filings.toolsItem 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
60K characters. Original on sec.gov · Markdown
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
| --- | --- |
The following discussion and analysis should be read in conjunction with the interim condensed consolidated financial statements and corresponding notes included elsewhere in this Form 10-Q. Certain percentages presented in this discussion and analysis are calculated from the underlying whole-dollar amounts and, therefore, may not recalculate from the rounded numbers used for disclosure purposes.
On February 5, 2021, we announced our intention to pursue a plan to spin off our Spine and Dental businesses to form ZimVie. We are targeting completion of the spin-off by mid-2022, subject to the satisfaction of certain conditions, including, among others, final approval of our Board of Directors, receipt of a favorable opinion and IRS ruling with respect to the tax-free nature of the transaction, obtaining debt financing for the new company, and the effectiveness of a Form 10 registration statement with the SEC. The following discussion and analysis includes these businesses in our discussion of financial condition and results of operations.
Executive Level Overview
Impact of the COVID-19 Global Pandemic
Our results continue to be impacted by the COVID-19 global pandemic. The vast majority of our net sales are derived from products used in elective surgical procedures. As COVID-19 rapidly started to spread throughout the world in early 2020, our net sales decreased dramatically as countries took precautions to prevent the spread of the virus with lockdowns and stay-at-home measures and as hospitals deferred elective surgical procedures. The timing, level and sustainability of the return of elective surgical procedures has been difficult to predict, as a number of factors are involved, including which geographies are affected and the different measures governments and healthcare systems may take in response to the virus in those areas. In the third quarter of 2021, the highly transmissible Delta variant has resulted in deferrals of elective surgical procedures, most notably in the U.S. Additionally, we believe that staffing shortages at hospitals are also contributing to the deferral of elective surgical procedures.
Results for the Three and Nine-Month Periods ended September 30, 2021
Our net sales decreased by 0.3 percent in the three-month period ended September 30, 2021 and increased by 17.4 percent in the nine-month period ended September 30, 2021, compared to the same prior year periods. The decline in the three-month period was primarily attributable to deferred elective surgical procedures due to the Delta variant, staffing shortages at hospitals and other COVID-19 related issues. The increase in net sales in the nine-month period was primarily due to the significant deferral of elective surgical procedures at the onset of the pandemic in 2020. Our net earnings were $145.6 million and $485.6 million in the three and nine-month periods ended September 30, 2021, respectively, compared to net earnings of $242.5 million and a net loss of $472.6 million in the same prior year periods, respectively. The decline in net earnings in the three-month period ended September 31, 2021 compared to the same prior year period was primarily due to higher litigation-related charges, costs related to the ZimVie spinoff and higher research and development (“R&D”) spending. For the nine-month period ended September 30, 2021, we returned to profitability compared to the net loss in the same prior year period, primarily due to a reduction in operating expenses including goodwill and intangible asset impairment charges, certain fixed overhead and hourly production worker labor expenses, and litigation-related charges. In the nine-month period ended September 30, 2020, we recognized $645.0 million of goodwill and intangible asset impairment charges primarily due to the forecasted impact of COVID-19 on our operating results. In the second quarter of 2020, we also temporarily suspended or limited production at certain manufacturing facilities, resulting in additional expense recognized in cost of products sold that related to certain fixed overhead costs and hourly production worker labor expenses that are included in the cost of inventory when these facilities are operating at normal capacity. Lastly, in the nine-month period ended September 30, 2021, we recognized net litigation-related charges of $53.3 million compared to $100.4 million in the same 2020 period.
2021 Outlook
In the fourth quarter of 2021, we expect deferrals of elective surgical procedures will continue due to the Delta variant and staffing shortages at hospitals. Since the clinical need for many of our products does not go away, we believe some patients will return for these surgical procedures, but how quickly that occurs continues to be uncertain. Additionally, we expect that China sales will be negatively impacted from a combination of variables related to the implementation of volume-based procurement (“VBP”) including potential distributor inventory reductions, ongoing pricing negotiations with distributor partners, revaluation of channel inventory and/ or volume reductions as patients may defer procedures until after VBP is effective. Although the government pricing levels have been finalized, the final impact of these variables may be materially different than what we have estimated. We also plan to continue our investments in key R&D and commercial initiatives as we prepare for the recovery of elective surgical procedures.
Results of Operations
We analyze sales by three geographies, the Americas, EMEA and Asia Pacific, and by the following product categories: Knees; Hips; S.E.T.; Dental & Spine; and Other. This sales analysis differs from our reportable operating segments, which are based upon our senior management organizational structure and how we allocate resources toward achieving operating profit goals. We analyze sales by geography because the underlying market trends in any particular geography tend to be similar across product categories and because we primarily sell the same products in all geographies. Our business is seasonal in nature to some extent, as many of our products are used in elective surgical procedures, which typically decline during the summer months and can increase at the end of the year once annual deductibles have been met on health insurance plans. In 2021, it is uncertain if this seasonal pattern will be similar to years prior to 2020, due to COVID-19 and its continued impacts.
