At December 31, 2019, we had receive-fixed-rate, pay-fixed-rate cross-currency interest rate swaps with notional amounts outstanding of Euro 1,450 million, Japanese Yen 7 billion and Swiss Franc 50 million. These transactions further hedge our net investment in certain wholly-owned foreign subsidiaries that have a functional currency of Euro, Japanese Yen and Swiss Franc. All changes in the fair value of a derivative instrument designated as a net investment hedge are recorded as a component of AOCI in the consolidated balance sheets. The portion of this change related to the excluded component will be amortized into earnings over the life of the derivative while the remainder will be recorded in AOCI until the hedged net investment is sold or substantially eliminated. We recognize the excluded component in interest expense, net on our consolidated statements of earnings. The net cash received related to the receive-fixed-rate, pay-fixed-rate component of the cross-currency interest rate swaps is reflected in investing cash flows in our consolidated statements of cash flows.
Derivatives Designated as Cash Flow Hedges
Our revenues are generated in various currencies throughout the world. However, a significant amount of our inventory is produced in U.S. Dollars. Therefore, movements in foreign currency exchange rates may have different proportional effects on our revenues compared to our cost of products sold. To minimize the effects of foreign currency exchange rate movements on cash flows, we hedge intercompany sales of inventory expected to occur within the next 30 months with foreign currency exchange forward contracts. We designate these derivative instruments as cash flow hedges.
We perform quarterly assessments of hedge effectiveness by verifying and documenting the critical terms of the hedge instrument and confirming that forecasted transactions have not changed significantly. We also assess on a quarterly basis whether there have been adverse developments regarding the risk of a counterparty default. For derivatives which qualify as hedges of future cash flows, the gains and losses are temporarily recorded in AOCI and then recognized in cost of products sold when the hedged item affects net earnings. On our consolidated statements of cash flows, the settlements of these cash flow hedges are recognized in operating cash flows.
For foreign currency exchange forward contracts outstanding at December 31, 2019, we had obligations to purchase U.S. Dollars and sell Euros, Japanese Yen, British Pounds, Canadian Dollars, Australian Dollars, Korean Won, Swedish Krona, Czech Koruna, Thai Baht, Taiwan Dollars, South African Rand, Russian Rubles, Indian Rupees, Polish Zloty, Danish Krone, and Norwegian Krone and obligations to purchase Swiss Francs and sell U.S. Dollars. These derivatives mature at dates ranging from January 2020 through June 2022. As of December 31, 2019, the notional amounts of outstanding forward contracts entered into with third parties to purchase U.S. Dollars were $1,496.3 million. As of December 31, 2019, the notional amounts of outstanding forward contracts entered into with third parties to purchase Swiss Francs were $276.0 million.
Derivatives Not Designated as Hedging Instruments
We enter into foreign currency forward exchange contracts with terms of one month to manage currency exposures for monetary assets and liabilities denominated in a currency other than an entity’s functional currency. As a result, any foreign currency re-measurement gains/losses recognized in earnings are generally offset with gains/losses on the foreign currency forward exchange contracts in the same reporting period. The net amount of these offsetting gains/losses is recorded in other expense, net. These contracts are settled on the last day of each reporting period. Therefore, there is no outstanding balance related to these contracts recorded on the balance sheet as of the end of the reporting period. The notional amounts of these contracts are typically in a range of $1.5 billion to $2.0 billion per quarter.
Income Statement Presentation
Derivatives Designated as Cash Flow Hedges
Derivative instruments designated as cash flow hedges had the following effects, before taxes, on AOCI and net earnings on our consolidated statements of earnings, consolidated statements of comprehensive income (loss) and consolidated balance sheets (in millions):
| Amount of Gain / (Loss) | Amount of Gain / (Loss) | |||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Recognized in AOCI | Location on | Reclassified from AOCI | ||||||||||||||||||||||||
| Years Ended December 31, | Statement of | Years Ended December 31, | ||||||||||||||||||||||||
| Derivative Instrument | 2019 | 2018 | 2017 | Earnings | 2019 | 2018 | 2017 | |||||||||||||||||||
| Foreign exchange forward contracts | $ | 34.6 | $ | 82.8 | $ | (116.5 | ) | Cost of products sold | $ | 38.4 | $ | (26.2 | ) | $ | 5.1 | |||||||||||
| Interest rate swaps | - | (1.7 | ) | 0.5 | Interest expense, net | 2.8 | - | - | ||||||||||||||||||
| Forward starting interest rate swaps | - | - | - | Interest expense, net | (0.6 | ) | (0.6 | ) | (0.5 | ) | ||||||||||||||||
| $ | 34.6 | $ | 81.1 | $ | (116.0 | ) | $ | 40.6 | $ | (26.8 | ) | $ | 4.6 |
The fair value of outstanding derivative instruments designated as cash flow hedges and recorded on the consolidated balance sheet at December 31, 2019, together with settled derivatives where the hedged item has not yet affected earnings, was a net unrealized gain of $17.4 million, or $16.4 million after taxes, which is deferred in AOCI. A gain of $38.4 million, or $33.1 million after taxes, is expected to be reclassified to earnings in cost of products sold and a loss of $0.6 million, or $0.5 million after taxes, is expected to be reclassified to earnings in interest expense, net over the next twelve months.
The following table presents the effects of fair value, cash flow and net investment hedge accounting on our consolidated statements of earnings (in millions):
| Location and Amount of Gain/(Loss) Recognized in Income on Fair Value, Cash Flow and Net Investment Hedging Relationships | ||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Years Ended December 31, | ||||||||||||||||||||||||||
| 2019 | 2018 | 2017 | ||||||||||||||||||||||||
| Cost of | Interest | Cost of | Interest | Cost of | Interest | |||||||||||||||||||||
| Products | Expense, | Products | Expense, | Products | Expense, | |||||||||||||||||||||
| Sold | Net | Sold | Net | Sold | Net | |||||||||||||||||||||
| Total amounts of income and expense line items presented in the statements of earnings in which the effects of fair value, cash flow and net investment hedges are recorded | $ | 2,252.6 | $ | (226.9 | ) | $ | 2,271.9 | $ | (289.3 | ) | $ | 2,132.9 | $ | (325.3 | ) | |||||||||||
| The effects of fair value, cash flow and net investment hedging: | ||||||||||||||||||||||||||
| Gain on fair value hedging relationships | ||||||||||||||||||||||||||
| Discontinued interest rate swaps | - | 8.2 | - | 8.5 | - | 8.3 | ||||||||||||||||||||
| Gain (loss) on cash flow hedging relationships | ||||||||||||||||||||||||||
| Forward starting interest rate swaps | - | (0.6 | ) | - | (0.6 | ) | - | (0.5 | ) | |||||||||||||||||
| Interest rate swaps | - | 2.8 | - | - | - | - | ||||||||||||||||||||
| Foreign exchange forward contracts | 38.4 | - | (26.2 | ) | - | 5.1 | - | |||||||||||||||||||
| Gain on net investment hedging relationships | ||||||||||||||||||||||||||
| Cross-currency interest rate swaps | - | 52.2 | - | 25.5 | - | - |
Derivatives Not Designated as Hedging Instruments
The following gains/(losses) from these derivative instruments were recognized on our consolidated statements of earnings (in millions):
| Location on | Years Ended December 31, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Derivative Instrument | Statements of Earnings | 2019 | 2018 | 2017 | ||||||||||
| Foreign exchange forward contracts | Other expense, net | $ | (11.0 | ) | $ | 24.7 | $ | (62.3 | ) |
These gains/(losses) do not reflect losses of $3.4 million and $41.2 million in 2019 and 2018, respectively, and gains of $45.5 million in 2017 recognized in other expense, net as a result of foreign currency re-measurement of monetary assets and liabilities denominated in a currency other than an entity’s functional currency.
Balance Sheet Presentation
As of December 31, 2019 and 2018, all derivative instruments designated as fair value hedges and cash flow hedges are recorded at fair value on our consolidated balance sheets. On our consolidated balance sheets, we recognize individual forward contracts with the same counterparty on a net asset/liability basis if we have a master netting agreement with the counterparty. Under these master netting agreements, we are able to settle derivative instrument assets and liabilities with the same counterparty in a single transaction, instead of settling each derivative instrument separately. We have master netting agreements with all of our counterparties.
