Zimmer Biomet Holdings, Inc. — Q2 2023 Form 10-Q Summary
Business context and reporting period
Zimmer Biomet designs, manufactures and markets orthopedic reconstructive products, sports medicine, biologics, extremities and trauma products, craniomaxillofacial and thoracic products, surgical products, and digital and robotic technologies. The report covers the three and six months ended June 30, 2023. Results are presented primarily on a continuing-operations basis following the March 2022 spinoff of the spine and dental businesses into ZimVie.
Financial performance and key metrics
| Metric | Three months ended June 30, 2023 | Three months ended June 30, 2022 | Six months ended June 30, 2023 | Six months ended June 30, 2022 |
|---|---|---|---|---|
| Net sales | $1,869.6 million | $1,781.8 million | $3,700.6 million | $3,445.0 million |
| Operating profit | $329.6 million | $280.9 million | $656.9 million | $479.3 million |
| Operating margin | 17.6% | 15.8% | 17.8% | 13.9% |
| Net earnings attributable to Zimmer Biomet | $209.6 million | $153.7 million | $442.1 million | $167.9 million |
| Diluted EPS | $1.00 | $0.73 | $2.10 | $0.80 |
| Operating cash flow from continuing operations | Not separately provided | Not separately provided | $655.6 million | $661.2 million |
- Second-quarter sales increased 4.9%; first-half sales increased 7.4%. Volume and mix contributed 7.0% and 10.7%, respectively, while pricing reduced growth by 1.0% and 1.2%.
- Foreign exchange reduced sales growth by 1.1% in the quarter and 2.1% year to date.
- Knees were the strongest product category, increasing 9.4% in the quarter and 12.1% year to date. Hips increased 3.5% and 6.3%, while S.E.T. declined 0.8% in the quarter and increased 1.5% year to date.
- Gross margin improved as cost of products sold declined to 28.1% of sales from 28.7% in the quarter and to 27.7% from 29.3% year to date. Benefits included higher hedge gains, operating leverage, lower royalty expense and, year to date, lower excess and obsolete inventory charges.
- Research and development increased to 6.3% of sales from 5.6% in the quarter and to 6.2% from 5.7% year to date, reflecting higher personnel costs, EU MDR compliance spending and other investments.
- Interest expense increased to $51.6 million in the quarter and $99.8 million year to date, compared with $38.8 million and $79.9 million, respectively, primarily because of higher borrowings and interest-rate swap losses.
- Cash and cash equivalents were $319.8 million at June 30, 2023, compared with $375.7 million at December 31, 2022. Inventories increased to $2,275.8 million from $2,147.2 million.
- Total debt was $5,709.4 million, including $520.0 million classified as current. Long-term debt was $5,189.4 million.
- Cash used in investing activities was $392.5 million, including $144.0 million for property, plant and equipment, $168.3 million for instruments, $73.3 million for intellectual-property rights and $32.9 million for acquisitions.
- Cash used in financing activities was $316.1 million, including $281.9 million of share repurchases and $100.6 million of dividends.
Material changes versus the prior comparable period
- Elective procedure volumes recovered as COVID-19-related disruptions and staffing shortages eased, driving sales growth across most major markets.
- Net earnings benefited from higher sales, lower litigation and restructuring charges, and the absence of the significant ZimVie investment losses recorded in 2022. The six-month 2022 comparison also included a $58.8 million loss from discontinued operations.
- Restructuring charges declined to $24.4 million in the quarter and $66.3 million year to date, versus $57.0 million and $100.9 million, respectively, in 2022. Quality remediation expense was zero in both 2023 periods after remediation milestones were completed in late 2022.
- The company acquired Embody, Inc. in February 2023 for initial consideration of $154.5 million and acquired another orthopedic medical device company in April 2023 for $15.0 million initially. Preliminary purchase accounting included $155.0 million of goodwill and $143.0 million of identifiable intangible assets for the 2023 acquisitions.
- The company purchased intellectual-property rights for $80.5 million, replacing variable royalty payments that otherwise would have continued through 2030.
- The company repurchased $281.9 million of common stock during the first half of 2023. Approximately $591.7 million remained available under the authorized repurchase program at June 30, 2023.
- In February 2023, the company disposed of its retained ZimVie shares and repaid the related short-term term loan using the shares and $33.9 million of cash.
Guidance, outlook, commentary and risks
- Management expects 2023 revenue growth to reflect market growth, recovery in procedure volumes and new product introductions. Based on recent exchange rates, foreign currency was expected to reduce full-year sales growth by approximately 0.5%.
- Supply-chain pressure was expected to ease in the second half of 2023, while inflation was expected to remain broadly stable relative to the end of 2022. Management expected higher interest expense because of increased interest rates.
- Management expected no recurrence of goodwill impairment charges and lower quality-remediation expenses. The 2021 restructuring plan is expected to produce approximately $190 million of gross annual pretax operating-expense reductions by the end of 2024.
- Management believes operating cash flow, cash on hand and available revolving credit capacity will meet liquidity needs for at least the next twelve months. On July 7, 2023, the company entered into replacement revolving facilities with $1.5 billion of five-year capacity and $1.0 billion of 364-day capacity.
- Material risks include elective-procedure volatility, pricing and reimbursement pressure, inflation, supply-chain disruption, foreign exchange and interest-rate exposure, substantial indebtedness, acquisitions and integration, cybersecurity, competition, product liability and intellectual-property litigation, regulatory compliance and FDA enforcement.
- The Warsaw FDA warning letter remained pending at June 30, 2023. Adverse regulatory action could restrict manufacturing, marketing or sales and materially affect results.
- Litigation liabilities were accrued at $264.4 million at June 30, 2023. The ultimate cost may exceed current estimates.
- Tax authorities have proposed adjustments involving prior-year transfer pricing and profit allocation. One proposal for 2013 could increase federal taxable income and tax expense by approximately $370 million, before interest and penalties. The company disputes the adjustments.
- Potential future payments under development, distribution and other contractual arrangements were estimated at $25 million to approximately $435 million, but timing and occurrence remain uncertain.
Important facts for investors to verify
- Reconcile reported sales growth with procedure-volume recovery, pricing pressure and foreign-exchange effects.
- Monitor inventory growth, operating cash conversion and the company’s plan to repay or refinance the $520.0 million current revolving-facility balance.
- Evaluate the effect of higher interest rates on interest expense, leverage and compliance with the 4.5-to-1.0 consolidated indebtedness-to-EBITDA covenant.
- Track Embody milestone payments, contingent consideration and the finalization of preliminary acquisition accounting.
- Assess progress under the 2019 and 2021 restructuring plans against expected savings and remaining charges.
- Follow the pending FDA warning letter, quality-system remediation and related regulatory restrictions.
- Review developments in product-liability litigation and the IRS tax disputes, including possible cash requirements beyond accrued amounts.