Net Sales by Geography
The following tables present our net sales by geography and the components of the percentage changes (dollars in millions):
| Three Months Ended | |||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, | Volume / | Foreign | |||||||||||||||||||||||
| 2021 | 2020 | % Inc / (Dec) | Mix | Price | Exchange | ||||||||||||||||||||
| Americas | $ | 1,180.5 | $ | 1,216.5 | (3.0 | ) | % | (2.1 | ) | % | (1.1 | ) | % | 0.2 | % | ||||||||||
| EMEA | 393.1 | 366.2 | 7.4 | 6.1 | (0.2 | ) | 1.5 | ||||||||||||||||||
| Asia Pacific | 350.4 | 346.6 | 1.1 | 5.2 | (4.7 | ) | 0.6 | ||||||||||||||||||
| Total | $ | 1,924.0 | $ | 1,929.3 | (0.3 | ) | 0.7 | (1.5 | ) | 0.5 | |||||||||||||||
| Nine Months Ended | |||||||||||||||||||||||||
| September 30, | Volume / | Foreign | |||||||||||||||||||||||
| 2021 | 2020 | % Inc | Mix | Price | Exchange | ||||||||||||||||||||
| Americas | $ | 3,535.1 | $ | 3,051.5 | 15.8 | % | 17.2 | % | (1.7 | ) | % | 0.3 | % | ||||||||||||
| EMEA | 1,207.1 | 983.0 | 22.8 | 16.2 | (0.2 | ) | 6.8 | ||||||||||||||||||
| Asia Pacific | 1,056.1 | 904.7 | 16.7 | 15.1 | (2.7 | ) | 4.3 | ||||||||||||||||||
| Total | $ | 5,798.3 | $ | 4,939.2 | 17.4 | 16.6 | (1.6 | ) | 2.4 | ||||||||||||||||
“Foreign Exchange,” as used in the tables in this report, represents the effect of changes in foreign currency exchange rates on sales.
Net Sales by Product Category
The following tables present our net sales by product category and the components of the percentage changes (dollars in millions):
| Three Months Ended | |||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, | Volume / | Foreign | |||||||||||||||||||||||
| 2021 | 2020 | % Inc / (Dec) | Mix | Price | Exchange | ||||||||||||||||||||
| Knees | $ | 647.9 | $ | 648.5 | (0.1 | ) | % | 1.4 | % | (2.1 | ) | % | 0.6 | % | |||||||||||
| Hips | 453.8 | 484.1 | (6.3 | ) | (2.8 | ) | (3.8 | ) | 0.3 | ||||||||||||||||
| S.E.T. | 437.6 | 417.1 | 4.9 | 3.5 | 0.7 | 0.7 | |||||||||||||||||||
| Dental & Spine | 238.6 | 253.4 | (5.8 | ) | (6.7 | ) | 0.6 | 0.3 | |||||||||||||||||
| Other | 146.1 | 126.2 | 15.7 | 17.3 | (1.9 | ) | 0.3 | ||||||||||||||||||
| Total | $ | 1,924.0 | $ | 1,929.3 | (0.3 | ) | 0.7 | (1.5 | ) | 0.5 | |||||||||||||||
| Nine Months Ended | |||||||||||||||||||||||||
| September 30, | Volume / | Foreign | |||||||||||||||||||||||
| 2021 | 2020 | % Inc | Mix | Price | Exchange | ||||||||||||||||||||
| Knees | $ | 1,927.8 | $ | 1,652.2 | 16.7 | % | 16.3 | % | (2.2 | ) | % | 2.6 | % | ||||||||||||
| Hips | 1,375.4 | 1,246.4 | 10.3 | 11.2 | (3.1 | ) | 2.2 | ||||||||||||||||||
| S.E.T. | 1,317.3 | 1,090.7 | 20.8 | 17.8 | 0.5 | 2.5 | |||||||||||||||||||
| Dental & Spine | 748.1 | 625.2 | 19.7 | 18.2 | (0.4 | ) | 1.9 | ||||||||||||||||||
| Other | 429.7 | 324.7 | 32.3 | 31.8 | (1.9 | ) | 2.4 | ||||||||||||||||||
| Total | $ | 5,798.3 | $ | 4,939.2 | 17.4 | 16.6 | (1.6 | ) | 2.4 | ||||||||||||||||
The following table presents our net sales by geography for our Knees and Hips product categories, which represent our most significant product categories (dollars in millions):
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | % Inc / (Dec) | 2021 | 2020 | % Inc | |||||||||||||||||||||
| Knees | ||||||||||||||||||||||||||
| Americas | $ | 386.3 | $ | 400.4 | (3.5 | ) | % | $ | 1,145.4 | $ | 999.2 | 14.6 | % | |||||||||||||
| EMEA | 135.2 | 126.2 | 7.1 | 415.1 | 344.3 | 20.6 | ||||||||||||||||||||
| Asia Pacific | 126.4 | 121.9 | 3.8 | 367.3 | 308.7 | 19.0 | ||||||||||||||||||||
| Total | $ | 647.9 | $ | 648.5 | (0.1 | ) | $ | 1,927.8 | $ | 1,652.2 | 16.7 | |||||||||||||||
| Hips | ||||||||||||||||||||||||||
| Americas | $ | 244.2 | $ | 268.6 | (9.1 | ) | % | $ | 737.5 | $ | 671.8 | 9.8 | % | |||||||||||||
| EMEA | 119.0 | 109.7 | 8.6 | 349.2 | 291.9 | 19.7 | ||||||||||||||||||||
| Asia Pacific | 90.6 | 105.8 | (14.4 | ) | 288.7 | 282.7 | 2.1 | |||||||||||||||||||
| Total | $ | 453.8 | $ | 484.1 | (6.3 | ) | $ | 1,375.4 | $ | 1,246.4 | 10.3 |
Demand (Volume and Mix) Trends
Changes in volume and mix of product sales had a positive effect of 0.7 percent and 16.6 percent on year-over-year sales during the three and nine-month periods ended September 30, 2021. We continued to see deferral of elective surgical procedures due to the Delta variant and nursing and staffing shortages at hospitals.
Based upon country dynamics, volume changes varied by region. In the Americas, the U.S. was significantly affected by the Delta variant in the third quarter. In EMEA, we saw mixed performance among the various countries. Among our geographic regions, EMEA had the highest volume and mix growth in the third quarter of 2021 as their recovery of elective surgical procedures in that region in 2020 was slower than the other regions, and therefore EMEA’s comparable prior year net sales were more affected. In
Asia Pacific, while net sales did increase it was at a slower rate than what we experienced in the first half of 2021 due to the China VBP, lockdowns in Tokyo due to the Olympics and some lingering capacity limitations in Australia, New Zealand and most of southeast Asia. The China VBP is expected to take effect in early 2022, and therefore we expect a continued negative impact on Asia Pacific Knees and Hips sales in the remainder of 2021 continuing into 2022 due to inventory reductions by distributors and short-term deferral of procedures as patients may wait until after VBP pricing is effective.