The fair value of derivative instruments on a gross basis is as follows (in millions):
| As of December 31, 2019 | As of December 31, 2018 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Balance Sheet | Fair | Balance Sheet | Fair | |||||||||
| Location | Value | Location | Value | |||||||||
| Asset Derivatives | ||||||||||||
| Foreign exchange forward contracts | Other current assets | $ | 41.8 | Other current assets | $ | 37.9 | ||||||
| Foreign exchange forward contracts | Other assets | 9.8 | Other assets | 20.9 | ||||||||
| Interest rate swaps | Other assets | - | Other assets | 2.8 | ||||||||
| Cross-currency interest rate swaps | Other assets | 60.5 | Other assets | 15.1 | ||||||||
| Total asset derivatives | $ | 112.1 | $ | 76.7 | ||||||||
| Liability Derivatives | ||||||||||||
| Foreign exchange forward contracts | Other current liabilities | $ | 7.9 | Other current liabilities | $ | 9.9 | ||||||
| Foreign exchange forward contracts | Other long-term liabilities | 5.2 | Other long-term liabilities | 3.7 | ||||||||
| Cross-currency interest rate swaps | Other long-term liabilities | - | Other long-term liabilities | 2.5 | ||||||||
| Total liability derivatives | $ | 13.1 | $ | 16.1 |
The table below presents the effects of our master netting agreements on our consolidated balance sheets (in millions):
| As of December 31, 2019 | As of December 31, 2018 | |||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Description | Location | Gross Amount | Offset | Net Amount in Balance Sheet | Gross Amount | Offset | Net Amount in Balance Sheet | |||||||||||||||||||
| Asset Derivatives | ||||||||||||||||||||||||||
| Cash flow hedges | Other current assets | $ | 41.8 | $ | 7.9 | $ | 33.9 | $ | 37.9 | $ | 9.6 | $ | 28.3 | |||||||||||||
| Cash flow hedges | Other assets | 9.8 | 4.6 | 5.2 | 20.9 | 3.5 | 17.4 | |||||||||||||||||||
| Liability Derivatives | ||||||||||||||||||||||||||
| Cash flow hedges | Other current liabilities | 7.9 | 7.9 | - | 9.9 | 9.6 | 0.3 | |||||||||||||||||||
| Cash flow hedges | Other long-term liabilities | 5.2 | 4.6 | 0.6 | 3.7 | 3.5 | 0.2 |
The following net investment hedge gains (losses) were recognized on our consolidated statements of comprehensive income (loss) (in millions):
| Amount of Gain / (Loss) | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Recognized in AOCI | ||||||||||||
| Years Ended December 31, | ||||||||||||
| Derivative Instrument | 2019 | 2018 | 2017 | |||||||||
| Euro Notes | $ | 10.7 | $ | 57.6 | $ | (146.0 | ) | |||||
| Cross-currency interest rate swaps | 47.9 | 62.8 | - | |||||||||
| $ | 58.6 | $ | 120.4 | $ | (146.0 | ) |
| 15. | Retirement Benefit Plans |
|---|
We have defined benefit pension plans covering certain U.S. and Puerto Rico employees. Plan benefits are primarily based on years of credited service and the participant’s average eligible compensation. The U.S. and Puerto Rico plans are frozen; meaning there are no new participants that can join the plan and participants in the plan do not accrue additional years of service or compensation. In addition to the U.S. and Puerto Rico defined benefit pension plans, we sponsor various foreign pension arrangements, including retirement and termination benefit plans required by local law or coordinated with government sponsored plans.
We use a December 31 measurement date for our benefit plans.
Defined Benefit Plans
The components of net pension expense for our defined benefit retirement plans were as follows (in millions):
| For the Years Ended December 31, | ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| U.S. and Puerto Rico | Foreign | |||||||||||||||||||||||
| 2019 | 2018 | 2017 | 2019 | 2018 | 2017 | |||||||||||||||||||
| Service cost | $ | 7.1 | $ | 8.0 | $ | 8.7 | $ | 19.0 | $ | 20.0 | $ | 17.7 | ||||||||||||
| Interest cost | 16.2 | 14.2 | 14.0 | 9.0 | 8.1 | 8.4 | ||||||||||||||||||
| Expected return on plan assets | (32.4 | ) | (32.9 | ) | (32.4 | ) | (13.4 | ) | (14.0 | ) | (12.2 | ) | ||||||||||||
| Curtailment gain | (7.2 | ) | - | - | - | - | - | |||||||||||||||||
| Settlements | 0.8 | 1.2 | 0.4 | - | 0.2 | 1.1 | ||||||||||||||||||
| Amortization of prior service cost | (3.4 | ) | (5.7 | ) | (5.9 | ) | (3.9 | ) | (4.2 | ) | (4.4 | ) | ||||||||||||
| Amortization of unrecognized actuarial loss | 19.3 | 23.7 | 17.9 | 2.5 | 2.5 | 4.2 | ||||||||||||||||||
| Net periodic benefit cost | $ | 0.4 | $ | 8.5 | $ | 2.7 | $ | 13.2 | $ | 12.6 | $ | 14.8 |
In our consolidated statements of earnings, service cost is reported in the same location as other compensation costs arising from services rendered by the pertinent employees while the other components of net pension expense are reported in other expense, net.
The weighted average actuarial assumptions used to determine net pension expense for our defined benefit retirement plans were as follows:
| For the Years Ended December 31, | ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| U.S. and Puerto Rico | Foreign | |||||||||||||||||||||||
| 2019 | 2018 | 2017 | 2019 | 2018 | 2017 | |||||||||||||||||||
| Discount rate | 4.38 | % | 3.79 | % | 4.33 | % | 1.44 | % | 1.18 | % | 1.38 | % | ||||||||||||
| Rate of compensation increase | 3.29 | % | 3.29 | % | 3.29 | % | 2.50 | % | 2.09 | % | 2.20 | % | ||||||||||||
| Expected long-term rate of return on plan assets | 7.75 | % | 7.75 | % | 7.75 | % | 2.14 | % | 2.19 | % | 2.30 | % |
The expected long-term rate of return on plan assets is based on the historical and estimated future rates of return on the different asset classes held in the plans. The expected long-term rate of return is the weighted average of the target asset allocation of each individual asset class. We believe that historical asset results approximate expected market returns applicable to the funding of a long-term benefit obligation.
Discount rates were determined for each of our defined benefit retirement plans at their measurement date to reflect the yield of a portfolio of high quality bonds matched against the timing and amounts of projected future benefit payments.
Changes in projected benefit obligations and plan assets were (in millions):
| For the Years Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| U.S. and Puerto Rico | Foreign | |||||||||||||||
| 2019 | 2018 | 2019 | 2018 | |||||||||||||
| Projected benefit obligation - beginning of year | $ | 396.0 | $ | 420.7 | $ | 631.1 | $ | 623.6 | ||||||||
| Service cost | 7.1 | 8.0 | 19.0 | 20.0 | ||||||||||||
| Interest cost | 16.2 | 14.2 | 9.0 | 8.1 | ||||||||||||
| Plan amendments | 3.6 | - | - | 2.2 | ||||||||||||
| Employee contributions | - | - | 20.6 | 18.1 | ||||||||||||
| Benefits paid | (16.9 | ) | (20.3 | ) | (36.5 | ) | (36.9 | ) | ||||||||
| Actuarial loss (gain) | 68.2 | (21.1 | ) | 77.8 | 6.0 | |||||||||||
| Expenses paid | - | - | (0.3 | ) | (0.3 | ) | ||||||||||
| Settlement | (2.2 | ) | (5.5 | ) | - | - | ||||||||||
| Translation gain (loss) | - | - | 19.7 | (9.7 | ) | |||||||||||
| Projected benefit obligation - end of year | $ | 472.0 | $ | 396.0 | $ | 740.4 | $ | 631.1 |
| For the Years Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| U.S. and Puerto Rico | Foreign | |||||||||||||||
| 2019 | 2018 | 2019 | 2018 | |||||||||||||
| Plan assets at fair market value - beginning of year | $ | 388.5 | $ | 433.6 | $ | 585.8 | $ | 574.9 | ||||||||
| Actual return on plan assets | 73.5 | (25.7 | ) | 57.8 | 7.5 | |||||||||||
| Employer contributions | 2.0 | 6.4 | 20.1 | 31.7 | ||||||||||||
| Employee contributions | - | - | 20.6 | 18.1 | ||||||||||||
| Settlements | (2.2 | ) | (5.5 | ) | - | - | ||||||||||
| Benefits paid | (16.9 | ) | (20.3 | ) | (36.5 | ) | (36.9 | ) | ||||||||
| Expenses paid | - | - | (0.3 | ) | (0.3 | ) | ||||||||||
| Translation gain (loss) | - | - | 17.7 | (9.2 | ) | |||||||||||
| Plan assets at fair market value - end of year | $ | 444.9 | $ | 388.5 | $ | 665.2 | $ | 585.8 | ||||||||
| Funded status | $ | (27.1 | ) | $ | (7.5 | ) | $ | (75.2 | ) | $ | (45.3 | ) |
| For the Years Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| U.S. and Puerto Rico | Foreign | |||||||||||||||
| 2019 | 2018 | 2019 | 2018 | |||||||||||||
| Amounts recognized in consolidated balance sheet: | ||||||||||||||||
| Prepaid pension | $ | - | $ | - | $ | 17.6 | $ | 15.3 | ||||||||
| Short-term accrued benefit liability | (0.2 | ) | (0.2 | ) | (1.1 | ) | (0.8 | ) | ||||||||
| Long-term accrued benefit liability | (26.9 | ) | (7.3 | ) | (91.7 | ) | (59.8 | ) | ||||||||
| Net amount recognized | $ | (27.1 | ) | $ | (7.5 | ) | $ | (75.2 | ) | $ | (45.3 | ) |
We estimate the following amounts recorded as part of AOCI will be recognized as part of our net pension expense during 2020 (in millions):
| U.S. and | ||||||||
|---|---|---|---|---|---|---|---|---|
| Puerto Rico | Foreign | |||||||
| Unrecognized prior service cost | $ | 0.3 | $ | (4.2 | ) | |||
| Unrecognized actuarial loss | 6.7 | 4.0 | ||||||
| $ | 7.0 | $ | (0.2 | ) |
The weighted average actuarial assumptions used to determine the projected benefit obligation for our defined benefit retirement plans were as follows:
| For the Years Ended December 31, | ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| U.S. and Puerto Rico | Foreign | |||||||||||||||||||||||
| 2019 | 2018 | 2017 | 2019 | 2018 | 2017 | |||||||||||||||||||
| Discount rate | 3.40 | % | 4.38 | % | 3.78 | % | 0.74 | % | 1.41 | % | 1.27 | % | ||||||||||||
| Rate of compensation increase | 3.29 | % | 3.29 | % | 3.29 | % | 2.45 | % | 2.13 | % | 2.19 | % |
Plans with projected benefit obligations in excess of plan assets were as follows (in millions):
| As of December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| U.S. and Puerto Rico | Foreign | |||||||||||||||
| 2019 | 2018 | 2019 | 2018 | |||||||||||||
| Projected benefit obligation | $ | 472.0 | $ | 396.0 | $ | 698.2 | $ | 451.4 | ||||||||
| Plan assets at fair market value | 444.9 | 388.5 | 619.1 | 394.4 |
Total accumulated benefit obligations and plans with accumulated benefit obligations in excess of plan assets were as follows (in millions):
| As of December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| U.S. and Puerto Rico | Foreign | |||||||||||||||
| 2019 | 2018 | 2019 | 2018 | |||||||||||||
| Total accumulated benefit obligations | $ | 472.0 | $ | 392.0 | $ | 721.5 | $ | 618.0 | ||||||||
| Plans with accumulated benefit obligations in excess of plan assets: | ||||||||||||||||
| Accumulated benefit obligation | 472.0 | 47.1 | 674.0 | 434.8 | ||||||||||||
| Plan assets at fair market value | 444.9 | 41.6 | 612.9 | 388.8 |
The benefits expected to be paid out in each of the next five years and for the five years combined thereafter are as follows (in millions):
| For the Years Ending December 31, | U.S. and Puerto Rico | Foreign | ||||||
|---|---|---|---|---|---|---|---|---|
| 2020 | $ | 20.2 | $ | 27.5 | ||||
| 2021 | 21.5 | 29.7 | ||||||
| 2022 | 22.4 | 28.3 | ||||||
| 2023 | 23.4 | 29.5 | ||||||
| 2024 | 23.8 | 29.6 | ||||||
| 2025-2029 | 126.1 | 158.9 |
The U.S. and Puerto Rico defined benefit retirement plans’ overall investment strategy is to balance total returns by emphasizing long-term growth of capital while mitigating risk. We have established target ranges of assets held by the plans of 30 to 65 percent for equity securities, 30 to 50 percent for debt securities and 0 to 15 percent in non-traditional investments. The plans strive to have sufficiently diversified assets so that adverse or unexpected results from one asset class will not have an unduly detrimental impact on the entire portfolio. We regularly review the investments in the plans and we may rebalance them from time-to-time based upon the target asset allocation of the plans.
For the U.S. and Puerto Rico plans, we maintain an investment policy statement that guides the investment allocation in the plans. The investment policy statement describes the target asset allocation positions described above. Our benefits committee, along with our investment advisor, monitor compliance with and administer the investment policy statement and the plans’ assets and oversee the general investment strategy and objectives of the plans. Our benefits committee generally meets quarterly to review performance.
The investment strategies of foreign based plans vary according to the plan provisions and local laws. The majority of the assets in foreign based plans are located in Switzerland-based plans. These assets are held in trusts and are commingled with the assets of other Swiss companies with representatives of all the companies making the investment decisions. The overall strategy is to maximize total returns while avoiding risk. The trustees of the assets have established target ranges of assets held by the plans of 30 to 50 percent in debt securities, 20 to 37 percent in equity securities, 15 to 24 percent in real estate, 3 to 15 percent in cash funds and 0 to 12 percent in other funds.
The fair value of our U.S. and Puerto Rico pension plan assets by asset category was as follows (in millions):
| As of December 31, 2019 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fair Value Measurements at Reporting Date Using: | ||||||||||||||||
| Asset Category | Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Cash and cash equivalents | $ | 4.7 | $ | 4.7 | $ | - | $ | - | ||||||||
| Equity securities | 282.5 | - | 282.5 | - | ||||||||||||
| Intermediate fixed income securities | 157.7 | - | 157.7 | - | ||||||||||||
| Total | $ | 444.9 | $ | 4.7 | $ | 440.2 | $ | - |
| As of December 31, 2018 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fair Value Measurements at Reporting Date Using: | ||||||||||||||||
| Asset Category | Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Cash and cash equivalents | $ | 3.1 | $ | 3.1 | $ | - | $ | - | ||||||||
| Equity securities | 231.7 | - | 231.7 | - | ||||||||||||
| Intermediate fixed income securities | 153.7 | - | 153.7 | - | ||||||||||||
| Total | $ | 388.5 | $ | 3.1 | $ | 385.4 | $ | - |
The fair value of our foreign pension plan assets was as follows (in millions):
| As of December 31, 2019 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fair Value Measurements at Reporting Date Using: | ||||||||||||||||
| Asset Category | Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Cash and cash equivalents | $ | 31.8 | $ | 31.8 | $ | - | $ | - | ||||||||
| Equity securities | 140.9 | 116.0 | 24.9 | - | ||||||||||||
| Fixed income securities | 245.2 | - | 245.2 | - | ||||||||||||
| Other types of investments | 123.6 | - | 123.6 | - | ||||||||||||
| Real estate | 123.7 | - | - | 123.7 | ||||||||||||
| Total | $ | 665.2 | $ | 147.8 | $ | 393.7 | $ | 123.7 |
| As of December 31, 2018 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fair Value Measurements at Reporting Date Using: | ||||||||||||||||
| Asset Category | Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Cash and cash equivalents | $ | 14.6 | $ | 14.6 | $ | - | $ | - | ||||||||
| Equity securities | 138.6 | 109.3 | 29.3 | - | ||||||||||||
| Fixed income securities | 226.9 | - | 226.9 | - | ||||||||||||
| Other types of investments | 96.8 | - | 96.8 | - | ||||||||||||
| Real estate | 108.9 | - | - | 108.9 | ||||||||||||
| Total | $ | 585.8 | $ | 123.9 | $ | 353.0 | $ | 108.9 |
As of December 31, 2019 and 2018, our defined benefit pension plans’ assets did not hold any direct investment in Zimmer Biomet Holdings common stock.
Equity securities are valued using a market approach, based on quoted prices for the specific security from transactions in active exchange markets (Level 1), or in some cases where we are invested in mutual or collective funds, based upon the net asset value per unit of the fund which is determined from quoted market prices of the underlying securities in the fund’s portfolio (Level 2). Fixed income securities are valued using a market approach, based upon quoted prices for the specific security or from institutional bid evaluations. Real estate is valued by discounting to present value the cash flows expected to be generated by the specific properties.
The following table provides a reconciliation of the beginning and ending balances of our foreign pension plan assets measured at fair value that used significant unobservable inputs (Level 3) (in millions):
| December 31, 2019 | ||||
|---|---|---|---|---|
| Beginning Balance | $ | 108.9 | ||
| Gain on assets sold | 0.2 | |||
| Change in fair value of assets | 6.9 | |||
| Net purchases and sales | 4.8 | |||
| Translation gain | 2.9 | |||
| Ending Balance | $ | 123.7 |
We expect that we will have minimal legally required funding requirements in 2020 for the qualified U.S. and Puerto Rico defined benefit retirement plans, and we do not expect to voluntarily contribute to these plans during 2020. Contributions to foreign defined benefit plans are estimated to be $19.6 million in 2020. We do not expect the assets in any of our plans to be returned to us in the next year.
Defined Contribution Plans
We also sponsor defined contribution plans for substantially all of the U.S. and Puerto Rico employees and certain employees in other countries.
The benefits offered under these plans are reflective of local customs and practices in the countries concerned. We expensed $52.6 million, $48.9 million and $47.9 million related to these plans for the years ended December 31, 2019, 2018 and 2017, respectively.
16.Income Taxes
A public referendum held in Switzerland passed the Federal Act on Tax Reform and AHV Financing (“TRAF”), effective January 1, 2020 and includes the abolishment of various favorable federal and cantonal tax regimes. Swiss Tax Reform provides transitional relief measures for companies that are losing the tax benefit of a ruling, including a "step-up" for amortizable goodwill, equal to the amount of future tax benefit they would have received under their
existing ruling, subject to certain limitations. Certain provisions of the TRAF were enacted in the third quarter of 2019, resulting in us recognizing a provisional net tax benefit of $263.8 million. In the fourth quarter of 2019, we recognized an additional $51.2 million related to TRAF as well as the tax impact of certain restructuring transactions in Switzerland.
The 2017 Tax Act was enacted on December 22, 2017 and contained several key provisions including, among other things:
| • | a one-time tax on the mandatory deemed repatriation of post-1986 untaxed foreign earnings and profits (“E&P”), referred to as the toll charge; |
|---|
| • | a reduction in the corporate income tax rate from 35 percent to 21 percent for tax years beginning after December 31, 2017; |
|---|
| • | the introduction of a new U.S. tax on certain off-shore earnings referred to as global intangible low-taxed income (“GILTI”) at an effective tax rate of 10.5 percent for tax years beginning after December 31, 2017 (increasing to 13.125 percent for tax years beginning after December 31, 2025), with a partial offset by foreign tax credits; and |
|---|
| • | the introduction of a territorial tax system beginning in 2018 by providing a 100 percent dividend received deduction on certain qualified dividends from foreign subsidiaries. |
|---|
In March 2018, the FASB issued ASU 2018-05, "Income Taxes - Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118." The guidance provided for a provisional one-year measurement period for entities to finalize their accounting for certain tax effects related to the 2017 Tax Act. In 2017, we recorded a $1,272.4 million income tax benefit related to provisional amounts for which the accounting had not been finalized. In 2018, we completed our calculation of the post-1986 E&P and related foreign taxes of our foreign subsidiaries, as well as the classification of the E&P as cash or non-cash and the finalization of all provisional items. Based on the completed calculations related to the effects of the 2017 Tax Act, and consideration of proposed regulations and other guidance issued during 2018, we recorded additional income tax expense of $8.3 million. The additional $8.3 million of tax expense consists of an adjustment to the toll charge or transition tax provision of $11.3 million and a benefit of $3.0 million related to the remeasurement of our deferred tax assets and liabilities.
The 2017 Tax Act created a provision known as GILTI that imposes a U.S. tax on certain earnings of foreign subsidiaries that are subject to foreign tax below a certain threshold. The Company has made an accounting policy election to reflect GILTI taxes, if any, as a current income tax expense in the period incurred.