Pricing Trends
Global selling prices had a negative effect of 1.5 percent and 1.6 percent on year-over-year sales during the three and nine-month periods ended September 30, 2021, respectively. The majority of countries in which we operate continue to experience pricing pressure from governmental healthcare cost containment efforts and from local hospitals and health systems. In the third quarter of 2021, Asia Pacific pricing was also negatively affected by the anticipated China VBP implementation, and we expect a continuing negative impact on selling prices in the remainder of 2021 and continuing into 2022.
Foreign Currency Exchange Rates
For the three and nine-month periods ended September 30, 2021, changes in foreign currency exchange rates had a positive effect of 0.5 percent and 2.4 percent on year-over-year sales, respectively. If foreign currency exchange rates remain at levels consistent with recent rates, we estimate there will be a positive impact of approximately 1.4 percent on full-year 2021 sales.
Expenses as a Percentage of Net Sales
| Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, | % Inc / | September 30, | % Inc / | |||||||||||||||||||||||||||
| 2021 | 2020 | (Dec) | 2021 | 2020 | (Dec) | |||||||||||||||||||||||||
| Cost of products sold, excluding intangible asset amortization | 30.2 | % | 29.5 | % | 0.7 | % | 29.0 | % | 30.0 | % | (1.0 | ) | % | |||||||||||||||||
| Intangible asset amortization | 8.0 | 7.8 | 0.2 | 8.0 | 9.0 | (1.0 | ) | |||||||||||||||||||||||
| Research and development | 5.7 | 4.5 | 1.2 | 6.6 | 5.5 | 1.1 | ||||||||||||||||||||||||
| Selling, general and administrative | 41.7 | 40.9 | 0.8 | 41.2 | 46.2 | (5.0 | ) | |||||||||||||||||||||||
| Goodwill and intangible asset impairment | - | - | - | 0.3 | 13.1 | (12.8 | ) | |||||||||||||||||||||||
| Restructuring and other cost reduction initiatives | 1.2 | 0.8 | 0.4 | 1.1 | 1.8 | (0.7 | ) | |||||||||||||||||||||||
| Quality remediation | 0.6 | 0.5 | 0.1 | 0.6 | 0.7 | (0.1 | ) | |||||||||||||||||||||||
| Acquisition, integration, divestiture and related | 1.4 | 0.5 | 0.9 | 1.1 | 0.3 | 0.8 | ||||||||||||||||||||||||
| Operating profit (loss) | 11.2 | 15.5 | (4.3 | ) | 12.1 | (6.7 | ) | 18.8 |
The increase in cost of products sold as a percentage of net sales for the three-month period ended September 30, 2021 compared to the same prior year period was primarily due to hedge losses recognized in the current year period as part of our hedging program compared to hedge gains in the prior year period, and lower average selling prices. These unfavorable items were partially offset by lower excess and obsolete charges in the 2021 period.
In the nine-month period ended September 30, 2021, our cost of products sold as a percentage of net sales declined due to lower excess and obsolete charges as well as the fact that the 2020 period had higher charges from certain fixed overhead costs and hourly production worker labor expenses when we temporarily suspended or limited production at certain manufacturing facilities. These favorable items were partially offset by hedge losses recognized in the current year period as part of our hedging program compared to hedge gains in the prior year period, and lower average selling prices.
Intangible asset amortization expense increased in the three and nine-month periods ended September 30, 2021 compared to the same prior year periods due to additional amortization from acquisitions made in the fourth quarter of 2020.
R&D expenses increased in both amount and as a percentage of net sales in the three and nine-month periods ended September 30, 2021 compared to the same prior year periods. The increase in expenses in the three-month period ended September 30, 2021 was primarily due to reengaging in R&D projects in the current year period compared to 2020 when COVID-19 caused delays in project spending. For the nine-month period ended September 30, 2021, in addition to reengaging in projects, we also entered into certain agreements to gain access to or acquire third-party in-process R&D projects that resulted in charges of $65.0 million.
Selling, general and administrative (“SG&A”) expenses increased in the three and nine-month periods ended September 30, 2021 when compared to the same prior year periods. The increase in the three-month period ended September 30, 2021 was primarily due to higher litigation-related charges of $43.6 million in 2021 compared to $19.3 million in 2020, and increased travel and medical training and education costs in the 2021 period as we have partially resumed these activities. These increased expenses were partially offset by lower variable selling and distribution costs in the Americas resulting from net sales declines in this region. Due primarily to the increase in SG&A expenses, SG&A as a percentage of net sales increased as well in the three-month period ended September 30, 2021.
In the nine-month period ended September 30, 2021, SG&A expenses increased primarily due to higher variable selling and distribution costs from increased net sales, higher performance-based compensation in the current year period as similar costs were reduced in the prior year periods due to the effect COVID-19 had on our operating results, and increased travel and medical training and education costs as we have partially resumed these activities. These increased costs were partially offset by lower litigation-related charges, as we recognized $53.3 million in the nine-month period ended September 30, 2021 compared to $100.4 million in the same 2020 period. Despite the increase in SG&A expenses, SG&A as a percentage of net sales declined in the nine-month period ended September 30, 2021 when compared to the same prior year period as our SG&A expenses included many fixed costs that did not increase ratably with the significant increase in net sales in the 2021 period.
In the nine-month period ended September 30, 2021, we recognized an intangible asset impairment charge of $16.3 million. In the nine-month period ended September 30, 2020, we recognized goodwill and intangible asset impairment charges of $645.0 million, including charges of $470.0 million and $142.0 million related to our EMEA and Dental reporting units, respectively, in the first quarter of 2020. For more information regarding these charges, see Note 8 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report.
In December 2019, our Board of Directors approved, and we initiated, the 2019 Restructuring Plan with an overall objective of reducing costs to allow us to invest in higher priority growth opportunities. We recognized expenses of $23.5 million and $64.9 million in the three and nine-month periods ended September 30, 2021, respectively, compared to $16.2 million and $89.2 million in the three and nine-month periods ended September 30, 2020, respectively, attributable to restructuring and other cost reduction initiatives, primarily related to employee termination benefits, distributor contract terminations, consulting and project management expenses associated with the 2019 Restructuring Plan. For more information regarding these charges, see Note 4 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report.
We continue to incur quality remediation expenses to complete our remediation milestones that address inspectional observations on Form 483 and a Warning Letter issued by the FDA at our Warsaw North Campus facility, among other matters.
Acquisition, integration, divestiture and related expenses increased in the three and nine-month periods ended September 30, 2021 compared to the same prior year periods due to consulting and other professional service expenses related to the planned spin-off of our Spine and Dental businesses and integration expenses related to the acquisitions made in 2020.
Other Income, Net, Interest Expense, Net, and Income Taxes
In the three and nine-month periods ended September 30, 2021 our other income, net was lower than in the same prior year periods. In the three-month period ended September 30, 2021, the lower other income, net was primarily due to losses recognized from changes to the fair value of our equity investments compared to gains recognized in the same prior year period. In the nine-month period ended September 30, 2021, other income, net was lower due to the net gains recognized from changes in the fair value of our equity investments being lower than those in the same prior year period, which were partially offset by lower foreign currency re-measurement losses when compared to the same prior year period.
Interest expense, net, decreased in the three-month period ended September 30, 2021 when compared to the same prior year period primarily due to the fixed-to-variable interest rate swaps we entered into in June 2021. In the nine-month period ended September 30, 2021, interest expense, net, was slightly higher compared to the same prior year period primarily due to lower net interest income from receive-fixed-rate, pay-fixed-rate cross-currency interest rate swaps designated as net investment hedges that matured in 2021.
In the three and nine-month periods ended September 30, 2021, our effective tax rate (“ETR”) was 10.4 percent and 12.8 percent, respectively, compared to 3.8 percent and negative 0.3 percent in the three and nine-month periods ended September 30, 2020, respectively. The 10.4 percent ETR in the three-month period ended September 30, 2021 was driven by the foreign rate differential as our foreign locations have lower tax rates, favorable return to provision changes in estimate offset by unfavorable tax rate changes. The 12.8 percent ETR in the nine-month period ended September 30, 2021 was the result of the foreign rate differential, favorable return to provision changes in estimate, unfavorable tax rate changes, favorable discrete adjustments from the filing of Swiss tax
returns and an excess tax benefit related to stock-based compensation. The 3.8 percent ETR in the three-month period ended September 30, 2020, was the result of the mix of some of our jurisdictions recognizing earnings while others had losses. The negative 0.3 percent ETR in the nine-month period ended September 30, 2020 was primarily due to the $612.0 million goodwill impairment charge, which resulted in a loss before taxes, but had no corresponding tax benefit, as well as the mix of earnings and losses among our jurisdictions. Absent discrete tax events, we expect our future ETR will be lower than the U.S. corporate income tax rate of 21.0 percent due to our mix of earnings between U.S. and foreign locations, which have lower corporate income tax rates. Our ETR in future periods could also potentially be impacted by: changes in our mix of pre-tax earnings; changes in tax rates, tax laws or their interpretation; the outcome of various federal, state and foreign audits; and the expiration of certain statutes of limitations. Currently, we cannot reasonably estimate the impact of these items on our financial results.
Segment Operating Profit
| Operating Profit as a | |||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Net Sales | Operating Profit | Percentage of Net Sales | |||||||||||||||||||||||
| Three Months Ended | Three Months Ended | Three Months Ended | |||||||||||||||||||||||
| September 30, | September 30, | September 30, | |||||||||||||||||||||||
| (dollars in millions) | 2021 | 2020 | 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||
| Americas Orthopedics | $ | 1,009.4 | $ | 1,033.2 | $ | 422.2 | $ | 452.1 | 41.8 | % | 43.8 | % | |||||||||||||
| EMEA | 366.2 | 339.7 | 88.3 | 84.6 | 24.1 | 24.9 | |||||||||||||||||||
| Asia Pacific | 339.9 | 336.0 | 114.7 | 113.4 | 33.7 | 33.8 | |||||||||||||||||||
| Americas Spine and Global Dental | 208.5 | 220.4 | 27.8 | 39.3 | 13.3 | 17.8 | |||||||||||||||||||
| Operating Profit as a | |||||||||||||||||||||||||
| Net Sales | Operating Profit | Percentage of Net Sales | |||||||||||||||||||||||
| Nine Months Ended | Nine Months Ended | Nine Months Ended | |||||||||||||||||||||||
| September 30, | September 30, | September 30, | |||||||||||||||||||||||
| (dollars in millions) | 2021 | 2020 | 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||
| Americas Orthopedics | $ | 3,013.9 | $ | 2,602.7 | $ | 1,254.7 | $ | 1,059.1 | 41.6 | % | 40.7 | % | |||||||||||||
| EMEA | 1,108.2 | 915.1 | 269.8 | 213.5 | 24.3 | 23.3 | |||||||||||||||||||
| Asia Pacific | 1,022.5 | 876.4 | 346.4 | 284.4 | 33.9 | 32.5 | |||||||||||||||||||
| Americas Spine and Global Dental | 653.7 | 545.0 | 106.9 | 61.8 | 16.4 | 11.3 |
In the Americas Orthopedics and Americas Spine and Global Dental operating segments, operating profit as a percentage of net sales declined in the three-month period ended September 30, 2021, when compared to the same prior year period, due to fixed expenses not declining in proportion to lower net sales. In our EMEA operating segment, operating profit as a percentage of net sales declined in the three-month period ended September 30, 2021, as net sales increases were partially offset by hedge losses. In our Asia Pacific operating segment, changes in operating profit and operating profit as a percentage of net sales were minimal in the three-month period ended September 30, 2021, when compared to the same prior year period.