The components of earnings (loss) before income taxes consisted of the following (in millions):
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | 2017 | ||||||||||
| United States operations | $ | (125.9 | ) | $ | (382.8 | ) | $ | (114.0 | ) | |||
| Foreign operations | 1,031.7 | 111.7 | 578.6 | |||||||||
| Total | $ | 905.8 | $ | (271.1 | ) | $ | 464.6 |
The (benefit)/provision for income taxes and the income taxes paid consisted of the following (in millions):
| Current: | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Federal | $ | 65.5 | $ | (46.2 | ) | $ | 438.5 | |||||
| State | 9.8 | 24.4 | 2.4 | |||||||||
| Foreign | 237.7 | 116.6 | (13.7 | ) | ||||||||
| 313.0 | 94.8 | 427.2 | ||||||||||
| Deferred: | ||||||||||||
| Federal | (90.2 | ) | 37.9 | (1,728.5 | ) | |||||||
| State | (4.2 | ) | (8.8 | ) | (95.5 | ) | ||||||
| Foreign | (444.3 | ) | (15.7 | ) | 48.0 | |||||||
| (538.7 | ) | 13.4 | (1,776.0 | ) | ||||||||
| (Benefit) provision for income taxes | $ | (225.7 | ) | $ | 108.2 | $ | (1,348.8 | ) | ||||
| Net income taxes paid | $ | 192.5 | $ | 237.1 | $ | 266.9 |
A reconciliation of the U.S. statutory income tax rate to our effective tax rate is as follows:
| For the Years Ended December 31, | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | 2017 | |||||||||||||
| U.S. statutory income tax rate | 21.0 | % | 21.0 | % | 35.0 | % | |||||||||
| State taxes, net of federal deduction | 0.8 | (2.5 | ) | 1.8 | |||||||||||
| Tax impact of foreign operations, including U.S. taxes on international income and foreign tax credits | (10.2 | ) | 54.3 | (32.0 | ) | ||||||||||
| Change in valuation allowance | 1.5 | (4.9 | ) | 0.8 | |||||||||||
| Non-deductible expenses | 0.4 | 1.7 | 2.7 | ||||||||||||
| Goodwill impairment | - | (75.2 | ) | 22.5 | |||||||||||
| Tax rate change | 0.6 | (12.2 | ) | (24.0 | ) | ||||||||||
| Tax benefit relating to foreign derived intangible income and U.S. manufacturer’s deduction | (4.5 | ) | (0.2 | ) | (1.7 | ) | |||||||||
| R&D tax credit | (1.2 | ) | 6.0 | (1.2 | ) | ||||||||||
| Share-based compensation | (0.4 | ) | 0.1 | (2.6 | ) | ||||||||||
| Net uncertain tax positions, including interest and penalties | 1.9 | (25.5 | ) | (17.0 | ) | ||||||||||
| U.S. tax reform | 0.1 | (3.1 | ) | (273.8 | ) | ||||||||||
| Switzerland tax reform and certain restructuring transactions | (34.8 | ) | - | - | |||||||||||
| Other | (0.1 | ) | 0.6 | (0.8 | ) | ||||||||||
| Effective income tax rate | (24.9 | ) | % | (39.9 | ) | % | (290.3 | ) | % |
Our operations in Puerto Rico benefit from various tax incentive grants. These grants expire between fiscal years 2026 and 2029.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Valuation allowances are recorded to reduce deferred income tax assets when it is more likely than not that an income tax benefit will not be realized.
The components of deferred taxes consisted of the following (in millions):
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | |||||||
| Deferred tax assets: | ||||||||
| Inventory | $ | 295.6 | $ | 271.5 | ||||
| Net operating loss carryover | 514.4 | 374.3 | ||||||
| Tax credit carryover | 33.8 | 29.2 | ||||||
| Capital loss carryover | 8.3 | 7.9 | ||||||
| Product liability and litigation | 40.4 | 92.6 | ||||||
| Accrued liabilities | 45.5 | 35.3 | ||||||
| Share-based compensation | 28.6 | 27.3 | ||||||
| Accounts receivable | 24.6 | 15.2 | ||||||
| Other | 79.0 | 48.8 | ||||||
| Total deferred tax assets | 1,070.2 | 902.1 | ||||||
| Less: Valuation allowances | (546.1 | ) | (390.9 | ) | ||||
| Total deferred tax assets after valuation allowances | 524.1 | 511.2 | ||||||
| Deferred tax liabilities: | ||||||||
| Fixed assets | $ | 77.6 | $ | 94.4 | ||||
| Intangible assets | 772.3 | 1,301.3 | ||||||
| Other | 42.9 | 14.1 | ||||||
| Total deferred tax liabilities | 892.8 | 1,409.8 | ||||||
| Total net deferred income taxes | $ | (368.7 | ) | $ | (898.6 | ) |
Net operating loss carryovers are available to reduce future federal, state and foreign taxable earnings. At December 31, 2019, $391.6 million of these net operating loss carryovers expire within a period of 1 to 20 years and $122.8 million of these net operating loss carryovers have an indefinite life. Valuation allowances for net operating loss carryovers have been established in the amount of $493.4 million and $348.9 million at December 31, 2019 and 2018, respectively.
Deferred tax assets related to tax credit carryovers are available to offset future federal and state tax liabilities. At December 31, 2019, $33.8 million of these tax credit carryovers generally expire within a period of 1 to 16 years. Valuation allowances for certain tax credit carryovers have been established in the amount of $32.3 million and $25.2 million at December 31, 2019 and 2018, respectively.
Deferred tax assets related to capital loss carryovers are also available to reduce future federal and foreign capital gains. At December 31, 2019, $1.8 million of these capital loss carryovers expire within a period of 1 year to 3 years and $6.5 million of these capital loss carryovers have an indefinite life. Valuation allowances for certain capital loss carryovers have been established in the amount of $8.3 million and $7.9 million at December 31, 2019 and 2018, respectively. The remaining valuation allowances booked against deferred tax assets of $12.1 million and $8.9 million at December 31, 2019 and 2018, respectively, relate primarily to accrued liabilities and intangible assets that management believes, more likely than not, will not be realized.
We intend to repatriate at least $5.0 billion of unremitted earnings, of which the additional tax related to remitting earnings is deemed immaterial as a portion of these earnings has already been taxed as toll tax or GILTI and is not subject to further U.S. federal tax. Portions of the additional tax would also be offset by allowable foreign tax credits. Of the $5.0 billion amount, we have an estimated $2.2 billion of cash and intercompany notes available to repatriate and the remainder is invested in the operations of our foreign entities. The remaining amounts earned overseas are expected to be permanently reinvested outside of the United States. If the Company decides at a later date to repatriate these earnings to the U.S., the Company would be required to provide for the net tax effects on these amounts. The Company estimates that the total tax effect of this repatriation would not be significant under current enacted tax laws and regulations and at current currency exchange rates.
The following is a tabular reconciliation of the total amounts of unrecognized tax benefits (in millions):
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | 2017 | ||||||||||
| Balance at January 1 | $ | 685.5 | $ | 626.8 | $ | 649.3 | ||||||
| Increases related to business combinations | - | 4.5 | 70.2 | |||||||||
| Increases related to prior periods | 24.7 | 34.6 | 172.8 | |||||||||
| Decreases related to prior periods | (35.6 | ) | (14.4 | ) | (262.2 | ) | ||||||
| Increases related to current period | 133.2 | 41.9 | 24.8 | |||||||||
| Decreases related to settlements with taxing authorities | (60.2 | ) | (3.8 | ) | (21.7 | ) | ||||||
| Decreases related to lapse of statute of limitations | (5.8 | ) | (4.1 | ) | (6.4 | ) | ||||||
| Balance at December 31 | $ | 741.8 | $ | 685.5 | $ | 626.8 | ||||||
| Amounts impacting effective tax rate, if recognized balance at December 31 | $ | 599.2 | $ | 549.1 | $ | 499.6 |
We recognize accrued interest and penalties related to unrecognized tax benefits as income tax expense. During 2019, we accrued interest and penalties of $15.0 million, and as of December 31, 2019, had a recognized liability for interest and penalties of $109.2 million, which does not include any increase related to business combinations.
During 2018, we accrued interest and penalties of $18.5 million, and as of December 31, 2018, had a recognized liability for interest and penalties of $94.2 million, which does not include any increases related to business combinations. During 2017, we released interest and penalties of $38.3 million, and as of December 31, 2017, had a recognized liability for interest and penalties of $75.7 million, which included $3.0 million of increase related to the Biomet merger.
We operate on a global basis and are subject to numerous and complex tax laws and regulations. Additionally, tax laws have and continue to undergo rapid changes in both application and interpretation by various countries, including state aid interpretations and the Organization for Economic Cooperation and Development led initiatives. Our income tax filings are subject to examinations by taxing authorities throughout the world. Income tax audits may require an extended period of time to reach resolution and may result in significant income tax adjustments when interpretation of tax laws or allocation of company profits is disputed. Although ultimate timing is uncertain, the net amount of tax liability for unrecognized tax benefits may change within the next twelve months due to changes in audit status, expiration of statutes of limitations, settlements of tax assessments and other events. Management’s best estimate of such change is within the range of a $290 million decrease to a $30 million increase.
Our U.S. Federal income tax returns have been audited by the IRS through 2012 and are currently under audit by the IRS for years 2013-2015. The IRS has proposed adjustments for years 2005-2012, primarily related to reallocating profits between certain of our U.S. and foreign subsidiaries. We have disputed these adjustments and intend to continue to vigorously defend our positions as we pursue resolution through petitions with the U.S. Tax Court for years 2005-2009 and the administrative process with the IRS Independent Office of Appeals for years 2010-2012.
State income tax returns are generally subject to examination for a period of 3 to 5 years after filing of the respective return. The state impact of any federal changes generally remains subject to examination by various states for a period of up to one year after formal notification to the states. We have various state income tax return positions in the process of examination, administrative appeals or litigation.