In the nine-month period September 30, 2021, each of our segments’ operating profit and operating profit as a percentage of net sales increased compared to the same prior year period due to the effect of fixed operating expenses that did not increase proportionally with higher net sales.
Non-GAAP Operating Performance Measures
We use financial measures that differ from financial measures determined in accordance with GAAP to evaluate our operating performance. These non-GAAP financial measures exclude, as applicable, certain inventory and manufacturing-related charges including charges to discontinue certain product lines; intangible asset amortization; goodwill and intangible asset impairment; restructuring and other cost reduction initiative expenses; quality remediation expenses; acquisition, integration, divestiture and related expenses; certain litigation gains and charges; expenses to establish initial compliance with the EU MDR; expenses related to certain R&D agreements; other charges; any related effects on our income tax provision associated with these items; the effect of Switzerland tax reform; other certain tax adjustments; and, with respect to earnings per share information, provide for the effect of dilutive shares assuming net earnings in a period of a reported net loss. We use these non-GAAP financial measures internally to evaluate the performance of the business. Additionally, we believe these non-GAAP measures provide meaningful incremental information to investors to consider when evaluating our performance. We believe these measures offer the ability to make period-to-period comparisons that are not impacted by certain items that can cause dramatic changes in reported income but that do not impact the fundamentals of our operations. The non-GAAP measures enable the evaluation of operating results and trend analysis by allowing a reader to better identify operating trends that may otherwise be masked or distorted by these types of items that are excluded from the non-GAAP measures. In addition, adjusted diluted earnings per share is used as a performance metric in our incentive compensation programs.
The following are reconciliations from our GAAP net earnings (loss) and diluted earnings (loss) per share to our non-GAAP adjusted net earnings and non-GAAP adjusted diluted earnings per share (in millions, except per share amounts):
| Three Months Ended | Nine Months Ended | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, | September 30, | |||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||
| Net Earnings (Loss) of Zimmer Biomet Holdings, Inc. | $ | 145.6 | $ | 242.5 | $ | 485.6 | $ | (472.6 | ) | |||||||
| Inventory and manufacturing-related charges(1) | 11.0 | 2.3 | 13.0 | 4.3 | ||||||||||||
| Intangible asset amortization(2) | 153.7 | 149.7 | 463.8 | 445.0 | ||||||||||||
| Goodwill and intangible asset impairment(3) | - | - | 16.3 | 645.0 | ||||||||||||
| Restructuring and other cost reduction initiatives(4) | 23.3 | 16.2 | 64.9 | 89.2 | ||||||||||||
| Quality remediation(5) | 11.8 | 10.0 | 33.0 | 35.8 | ||||||||||||
| Acquisition, integration, divestiture and related(6) | 27.3 | 9.1 | 66.1 | 15.7 | ||||||||||||
| Litigation(7) | 43.6 | 19.3 | 53.3 | 100.4 | ||||||||||||
| European Union Medical Device Regulation(8) | 11.9 | 2.0 | 29.4 | 19.1 | ||||||||||||
| Certain R&D agreements(9) | - | - | 65.0 | - | ||||||||||||
| Other charges(10) | 7.9 | (8.3 | ) | (1.1 | ) | 5.6 | ||||||||||
| Taxes on above items(11) | (50.5 | ) | (58.4 | ) | (163.1 | ) | (152.1 | ) | ||||||||
| Swiss tax reform(12) | 9.6 | (4.6 | ) | 28.4 | 11.6 | |||||||||||
| Other certain tax adjustments(13) | (14.0 | ) | (3.0 | ) | (13.8 | ) | (6.1 | ) | ||||||||
| Adjusted Net Earnings | $ | 381.2 | $ | 376.8 | $ | 1,140.8 | $ | 740.9 |
| Three Months Ended | Nine Months Ended | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, | September 30, | |||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||
| Diluted Earnings (Loss) Per Share | $ | 0.69 | $ | 1.16 | $ | 2.31 | $ | (2.29 | ) | |||||||
| Inventory and manufacturing-related charges(1) | 0.05 | 0.01 | 0.06 | 0.02 | ||||||||||||
| Intangible asset amortization(2) | 0.73 | 0.72 | 2.20 | 2.15 | ||||||||||||
| Goodwill and intangible asset impairment(3) | - | - | 0.08 | 3.12 | ||||||||||||
| Restructuring and other cost reduction initiatives(4) | 0.11 | 0.08 | 0.31 | 0.43 | ||||||||||||
| Quality remediation(5) | 0.05 | 0.05 | 0.16 | 0.17 | ||||||||||||
| Acquisition, integration, divestiture and related(6) | 0.13 | 0.04 | 0.31 | 0.08 | ||||||||||||
| Litigation(7) | 0.21 | 0.09 | 0.25 | 0.49 | ||||||||||||
| European Union Medical Device Regulation(8) | 0.06 | 0.01 | 0.14 | 0.09 | ||||||||||||
| Certain R&D agreements(9) | - | - | 0.31 | - | ||||||||||||
| Other charges(10) | 0.04 | (0.04 | ) | - | 0.03 | |||||||||||
| Taxes on above items(11) | (0.24 | ) | (0.28 | ) | (0.77 | ) | (0.74 | ) | ||||||||
| Swiss tax reform(12) | 0.05 | (0.02 | ) | 0.13 | 0.06 | |||||||||||
| Other certain tax adjustments(13) | (0.07 | ) | (0.01 | ) | (0.07 | ) | (0.03 | ) | ||||||||
| Effect of dilutive shares assuming net earnings(14) | - | - | - | (0.02 | ) | |||||||||||
| Adjusted Diluted Earnings Per Share | $ | 1.81 | $ | 1.81 | $ | 5.42 | $ | 3.56 |
| (1) | Inventory and manufacturing-related charges include excess and obsolete inventory charges on certain product lines we intend to discontinue, incremental cost of products sold from stepping up inventory to its fair value from its manufactured cost in business combination accounting and other inventory and manufacturing-related charges or gains. |
|---|
| (2) | We exclude intangible asset amortization from our non-GAAP financial measures because we internally assess our performance against our peers without this amortization. Due to various levels of acquisitions among our peers, intangible asset amortization can vary significantly from company to company. |
|---|
| (3) | In the first quarter of 2020, we recognized goodwill impairment charges of $470.0 million and $142.0 million related to our EMEA and Dental reporting units, respectively. In the second quarters of 2021 and 2020, we recognized $16.3 million and $33.0 million, respectively, of in-process research and development (“IPR&D”) intangible asset impairments on certain IPR&D projects. |
|---|
| (4) | In December 2019, our Board of Directors approved, and we initiated, a new global restructuring program that includes a reorganization of key businesses and an overall effort to reduce costs in order to accelerate decision-making and focus the organization on priorities to drive growth. Restructuring and other cost reduction initiatives also include other cost reduction initiatives that have the goal of reducing costs across the organization. The costs include employee termination benefits; contract terminations for facilities and sales agents; and other charges, such as retention period salaries and benefits and relocation costs. |
|---|
| (5) | We are addressing inspectional observations on Form 483 and a Warning Letter issued by the FDA following its previous inspections of our Warsaw North Campus facility, among other matters. This quality remediation has required us to devote significant financial resources. The majority of the expenses are related to consultants who are helping us to update previous documents and redesign certain processes. |
|---|
| (6) | The acquisition, integration, divestiture and related gains and expenses we have excluded from our non-GAAP financial measures resulted from the planned spinoff of ZimVie and various acquisitions. |
|---|
| (7) | We are involved in routine patent litigation, product liability litigation, commercial litigation and other various litigation matters. We review litigation matters from both a qualitative and quantitative perspective to determine if excluding the losses or gains will provide our investors with useful incremental information. Litigation matters can vary in their characteristics, frequency and significance to our operating results. The litigation charges and gains excluded from our non-GAAP financial measures in the periods presented relate to product liability matters where we have received numerous claims on specific products, patent litigation and commercial litigation related to a common matter in multiple jurisdictions. In regards to the product liability matters, due to the complexities involved and claims filed in multiple districts, the expenses associated with these matters are significant to our operating results. Once the litigation matter has been excluded from our non-GAAP financial measures in a particular period, any additional expenses or gains from changes in estimates are also excluded, even if they are not significant, to ensure consistency in our non-GAAP financial measures from period-to-period. |
|---|
| (8) | The European Union Medical Device Regulation imposes significant additional premarket and postmarket requirements. The new regulations provided a transition period until May 2021 for previously-approved medical devices to meet the additional requirements. For certain devices, this transition period can be extended until May 2024. We are excluding from our non-GAAP financial measures the incremental costs incurred to establish initial compliance with the regulations related to our previously-approved medical devices. The incremental costs primarily include temporary personnel and third-party professionals necessary to supplement our internal resources. |
|---|
| (9) | During the three and nine-month periods ended September 30, 2021, we entered into certain agreements to gain access to or acquire third-party IPR&D projects. |
|---|
| (10) | We have incurred other various expenses from specific events or projects that we consider highly variable or that have a significant impact to our operating results that we have excluded from our non-GAAP measures. These include costs related to legal entity, distribution and manufacturing optimization, including contract terminations, gains and losses from changes in fair value on our equity investments, as well as, in the 2020 period, our costs of complying with a Deferred Prosecution Agreement (“DPA”) with the U.S. government related to certain Foreign Corrupt Practices Act matters involving Biomet and certain of its subsidiaries, which DPA concluded in February 2021. |
|---|
| (11) | Represents the tax effects on the previously specified items, including deferred tax rate changes on intangible assets. The tax effect for the U.S. jurisdiction is calculated based on an effective rate considering federal and state taxes, as well as permanent items. For jurisdictions outside the U.S., the tax effect is calculated based upon the statutory rates where the items were incurred. |
|---|
| (12) | We recognized a tax benefit related to TRAF in addition to an impact from certain restructuring transactions in Switzerland. Also included are tax adjustments relating to the ongoing impacts of tax only amortization resulting from TRAF as well as certain restructuring transactions in Switzerland. |
|---|
| (13) | Other certain tax adjustments relate to various discrete tax period adjustments as well as U.S. tax reform planning. |
|---|
| (14) | Diluted share count used in Adjusted Diluted EPS: |
|---|
| Nine Months Ended | |||
|---|---|---|---|
| September 30, 2020 | |||
| Diluted shares | 206.8 | ||
| Dilutive shares assuming net earnings | 1.4 | ||
| Adjusted diluted shares | 208.2 |
Liquidity and Capital Resources
The COVID-19 pandemic has had an adverse effect on our liquidity and capital resource needs, primarily driven by the reduction in net sales due to elective surgical procedure deferrals. We have taken prudent measures in an effort to maintain an adequate financial profile and to have access to capital to fund the business during these unprecedented times. These measures included reductions in discretionary spending such as travel, meetings and other project spend that can be delayed with limited long-term detriment to the business. More recently, we have increased spending on travel, meetings and other projects, but not to the extent that existed prior to the pandemic as we continue to better utilize technology that has made travel less necessary.
As of September 30, 2021, we had $919.6 million in cash and cash equivalents. In addition, we had $1.0 billion available to borrow under our 2021 364-Day Credit Agreement that matures on August 19, 2022, and $1.5 billion available under our 2021 Five-Year Revolving Facility that matures on August 20, 2026. The terms of the 2021 364-Day Credit Agreement and the 2021 Five-Year Revolving Facility are described further in Note 10 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report.