In other major jurisdictions, open years are generally 2011 or later.
| 17. | Capital Stock and Earnings per Share |
|---|
We are authorized to issue 250.0 million shares of preferred stock, none of which were issued or outstanding as of December 31, 2019.
The numerator for both basic and diluted earnings per share is net earnings available to common stockholders. The denominator for basic earnings per share is the weighted average number of common shares outstanding during the period. The denominator for diluted earnings per share is weighted average shares outstanding adjusted for the effect of dilutive stock options and other equity awards. The following is a reconciliation of weighted average shares for the basic and diluted share computations (in millions):
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | 2017 | ||||||||||
| Weighted average shares outstanding for basic net earnings per share | 205.1 | 203.5 | 201.9 | |||||||||
| Effect of dilutive stock options and other equity awards | 1.6 | - | 1.8 | |||||||||
| Weighted average shares outstanding for diluted net earnings per share | 206.7 | 203.5 | 203.7 |
For the years ended December 31, 2019 and 2017, an average of 0.9 million and 1.0 million options, respectively, to purchase shares of common stock were not included in the computation of diluted earnings per share as the exercise prices of these options were greater than the average market price of the common stock. Since we incurred a net loss in the year ended December 31, 2018, no dilutive stock options or other equity awards were included as diluted shares.
18.Segment Data
We design, manufacture and market orthopedic reconstructive products; sports medicine, biologics, extremities and trauma products; spine, craniomaxillofacial and thoracic products (“CMF”); office based technologies; dental implants; and related surgical products. Our chief operating decision maker (“CODM”) allocates resources to achieve our operating profit goals through seven operating segments. Our operating segments are comprised of both geographic and product category business units. The geographic operating segments are the Americas, which is comprised principally of the U.S. and includes other North, Central and South American markets; EMEA, which is comprised principally of Europe and includes the Middle East and African markets; and Asia Pacific, which is comprised primarily of Japan, China and Australia and includes other Asian and Pacific markets. The product category operating segments are Spine, Office Based Technologies, CMF and Dental. The geographic operating segments include results from all of our product categories except those in the product category operating segments. The Office Based Technologies, CMF and Dental product category operating segments reflect those respective product category results from all regions, whereas the Spine product category operating segment includes all spine product results excluding those from Asia Pacific.
As it relates to the geographic operating segments, our CODM evaluates performance based upon segment operating profit exclusive of operating expenses pertaining to inventory step-up and other inventory and manufacturing-related charges, intangible asset amortization, goodwill and intangible asset impairment, quality remediation, restructuring and other cost reduction initiatives, acquisition, integration and related, litigation, litigation settlement gain, certain EU Medical Device Regulation expenses, other charges, and global operations and corporate functions. Global operations and corporate functions include research, development engineering, medical education, brand management, corporate legal, finance and human resource functions, manufacturing operations and logistics and share-based payment expense. As it relates to each product category operating segment, research, development engineering, medical education, brand management and other various costs that are specific to the product category operating segment’s operations are reflected in its operating profit results. Due to these additional costs included in the product category operating segments, profitability metrics among the geographic operating segments and product category operating segments are not comparable. Intercompany transactions have been eliminated from segment operating profit.
Our CODM does not review asset information by operating segment. Instead, our CODM reviews cash flow and other financial ratios by operating segment.
These seven operating segments are the basis for our reportable segment information provided below. The four product category operating segments are individually insignificant to our consolidated results and therefore do not constitute a reporting segment either individually or combined. For presentation purposes, these product category operating segments have been aggregated. Certain insignificant prior period reportable segment financial information has been reclassified to conform to the current presentation.
As discussed in Note 4, in 2019 we initiated a restructuring program. As of December 31, 2019, our operating segments have not changed. However, it is likely in 2020 there will be changes in either our operating segments or the composition of operating profit in our current operating segments. We cannot determine at this time what the impact of those changes may be.
Net sales and other information by segment is as follows (in millions):
| Americas | EMEA | Asia Pacific | Immaterial Product Category Operating Segments | Global Operations and Corporate Functions | Total | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| For the Year Ended December 31, 2019 | ||||||||||||||||||||||||
| Net sales | $ | 3,978.1 | $ | 1,538.6 | $ | 1,297.0 | $ | 1,168.5 | $ | - | $ | 7,982.2 | ||||||||||||
| Depreciation and amortization | 109.3 | 71.0 | 65.2 | 45.5 | 715.1 | 1,006.1 | ||||||||||||||||||
| Segment operating profit | 2,163.2 | 477.1 | 458.9 | 208.2 | (1,124.1 | ) | 2,183.3 | |||||||||||||||||
| Inventory and manufacturing-related charges | (53.9 | ) | ||||||||||||||||||||||
| Intangible asset amortization | (584.3 | ) | ||||||||||||||||||||||
| Intangible asset impairment | (70.1 | ) | ||||||||||||||||||||||
| Quality remediation | (82.4 | ) | ||||||||||||||||||||||
| Restructuring and other cost reduction initiatives | (50.0 | ) | ||||||||||||||||||||||
| Acquisition, integration and related | (12.2 | ) | ||||||||||||||||||||||
| Litigation | (65.0 | ) | ||||||||||||||||||||||
| Litigation settlement gain | 23.5 | |||||||||||||||||||||||
| European Union Medical Device Regulation | (30.9 | ) | ||||||||||||||||||||||
| Other charges | (120.5 | ) | ||||||||||||||||||||||
| Operating profit | 1,137.5 | |||||||||||||||||||||||
| For the Year Ended December 31, 2018 | ||||||||||||||||||||||||
| Net sales | $ | 3,932.6 | $ | 1,576.1 | $ | 1,236.9 | $ | 1,187.3 | $ | - | $ | 7,932.9 | ||||||||||||
| Depreciation and amortization | 120.4 | 70.3 | 66.6 | 45.0 | 738.2 | 1,040.5 | ||||||||||||||||||
| Segment operating profit | 2,084.4 | 479.3 | 435.3 | 206.6 | (995.3 | ) | 2,210.3 | |||||||||||||||||
| Inventory and manufacturing-related charges | (32.5 | ) | ||||||||||||||||||||||
| Intangible asset amortization | (595.9 | ) | ||||||||||||||||||||||
| Goodwill and intangible asset impairment | (979.7 | ) | ||||||||||||||||||||||
| Quality remediation | (165.4 | ) | ||||||||||||||||||||||
| Restructuring and other cost reduction initiatives | (34.2 | ) | ||||||||||||||||||||||
| Acquisition, integration and related | (99.5 | ) | ||||||||||||||||||||||
| Litigation | (186.0 | ) | ||||||||||||||||||||||
| European Union Medical Device Regulation | (3.7 | ) | ||||||||||||||||||||||
| Other charges | (79.6 | ) | ||||||||||||||||||||||
| Operating profit | 33.8 | |||||||||||||||||||||||
| For the Year Ended December 31, 2017 | ||||||||||||||||||||||||
| Net sales | $ | 3,928.9 | $ | 1,523.4 | $ | 1,158.3 | $ | 1,192.7 | $ | - | $ | 7,803.3 | ||||||||||||
| Depreciation and amortization | 127.6 | 71.7 | 60.2 | 45.7 | 757.5 | 1,062.7 | ||||||||||||||||||
| Segment operating profit | 2,126.8 | 478.1 | 417.6 | 262.9 | (859.8 | ) | 2,425.6 | |||||||||||||||||
| Inventory step-up and other inventory and manufacturing-related charges | (70.8 | ) | ||||||||||||||||||||||
| Intangible asset amortization | (603.9 | ) | ||||||||||||||||||||||
| Goodwill and intangible asset impairment | (331.5 | ) | ||||||||||||||||||||||
| Quality remediation | (195.1 | ) | ||||||||||||||||||||||
| Restructuring and other cost reduction initiatives | (17.6 | ) | ||||||||||||||||||||||
| Acquisition, integration and related | (262.2 | ) | ||||||||||||||||||||||
| Litigation | (104.0 | ) | ||||||||||||||||||||||
| Other charges | (41.2 | ) | ||||||||||||||||||||||
| Operating profit | 799.3 |
We conduct business in the following countries that hold 10 percent or more of our total consolidated Property, plant and equipment, net (in millions):
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | |||||||
| United States | $ | 1,295.0 | $ | 1,235.1 | ||||
| Other countries | 782.4 | 780.3 | ||||||
| Property, plant and equipment, net | $ | 2,077.4 | $ | 2,015.4 |
U.S. sales were $4,592.1 million, $4,560.0 million, and $4,582.2 million for the years ended December 31, 2019, 2018 and 2017, respectively. Sales within any other individual country were less than 10 percent of our consolidated sales in each of those years. Sales are attributable to a country based upon the customer's country of domicile.
| 19. | Leases |
|---|
We own most of our manufacturing facilities, but lease various office space, vehicles and other less significant assets throughout the world. Our contracts contain a lease if they convey a right to control the use of an identified asset, either explicitly or implicitly, in exchange for consideration. Our lease contracts are a necessary part of our business, but we do not believe they are significant to our overall operations. We do not have any significant finance leases. Additionally, we do not have significant leases: where we are considered a lessor; where we sublease our assets; with an initial term of twelve months or less; with related parties; with residual value guarantees; that impose restrictions or covenants on us; or that have not yet commenced, but create significant rights and obligations against us.
Our real estate leases generally have terms of between 5 to 10 years and contain lease extension options that can vary from month-to-month extensions to up to 5 year extensions. We include extension options in our lease term if we are reasonably certain to exercise that option. In determining whether an extension is reasonably certain, we consider the uniqueness of the property for our needs, the availability of similar properties, whether the extension period payments remain the same or may change due to market rates or fixed price increases in the contract, and other economic factors. Our vehicle leases generally have terms of between 3 to 5 years and contain lease extension options on a month-to-month basis. Our vehicle leases are generally not reasonably certain to be extended.