We believe that cash flows from operations, our cash and cash equivalents on hand, and available borrowings under our revolving credit facilities will be sufficient to meet our ongoing liquidity requirements for at least the next twelve months. At this time, we do not anticipate needing to borrow against our revolving credit facilities to fund our operations. However, due to the continued uncertainties related to the COVID-19 pandemic, it is possible our needs may change. Further, there can be no assurance that, if needed, we will be able to secure additional financing on terms favorable to us, if at all.
Sources of Liquidity
Cash flows provided by operating activities were $1,133.5 million in the nine-month period ended September 30, 2021, compared to $779.4 million in the same prior year period. The increase in cash flows from operating activities was primarily the result of higher earnings in the 2021 period. Additionally, in the nine-month period ended September 30, 2020, we sold fewer of our accounts receivables to a third party which we estimate negatively impacted operating cash flows by approximately $230 million.
Cash flows used in investing activities were $357.4 million in the nine-month period ended September 30, 2021, compared to $297.9 million in the same prior year period. Instrument and property, plant and equipment additions reflected ongoing investments in our product portfolio and optimization of our manufacturing and logistics network. Additionally, in the 2021 period we had portions of our cross-currency interest rate swaps designated as net investment hedges mature at a loss, which resulted in net investing outflows of $2.4 million compared to the same prior year period when we had cash inflows of $43.0 million, based upon the terms of our swaps.
Cash flows used in financing activities were $650.2 million in the nine-month period ended September 30, 2021, compared to $135.5 million in the same prior year period. In the 2021 period, we paid the remaining $500.0 million on senior notes which matured in the period. We also had a deferred business combination payment of $100.0 million that was paid in the 2021 period under the terms of the purchase agreement. In the 2020 period, we issued senior notes and received $1,497.1 million in proceeds, which were used to pay our $1,500.0 million senior notes at maturity on April 1, 2020.
At September 30, 2021, we had outstanding debt of $7,503.8 million, of which $1,045.7 million was classified as current debt. The current debt consists of $750.0 million senior notes due April 1, 2022 and two Japan term loans that mature on September 27, 2022. For the debt that matures in 2022, we believe we can satisfy these debt obligations with cash generated from our operations, by issuing new debt, by entering into new term debt arrangements, and/or by borrowing on our revolving credit facilities.
For additional information on our debt, including types of debt, maturity dates, interest rates, debt covenants and available revolving credit facilities, see Note 10 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report.
We place our cash and cash equivalents in highly-rated financial institutions and limit the amount of credit exposure to any one entity. We invest only in high-quality financial instruments in accordance with our internal investment policy.
As of September 30, 2021, $338.2 million of our cash and cash equivalents were held in jurisdictions outside of the U.S. Of this amount, $81.6 million is denominated in U.S. Dollars and, therefore, bears no foreign currency translation risk. The balance of these assets is denominated in currencies of the various countries where we operate. We intend to repatriate at least $5.5 billion of unremitted earnings in future years.
Our concentrations of credit risks with respect to trade accounts receivable are limited due to the large number of customers and their dispersion across a number of geographic areas and by frequent monitoring of the creditworthiness of the customers to whom credit is granted in the normal course of business. Substantially all of our trade receivables are concentrated in the public and private hospital and healthcare industry in the U.S. and internationally or with distributors or dealers who operate in international markets and, accordingly, are exposed to their respective business, economic and country-specific variables. We have continued to collect on outstanding receivables throughout the pandemic. However, we are closely monitoring the financial stability of our customers and the country-specific risks, including those customers in markets with hospitals sponsored by the government.
In February, May and August 2021, our Board of Directors declared a quarterly cash dividend of $0.24 per share. We expect to continue paying cash dividends on a quarterly basis; however, future dividends are subject to approval of the Board of Directors and may be adjusted as business needs or market conditions change.
In February 2016, our Board of Directors authorized a new $1.0 billion share repurchase program effective March 1, 2016, with no expiration date. The previous program expired on February 29, 2016. As of September 30, 2021, all $1.0 billion remained authorized.
As discussed in Note 4 to our interim condensed consolidated financial statements in Part I, Item 1 of this report, in December 2019, our Board of Directors approved, and we initiated, the 2019 Restructuring Plan with an objective of reducing costs to allow us to further invest in higher priority growth opportunities. The 2019 Restructuring Plan is expected to result in total pre-tax restructuring charges of approximately $350 million to $400 million, with approximately $220 million of that total expected to be incurred by the end of 2021. We expect to reduce gross annual pre-tax operating expenses by approximately $200 million to $300 million by the end of 2023 as program benefits under the 2019 Restructuring Plan are realized.
As discussed in Note 7 to our interim condensed consolidated financial statements in Part I, Item 1 of this report, we completed the acquisitions of A&E Medical Corporation and Relign Corp. in 2020. These acquisitions included guaranteed deferred payments including a remaining $45.0 million payment that we are obligated to make in the fourth quarter of 2021.
As discussed in Note 14 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report, the IRS has issued proposed adjustments for years 2010 through 2012, as well as proposed adjustments for years 2013 through 2015, reallocating profits between certain of our U.S. and foreign subsidiaries. We have disputed these proposed adjustments and intend to continue to vigorously defend our positions. Although the ultimate timing for resolution of the disputed tax issues is uncertain, future payments may be significant to our operating cash flows.
As discussed in Note 17 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report, we are involved in various litigation matters with respect to which we expect to continue paying settlements over the next few years. Additionally, we have entered into development, distribution and other contractual arrangements that may result in future payments dependent upon various events such as the achievement of certain product R&D milestones, sales milestones, or, at our discretion, maintenance of exclusive rights to distribute a product. Since there is uncertainty on the timing or whether such payments will have to be made, they have not been recognized on our condensed consolidated balance sheets. These estimated payments could range from $0 to approximately $370 million.