Under GAAP, we are required to discount our lease liabilities to present value using the rate implicit in the lease, or our incremental borrowing rate for a similar term as the lease term if the implicit rate is not readily available. We generally do not have adequate information to know the implicit rate in a lease and therefore use our incremental borrowing rate. Under GAAP, the incremental borrowing rate must be on a collateralized basis, but our debt arrangements are unsecured. We have determined our incremental borrowing rate by using our credit rating to estimate our unsecured borrowing rate and applying reasonable assumptions to reduce the unsecured rate for a risk adjustment effect from collateral.
We adopted ASU 2016-02 – Leases (Topic 842) effective January 1, 2019. Since we adopted the new standard using the period of adoption transition method (see Note 2 for additional information regarding the new standard), we are not required to present 2018 and 2017 comparative disclosures under the new standard. However, we are required to present the required annual disclosures under the previous GAAP lease accounting standard.
Information on our leases is as follows ($ in millions):
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2019 | 2018 | 2017 | ||||||||||
| Lease cost | $ | 76.0 | $ | 72.2 | $ | 87.2 | ||||||
| Cash paid for leases recognized in operating cash flows | $ | 73.6 | ||||||||||
| Right-of-use assets obtained in exchange for new lease liabilities | $ | 55.0 |
| As of | ||||||||
|---|---|---|---|---|---|---|---|---|
| December 31, 2019 | ||||||||
| Right-of-use assets recognized in Other assets | $ | 266.7 | ||||||
| Lease liabilities recognized in Other current liabilities | $ | 64.2 | ||||||
| Lease liabilities recognized in Other long-term liabilities | $ | 215.5 | ||||||
| Weighted-average remaining lease term | 6.3 years | |||||||
| Weighted-average discount rate | 2.7 | % |
Our variable lease costs are not significant.
Our future minimum lease payments as of December 31, 2019 were (in millions):
| For the Years Ending December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2020 | $ | 70.5 | ||||||
| 2021 | 57.4 | |||||||
| 2022 | 42.0 | |||||||
| 2023 | 34.3 | |||||||
| 2024 | 29.0 | |||||||
| Thereafter | 74.1 | |||||||
| Total | 307.3 | |||||||
| Less imputed interest | 27.6 | |||||||
| Total | $ | 279.7 |
| 20. | Commitments and Contingencies |
|---|
On a quarterly and annual basis, we review relevant information with respect to loss contingencies and update our accruals, disclosures and estimates of reasonably possible losses or ranges of loss based on such reviews. We establish liabilities for loss contingencies when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. For matters where a loss is believed to be reasonably possible, but not probable, no accrual has been made.
Litigation
Durom Cup-related claims: On July 22, 2008, we temporarily suspended marketing and distribution of the Durom Cup in the U.S. Subsequently, a number of product liability lawsuits were filed against us in various U.S. and foreign jurisdictions. The plaintiffs seek damages for personal injury, and they generally allege that the Durom Cup contains defects that result in complications and premature revision of the device. We have settled the majority of these claims and others are still pending. The majority of the pending U.S. lawsuits are currently in a federal Multidistrict Litigation (“MDL”) in the District of New Jersey (In Re: Zimmer Durom Hip Cup Products Liability Litigation). Litigation activity in the MDL is stayed pending finalization of the U.S. Durom Cup Settlement Program, an extrajudicial program created to resolve actions and claims of eligible U.S. plaintiffs and claimants. Other lawsuits are pending in various domestic and foreign jurisdictions, and additional claims may be asserted in the future. The majority of claims outside the U.S. are pending in Germany, Netherlands and Italy.
Since 2008, we have recognized net expense of $443.0 million for Durom Cup-related claims. In the years ended December 31, 2019 and 2018, we lowered our estimate of the number of Durom Cup-related claims we expect to settle and, as a result, we recognized gains of $9.5 million and $37.2 million, respectively, in selling, general and administrative expense. We recognized $10.3 million in expense for Durom Cup-related claims in 2017.
Our estimate as of December 31, 2019 of the remaining liability for all Durom Cup-related claims is $59.9 million. We expect to pay the majority of the Durom Cup-related claims within the next few years.
Our understanding of clinical outcomes with the Durom Cup and other large diameter hip cups continues to evolve. We rely on significant estimates in determining the provisions for Durom Cup-related claims, including our estimate of the number of claims that we will receive and the average amount we will pay per claim. The actual
number of claims and the actual amount we pay per claim may differ from our estimates. Among other factors, since our understanding of the clinical outcomes is still evolving, we cannot reasonably estimate the possible loss or range of loss that may result from Durom Cup-related claims in excess of the losses we have accrued. Although we are vigorously defending these lawsuits, their ultimate resolution is uncertain.
Zimmer M/L Taper, M/L Taper with Kinectiv Technology, and Versys Femoral Head-related claims: We are a defendant in a number of product liability lawsuits relating to our M/L Taper and M/L Taper with Kinectiv Technology hip stems, and Versys Femoral Head implants. The plaintiffs seek damages for personal injury, alleging that defects in the products lead to corrosion at the head/stem junction resulting in, among other things, pain, inflammation and revision surgery. The majority of the cases are consolidated in an MDL created on October 3, 2018 in the U.S. District Court for the Southern District of New York (In Re: Zimmer M/L Taper Hip Prosthesis or M/L Taper Hip Prosthesis with Kinectiv Technology and Versys Femoral Head Products Liability Litigation). Other related cases are pending in various state and federal courts. Additional lawsuits are likely to be filed. Although we are vigorously defending these lawsuits, their ultimate resolution is uncertain.
Biomet metal-on-metal hip implant claims: Biomet is a defendant in a number of product liability lawsuits relating to metal-on-metal hip implants, most of which involve the M2a-Magnum hip system. Cases are currently consolidated in an MDL in the U.S. District Court for the Northern District of Indiana (In Re: Biomet M2a Magnum Hip Implant Product Liability Litigation) and in various state, federal and foreign courts, with the majority of domestic state court cases pending in Indiana and Florida.
On February 3, 2014, Biomet announced the settlement of the MDL. Lawsuits filed in the MDL by April 15, 2014 were eligible to participate in the settlement. Those claims that did not settle via the MDL settlement program have re-commenced litigation in the MDL under a new case management plan, or are in the process of being remanded to their originating jurisdictions. The settlement does not affect certain other claims relating to Biomet’s metal-on-metal hip products that are pending in various state and foreign courts, or other claims that may be filed in the future. Our estimate as of December 31, 2019 of the remaining liability for all Biomet metal-on-metal hip implant claims is $50.1 million. Although we are vigorously defending these lawsuits, their ultimate resolution is uncertain.
Heraeus trade secret misappropriation lawsuits: In December 2008, Heraeus Kulzer GmbH (together with its affiliates, “Heraeus”) initiated legal proceedings in Germany against Biomet, Inc., Biomet Europe BV, certain other entities and certain employees alleging that the defendants misappropriated Heraeus trade secrets when developing Biomet Europe’s Refobacin and Biomet Bone Cement line of cements (“European Cements”). The lawsuit sought to preclude the defendants from producing, marketing and offering for sale their then-current line of European Cements and to compensate Heraeus for any damages incurred.
Germany: On June 5, 2014, the German appeals court in Frankfurt (i) enjoined Biomet, Inc., Biomet Europe BV and Biomet Deutschland GmbH from manufacturing, selling or offering the European Cements to the extent they contain certain raw materials in particular specifications; (ii) held the defendants jointly and severally liable to Heraeus for any damages from the sale of European Cements since 2005; and (iii) ruled that no further review may be sought (the “Frankfurt Decision”). The Heraeus and Biomet parties both sought appeal against the Frankfurt Decision. In a decision dated June 16, 2016, the German Supreme Court dismissed the parties’ appeals without reaching the merits, rendering that decision final.
In December 2016, Heraeus filed papers to restart proceedings against Biomet Orthopaedics Switzerland GmbH, seeking to require that entity to relinquish its CE certificates for the European Cements. In January 2017, Heraeus notified Biomet it had filed a claim for damages in the amount of €121.9 million for sales in Germany, which it first increased to €125.9 million and with a filing in June 2019 further increased to €146.7 million plus statutory interest. As of December 31, 2019, these two proceedings remained pending in front of the Darmstadt court. In September 2017, Heraeus filed an enforcement action in the Darmstadt court against Biomet Europe, requesting that a fine be imposed against Biomet Europe for failure to disclose the amount of the European Cements which Biomet Orthopaedics Switzerland had ordered to be manufactured in Germany (e.g., for the Chinese market). In June 2018, the Darmstadt court dismissed Heraeus’ request. Heraeus appealed the decision. Also in September 2017, Heraeus filed suit against Zimmer Biomet Deutschland in the court of first instance in Freiberg concerning the sale of the European Cements with certain changed raw materials. Heraeus seeks an injunction on the basis that the continued use of the product names for the European Cements is misleading for customers and thus an act of unfair competition. On June 29, 2018, the court in Freiberg, Germany dismissed Heraeus’ request for an injunction prohibiting the marketing of the European Cements under their current names on the grounds that the same request had already been decided upon by the Frankfurt Decision which became final and binding. Heraeus has appealed this decision to the Court of Appeals in Karlsruhe, Germany. The appeals hearing occurred in December 2019.
United States: On September 8, 2014, Heraeus filed a complaint against a Biomet supplier, Esschem, Inc. (“Esschem”), in the U.S. District Court for the Eastern District of Pennsylvania. The lawsuit contained allegations that focused on two copolymer compounds that Esschem sold to Biomet, which Biomet incorporated into certain bone cement products that compete with Heraeus’ bone cement products. The complaint alleged that Biomet helped Esschem to develop these copolymers, using Heraeus trade secrets that Biomet allegedly misappropriated. The complaint asserted a claim under the Pennsylvania Uniform Trade Secrets Act, as well as other various common law tort claims, all based upon the same trade secret misappropriation theory. Heraeus sought to enjoin Esschem from supplying the copolymers to any third party and actual damages. The complaint also sought punitive damages, costs and attorneys’ fees. Although Biomet was not a party to this lawsuit, Biomet agreed, at Esschem’s request and subject to certain limitations, to indemnify Esschem for any liability, damages and legal costs related to this matter. On November 3, 2014, the court entered an order denying Heraeus’ motion for a temporary restraining order. On June 30, 2016, the court entered an order denying Heraeus’ request to give preclusive effect to the factual findings in the Frankfurt Decision. On June 6, 2017, the court entered an order denying Heraeus’ motion to add Biomet as a party to the lawsuit. On January 26, 2018, the court entered an order granting Esschem’s motion for summary judgment and dismissed all of Heraeus’ claims with prejudice. On February 21, 2018, Heraeus filed a notice of appeal to the U.S. Court of Appeals for the Third Circuit, which heard oral argument on the appeal on October 23, 2018. On June 21, 2019, the Third Circuit partially reversed the decision of the U.S. District Court for the Eastern District of Pennsylvania granting Esschem summary judgment and remanded the case back to the lower court. On July 5, 2019, Esschem filed a petition in the Third Circuit for rehearing en banc and a motion in the alternative to certify a question of state law to the Supreme Court of Pennsylvania, which was denied on August 1, 2019.
On December 7, 2017, Heraeus filed a complaint against Zimmer Biomet Holdings, Inc. and Biomet, Inc. in the U.S. District Court for the Eastern District of Pennsylvania alleging a single claim of trade secret misappropriation under the Pennsylvania Uniform Trade Secrets Act based on the same factual allegations as the Esschem litigation. On March 5, 2018, Heraeus filed an amended complaint adding a second claim of trade secret misappropriation under Pennsylvania common law. Heraeus seeks to enjoin the Zimmer Biomet parties from future use of the allegedly misappropriated trade secrets and recovery of unspecified damages for alleged past use. On April 18, 2018, the Zimmer Biomet parties filed a motion to dismiss both claims. On March 8, 2019, the court stayed the case pending the Third Circuit’s decision in the Esschem case described above. In September 2019, the Zimmer Biomet parties filed a motion to stay the proceedings pending (1) the court’s decision on Esschem’s motion for summary judgment in the Esschem case described above and (2) the outcome of the U.S. International Trade Commission complaint filed by Heraeus asserting similar claims, described below under “Regulatory Matters, Government Investigations and Other Matters.” The Zimmer Biomet parties’ motion remained pending as of December 31, 2019.
Other European Countries: Heraeus continues to pursue other related legal proceedings in Europe seeking various forms of relief, including injunctive relief and damages, against Biomet-related entities relating to the European Cements. On October 2, 2018, the Belgian Court of Appeal of Mons issued a judgment in favor of Heraeus relating to its request for past damages caused by the alleged misappropriation of its trade secrets, and an injunction preventing future sales of certain European Cements in Belgium (the “Belgian Decision”). We appealed this judgment to the Belgian Supreme Court. The Belgian Supreme Court dismissed our appeal in October 2019 and this decision is final. Heraeus filed a suit in Belgium concerning the continued sale of the European Cements with certain changed materials. Like its suit in Germany, Heraeus seeks an injunction on the basis that the continued use of the product names for the European Cements is misleading for customers and thus an act of unfair competition. On May 7, 2019, the Liège Commercial Court issued a judgment that Zimmer Biomet failed to inform its hospital and surgeon customers of the changes made to the composition of the cement with certain changed materials and ordered, as a sole remedy, that Zimmer Biomet send letters to those customers, which we have done. We and Heraeus have each filed an appeal to the judgment.
On February 13, 2019, a Norwegian court of first instance issued a judgment in favor of Heraeus on its claim for misappropriation of trade secrets. The court awarded damages of 19,500,000 NOK, or approximately $2.3 million, plus attorneys’ fees, and issued an injunction, which is not final and thus not currently being enforced, preventing Zimmer Biomet Norway from marketing in Norway bone cements identified with the current product names and bone cements making use of the trade secrets which were acknowledged in the Frankfurt Decision. We have appealed the Norwegian judgment to the court of second instance.
On October 29, 2019, an Italian court of first instance issued a judgment in favor of Heraeus on its claim of misappropriation of trade secrets, but did not yet order an award of damages. We intend to appeal the decision.
Heraeus is pursuing damages and injunctive relief in France in an effort to prevent us from manufacturing, marketing and selling the European Cements (the “France Litigation”). The European Cements are manufactured at
our facility in Valence, France. On December 11, 2018, a hearing was held in the France Litigation before the commercial court in Romans-sur-Isère. On May 23, 2019, the commercial court ruled in our favor. On July 12, 2019, Hereaus filed an appeal to the court of second instance in Grenoble, France. Although we are vigorously defending the France Litigation, the ultimate outcome is uncertain. An adverse ruling in the France Litigation could have a material adverse effect on our business, financial condition and results of operations.
We have accrued an estimated loss relating to the collective trade secret litigation, including estimated legal costs to defend. Damages relating to the Frankfurt Decision are subject to separate proceedings, and the Belgian court appointed an expert to determine the amount of damages related to the Belgian Decision. Thus, it is reasonably possible that our estimate of the loss we may incur may change in the future. Although we are vigorously defending these lawsuits, their ultimate resolution is uncertain.
Stryker patent infringement lawsuit: On December 10, 2010, Stryker Corporation and related entities (“Stryker”) filed suit against us in the U.S. District Court for the Western District of Michigan, alleging that certain of our Pulsavac® Plus Wound Debridement Products infringe three U.S. patents assigned to Stryker. The case was tried beginning on January 15, 2013, and on February 5, 2013, the jury found that we infringed certain claims of the subject patents. The jury awarded $70.0 million in monetary damages for lost profits. The jury also found that we willfully infringed the subject patents. We filed multiple post-trial motions, including a motion seeking a new trial. On August 7, 2013, the trial court issued a ruling denying all of our motions and awarded treble damages and attorneys’ fees to Stryker. We filed a notice of appeal to the Court of Appeals for the Federal Circuit to seek reversal of both the jury’s verdict and the trial court’s rulings on our post-trial motions. Oral argument before the Court of Appeals for the Federal Circuit took place on September 8, 2014. On December 19, 2014, the Federal Circuit issued a decision affirming the $70.0 million lost profits award but reversed the willfulness finding, vacating the treble damages award and vacating and remanding the attorneys’ fees award. We accrued an estimated loss of $70.0 million related to this matter in the three month period ended December 31, 2014. On January 20, 2015, Stryker filed a motion with the Federal Circuit for a rehearing en banc. On March 23, 2015, the Federal Circuit denied Stryker’s petition. Stryker subsequently filed a petition for certiorari to the U.S. Supreme Court. In July 2015, we paid the final lost profits award of $90.3 million, which includes the original $70.0 million plus pre- and post-judgment interest and damages for sales that occurred post-trial but prior to our entry into a license agreement with Stryker. On October 19, 2015, the U.S. Supreme Court granted Stryker’s petition for certiorari. Oral argument took place on February 23, 2016. On June 13, 2016, the U.S. Supreme Court issued its decision, vacating the judgment of the Federal Circuit and remanding the case for further proceedings related to the willfulness issue. On September 12, 2016, the Federal Circuit issued an opinion affirming the jury’s willfulness finding and vacating and remanding the trial court’s award of treble damages, its finding that this was an exceptional case and its award of attorneys’ fees. The case was remanded back to the trial court. Oral argument on Stryker’s renewed consolidated motion for enhanced damages and attorneys’ fees took place on June 28, 2017. On July 12, 2017, the trial court issued an order reaffirming its award of treble damages, its finding that this was an exceptional case and its award of attorneys’ fees. On July 24, 2017, we appealed the ruling to the Federal Circuit and obtained a supersedeas bond staying enforcement of the judgment pending appeal. Oral argument before the Federal Circuit took place on December 3, 2018 and the Federal Circuit affirmed the trial court’s ruling in full on December 10, 2018. We accrued an estimated loss of approximately $168.0 million related to the award of treble damages and attorneys’ fees in the three-month period ended December 31, 2018. On January 23, 2019, we filed a petition with the Federal Circuit for a rehearing en banc. On March 19, 2019, the petition for rehearing en banc was denied. In late March 2019, we paid the outstanding judgment of approximately $168.0 million. On June 17, 2019, we filed a petition for certiorari seeking U.S. Supreme Court review of the Federal Circuit’s decision. On October 7, 2019, the U.S. Supreme Court denied certiorari.