Recent Accounting Pronouncements
Information pertaining to recent accounting pronouncements can be found in Note 2 to our interim condensed consolidated financial statements included in Part I, Item 1 of this report.
Critical Accounting Estimates
Our financial results are affected by the selection and application of accounting policies and methods. There were no changes in the three or nine-month periods ended September 30, 2021 to the application of critical accounting policies as described in our Annual Report on Form 10-K for the year ended December 31, 2020.
Cautionary Note Regarding Forward-Looking Statements and Factors That May Affect Future Results
This quarterly report contains certain statements that are forward-looking statements within the meaning of federal securities laws. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. When used in this report, the words “may,” “will,” “can,” “should,” “would,” “could,” “anticipate,” “expect,” “plan,” “seek,” “believe,” “are confident that,” “predict,” “estimate,” “potential,” “project,” “target,” “forecast,” “intend,” “strategy,” “future,” “opportunity,” “assume,” “guide,” “position,” “continue” and similar expressions are intended to identify forward-looking statements. Forward-looking statements are based on current beliefs, expectations and assumptions that are subject to significant risks, uncertainties and changes in circumstances that could cause actual results to differ materially from such forward-looking statements. These risks, uncertainties and changes in circumstances include, but are not limited to:
| • | the effects of the COVID-19 global pandemic and other adverse public health developments on the global economy, our business and operations and the business and operations of our suppliers and customers, including the deferral of elective surgical procedures and our ability to collect accounts receivable, the failure of vaccine rollouts and other strategies to mitigate or reverse the impacts of the COVID-19 pandemic, and the failure of elective surgical procedures to recover at the levels or on the timeline anticipated; |
|---|
| • | the risks and uncertainties related to our ability to successfully execute our restructuring plans; |
|---|
| • | our ability to attract, retain and develop the highly skilled employees we need to support our business; |
|---|
| • | the success of our quality and operational excellence initiatives, including ongoing quality remediation efforts at our Warsaw North Campus facility; |
|---|
| • | the ability to remediate matters identified in inspectional observations or warning letters issued by the FDA, while continuing to satisfy the demand for our products; |
|---|
| • | the risks and uncertainties associated with the proposed spin-off of our Spine and Dental businesses, including, without limitation, the significant expenses, time and efforts related to implementing such transaction, the ability to complete the transaction on our expected timeline or at all, the tax-free nature of the transaction, possible disruptions in our relationships with customers, suppliers and other business partners, and the possibility that the anticipated benefits and synergies of the transaction, strategic and competitive advantages of each company, and future growth and other opportunities for each company will not be realized within the expected time periods or at all; |
|---|
| • | the impact of substantial indebtedness on our ability to service our debt obligations and/or refinance amounts outstanding under our debt obligations at maturity on terms favorable to us, or at all; |
|---|
| • | the ability to retain the independent agents and distributors who market our products; |
|---|
| • | dependence on a limited number of suppliers for key raw materials and outsourced activities; |
|---|
| • | the possibility that the anticipated synergies and other benefits from mergers and acquisitions will not be realized, or will not be realized within the expected time periods; |
|---|
| • | the risks and uncertainties related to our ability to successfully integrate the operations, products, employees and distributors of acquired companies; |
|---|
| • | the effect of the potential disruption of management’s attention from ongoing business operations due to integration matters related to mergers and acquisitions; |
|---|
| • | the effect of mergers and acquisitions on our relationships with customers, suppliers and lenders and on our operating results and businesses generally; |
|---|
| • | challenges relating to changes in and compliance with governmental laws and regulations affecting our U.S. and international businesses, including regulations of the FDA and foreign government regulators, such as more stringent requirements for regulatory clearance of products; |
|---|
| • | the outcome of government investigations; |
|---|
| • | competition; |
|---|
| • | pricing pressures; |
|---|
| • | changes in customer demand for our products and services caused by demographic changes or other factors; |
|---|
| • | the impact of healthcare reform measures; |
|---|
| • | reductions in reimbursement levels by third-party payors and cost containment efforts sponsored by government agencies, legislative bodies, the private sector and healthcare purchasing organizations, including the volume-based procurement in China; |
|---|
| • | dependence on new product development, technological advances and innovation; |
|---|
| • | shifts in the product category or regional sales mix of our products and services; |
|---|
| • | supply and prices of raw materials and products; |
|---|
| • | control of costs and expenses; |
|---|
| • | the ability to obtain and maintain adequate intellectual property protection; |
|---|
| • | breaches or failures of our information technology systems or products, including by cyber-attack, unauthorized access or theft; |
|---|
| • | the ability to form and implement alliances; |
|---|
| • | changes in tax obligations arising from tax reform measures, including European Union rules on state aid, or examinations by tax authorities; |
|---|
| • | product liability, intellectual property and commercial litigation losses; |
|---|
| • | changes in general industry and market conditions, including domestic and international growth rates; |
|---|
| • | changes in general domestic and international economic conditions, including interest rate and currency exchange rate fluctuations; and |
|---|
| • | the impact of the ongoing financial and political uncertainty on countries in EMEA on the ability to collect accounts receivable in affected countries. |
|---|
Our Annual Report on Form 10-K for the year ended December 31, 2020 and this Quarterly Report on Form 10-Q contain detailed discussions of these and other important factors under the heading “Risk Factors.” You should understand that it is not possible to predict or identify all factors that could cause actual results to differ materially from forward-looking statements. Consequently, you should not consider any list or discussion of such factors to be a complete set of all potential risks or uncertainties.
Forward-looking statements speak only as of the date they are made and we expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Readers of this report are cautioned not to rely on these forward-looking statements since there can be no assurance that these forward-looking statements will prove to be accurate. This cautionary statement is applicable to all forward-looking statements contained in this report.
Previous: Item 1. Financial Statements · Next: Item 3. Quantitative and Qualitative Disclosures About Market Risk