Putative Securities Class Action: On December 2, 2016, a complaint was filed in the U.S. District Court for the Northern District of Indiana (Shah v. Zimmer Biomet Holdings, Inc. et al.), naming us, one of our officers and two of our now former officers as defendants. On June 28, 2017, the plaintiffs filed a corrected amended complaint, naming as defendants, in addition to those previously named, current and former members of our Board of Directors, one additional officer, and the underwriters in connection with secondary offerings of our common stock by certain selling stockholders in 2016. On October 6, 2017, the plaintiffs voluntarily dismissed the underwriters without prejudice. On October 8, 2017, the plaintiffs filed a second amended complaint, naming as defendants, in addition to those current and former officers and Board members previously named, certain former stockholders of ours who sold shares of our common stock in secondary public offerings in 2016. We and our current and former officers and Board members named as defendants are sometimes hereinafter referred to as the “Zimmer Biomet Defendant group”. The former stockholders of ours who sold shares of our common stock in secondary public offerings in 2016 are sometimes hereinafter referred to as the “Private Equity Fund Defendant group”. The second amended complaint relates to a putative class action on behalf of persons who purchased our common stock between June 7, 2016 and November 7, 2016. The second amended complaint generally alleges that the defendants violated
federal securities laws by making materially false and/or misleading statements and/or omissions about our compliance with U.S. Food and Drug Administration (“FDA”) regulations and our ability to continue to accelerate our organic revenue growth rate in the second half of 2016. The defendants filed their respective motions to dismiss on December 20, 2017, plaintiffs filed their omnibus response to the motions to dismiss on March 13, 2018 and the defendants filed their respective reply briefs on May 18, 2018. On September 27, 2018, the court denied the Zimmer Biomet Defendant group’s motion to dismiss in its entirety. The court granted the Private Equity Fund Defendant group’s motion to dismiss, without prejudice. On October 9, 2018, the Zimmer Biomet Defendant group filed a motion (i) to amend the court’s order on the motion to certify two issues for interlocutory appeal, and (ii) to stay proceedings pending appeal. On February 21, 2019, that motion was denied. On April 11, 2019, the plaintiffs moved for class certification. On June 20, 2019, the Zimmer Biomet Defendant group filed its response. The plaintiffs’ motion remained pending as of February 18, 2020. The plaintiffs seek unspecified damages and interest, attorneys’ fees, costs, and other relief. Although we believe this lawsuit is without merit, during a mediation in December 2019, plaintiffs and defendants, along with Zimmer Biomet’s insurers, reached a settlement in principle to resolve the claims. We have made an accrual for the proposed settlement that we expect to be fully covered by our insurers.
Shareholder Derivative Actions: On June 14, 2019 and July 29, 2019, two shareholder derivative actions, Green v. Begley et al. and Detectives Endowment Association Annuity Fund v. Begley et al., were filed in the Court of Chancery in the State of Delaware. On October 2, 2019 and October 11, 2019, two additional shareholder derivative actions, Karp v. Begley et al. and DiGaudio v. Begley et al., were filed in the U.S. District Court for the District of Delaware. The plaintiff in each action seeks to maintain the action purportedly on our behalf against certain of our current and former directors and officers (the “individual defendants”) and certain former stockholders of ours who sold shares of our common stock in various secondary public offerings in 2016 (the “private equity fund defendants”). The plaintiff in each action alleges, among other things, breaches of fiduciary duties against the individual defendants and insider trading against two individual defendants and the private equity fund defendants, based on substantially the same factual allegations as the putative federal securities class action referenced above (Shah v. Zimmer Biomet Holdings, Inc. et al.). The plaintiffs do not seek damages from us, but instead request damages on our behalf from the defendants of an unspecified amount. The plaintiffs also seek attorneys’ fees, costs and other relief.
Regulatory Matters, Government Investigations and Other Matters
U.S. International Trade Commission Investigation: On March 5, 2019, Heraeus filed a complaint with the U.S. International Trade Commission (“ITC”) against us and certain of our subsidiaries. The complaint alleges that Biomet misappropriated Heraeus’ trade secrets in the formulation and manufacture of two bone cement products now sold by Zimmer Biomet, both of which are imported from our Valence, France facility. Heraeus requested that the ITC institute an investigation and, after the investigation, issue a limited exclusion order and cease and desist orders. On April 5, 2019, the ITC ordered an investigation be instituted into whether we have committed an “unfair act” in the importation, sale for importation, or sale after importation of certain bone cement products, and the investigation is ongoing. An evidentiary hearing in front of an administrative law judge at the ITC was held in January 2020 and an initial determination is expected to issue by May 2020. We cannot currently predict the outcome of this investigation. An adverse outcome in this ITC proceeding could have a material adverse effect on our business, financial condition and results of operations.
FDA warning letters: In August 2018, we received a warning letter from the FDA related to observed non-conformities with current good manufacturing practice requirements of the FDA’s Quality System Regulation (21 CFR Part 820) (“QSR”) at our legacy Biomet manufacturing facility in Warsaw, Indiana (this facility is sometimes referred to in this report as the “Warsaw North Campus”). In September 2012, we received a warning letter from the FDA citing concerns relating to certain processes pertaining to products manufactured at our Ponce, Puerto Rico manufacturing facility. We have provided detailed responses to the FDA as to our corrective actions and will continue to work expeditiously to address the issues identified by the FDA during inspections in Warsaw and Ponce. As of December 31, 2019, the Warsaw and Ponce warning letters remained pending. Until the violations cited in the pending warning letters are corrected, we may be subject to additional regulatory action by the FDA, as described more fully below. Additionally, requests for Certificates to Foreign Governments related to products manufactured at certain of our facilities may not be granted and premarket approval applications for Class III devices to which the QSR deviations at these facilities are reasonably related will not be approved until the violations have been corrected. In addition to responding to the warning letters described above, we are in the process of addressing various FDA Form 483 inspectional observations at certain of our manufacturing facilities, including new observations issued by the FDA following an inspection of the Warsaw North Campus in January 2020. The ultimate outcome of these matters is presently uncertain. Among other available regulatory actions, the FDA may
impose operating restrictions, including a ceasing of operations, at one or more facilities, enjoining and restraining certain violations of applicable law pertaining to products, seizure of products and assessing civil or criminal penalties against our officers, employees or us. The FDA could also issue a corporate warning letter or a recidivist warning letter or negotiate the entry of a consent decree of permanent injunction with us. The FDA may also recommend prosecution by the U.S. Department of Justice (“DOJ”). Any adverse regulatory action, depending on its magnitude, may restrict us from effectively manufacturing, marketing and selling our products and could have a material adverse effect on our business, financial condition and results of operations.
Deferred Prosecution Agreement (“DPA”) relating to U.S. Foreign Corrupt Practices Act (“FCPA”) matters: On January 12, 2017, we resolved previously-disclosed FCPA matters involving Biomet and certain of its subsidiaries. As part of the settlement, (i) Biomet resolved matters with the U.S. Securities and Exchange Commission (the “SEC”) through an administrative cease-and-desist order (the “Order”); (ii) we entered into a DPA with the DOJ; and (iii) JERDS Luxembourg Holding S.à r.l. (“JERDS”), the direct parent company of Biomet 3i Mexico SA de CV and an indirect, wholly-owned subsidiary of Biomet, entered into a plea agreement (the “Plea Agreement”) with the DOJ. The conduct underlying these resolutions occurred prior to our acquisition of Biomet.
Pursuant to the terms of the Order, Biomet resolved claims with the SEC related to violations of the books and records, internal controls and anti-bribery provisions of the FCPA by disgorging profits to the U.S. government in an aggregate amount of approximately $6.5 million, inclusive of pre-judgment interest, and paying a civil penalty in the amount of $6.5 million (collectively, the “Civil Settlement Payments”). We also agreed to pay a criminal penalty of approximately $17.5 million (together with the Civil Settlement Payments, the “Settlement Payments”) to the U.S. government pursuant to the terms of the DPA. We made the Settlement Payments in January 2017 and, as previously disclosed, had accrued, as of June 24, 2015, the closing date of the Biomet merger, an amount sufficient to cover this matter.
Under the DPA, which has a term of three years, the DOJ agreed to defer criminal prosecution of us in connection with the charged violation of the internal controls provision of the FCPA as long as we comply with the terms of the DPA. In addition, we are subject to oversight by an independent compliance monitor, who was appointed effective as of August 7, 2017. The monitorship may remain in place until August 7, 2020. If we remain in compliance with the DPA during its term, the charges against us will be dismissed with prejudice. The term of the DPA and monitorship may be extended for up to one additional year at the DOJ’s discretion. In addition, under its Plea Agreement with the DOJ, JERDS pleaded guilty on January 13, 2017 to aiding and abetting a violation of the books and records provision of the FCPA. In light of the DPA we entered into, JERDS paid only a nominal assessment and no criminal penalty.
If we do not comply with the terms of the DPA, we could be subject to prosecution for violating the internal controls provisions of the FCPA and the conduct of Biomet and its subsidiaries described in the DPA, which conduct pre-dated our acquisition of Biomet, as well as any new or continuing violations. We could also be subject to exclusion by the Office of Inspector General of the Department of Health and Human Services (“OIG”) from participation in federal healthcare programs, including Medicaid and Medicare. Any of these events could have a material adverse effect on our business, financial condition, results of operations and cash flows.
| 21. | Quarterly Financial Information (Unaudited) |
|---|
| (in millions, except per share data) | ||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2019 Quarter Ended | 2018 Quarter Ended | |||||||||||||||||||||||||||||||
| Mar | Jun | Sep | Dec | Mar | Jun | Sep | Dec | |||||||||||||||||||||||||
| Net sales | $ | 1,975.5 | $ | 1,988.6 | $ | 1,892.4 | $ | 2,125.7 | $ | 2,017.6 | $ | 2,007.6 | $ | 1,836.7 | $ | 2,071.0 | ||||||||||||||||
| Gross profit | 1,278.7 | 1,260.4 | 1,210.1 | 1,396.1 | 1,291.0 | 1,274.4 | 1,160.1 | 1,339.6 | ||||||||||||||||||||||||
| Net earnings (loss) of Zimmer Biomet Holdings, Inc. | 246.1 | 133.7 | 431.1 | 320.7 | 174.7 | 185.0 | 162.2 | (901.1 | ) | |||||||||||||||||||||||
| Earnings (loss) per common share | ||||||||||||||||||||||||||||||||
| Basic | 1.20 | 0.65 | 2.10 | 1.56 | 0.86 | 0.91 | 0.80 | (4.42 | ) | |||||||||||||||||||||||
| Diluted | 1.20 | 0.65 | 2.08 | 1.54 | 0.85 | 0.90 | 0.79 | (4.42 | ) |
In the three month period ended December 31, 2019, we recognized a $51.2 million tax benefit related to TRAF as well as the tax impact of certain restructuring transactions in Switzerland.
In the three month period ended December 31, 2018, we recorded goodwill impairment charges of $975.9 million.
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