Zimmer Biomet Holdings, Inc. — Q3 2021 Form 10-Q Summary
Business context and reporting period
Zimmer Biomet designs, manufactures and markets orthopedic reconstructive products, sports medicine, extremities and trauma products, spine and dental products, and related surgical technologies. This unaudited Form 10-Q covers the three and nine months ended September 30, 2021, compared with the corresponding 2020 periods.
Results remained affected by COVID-19, including Delta-variant disruptions and hospital staffing shortages that deferred elective procedures. The company also continued preparing to spin off its Spine and Dental businesses into ZimVie, targeted for completion by mid-2022 subject to regulatory, tax, financing, board and registration conditions.
Key financial metrics
| Metric | Q3 2021 | Q3 2020 | 9M 2021 | 9M 2020 |
|---|---|---|---|---|
| Net sales | $1,924.0 million | $1,929.3 million | $5,798.3 million | $4,939.2 million |
| Operating profit (loss) | $214.9 million | $299.2 million | $701.0 million | $(328.5) million |
| Operating margin | 11.2% | 15.5% | 12.1% | (6.7)% |
| Net earnings (loss) attributable to Zimmer Biomet | $145.6 million | $242.5 million | $485.6 million | $(472.6) million |
| Diluted EPS | $0.69 | $1.16 | $2.31 | $(2.29) |
| Adjusted diluted EPS | $1.81 | $1.81 | $5.42 | $3.56 |
| Operating cash flow | Not separately provided | Not separately provided | $1,133.5 million | $779.4 million |
Q3 net margin was approximately 7.6%, compared with 12.6% in the prior-year quarter. Nine-month net margin was approximately 8.4%, compared with a negative 9.6% in 2020. The nine-month 2020 results included $645.0 million of goodwill and intangible-asset impairment charges, while 2021 included $16.3 million of impairment charges.
- Q3 sales decreased 0.3% year over year; volume and mix increased 0.7%, pricing reduced sales by 1.5%, and foreign exchange increased sales by 0.5%.
- Nine-month sales increased 17.4%; volume and mix contributed 16.6%, pricing reduced sales by 1.6%, and foreign exchange contributed 2.4%.
- Q3 sales by geography were $1,180.5 million in the Americas, $393.1 million in EMEA and $350.4 million in Asia Pacific.
- Nine-month sales by geography were $3,535.1 million in the Americas, $1,207.1 million in EMEA and $1,056.1 million in Asia Pacific.
- Q3 product-category sales included knees of $647.9 million, hips of $453.8 million, S.E.T. of $437.6 million, Dental & Spine of $238.6 million and Other of $146.1 million.
- Research and development expense increased to $108.9 million in Q3 and $383.8 million for nine months, including $65.0 million of charges for certain third-party in-process research and development agreements during the nine-month period.
Liquidity, debt and capital resources
- Cash and cash equivalents were $919.6 million at September 30, 2021, compared with $802.1 million at December 31, 2020.
- Total debt was $7,503.8 million, including $1,045.7 million classified as current and $6,458.1 million classified as long-term.
- Debt due in 2022 included $750.0 million of senior notes and two Japan term loans. Management stated that operating cash flow, new debt, term financing and available revolver capacity could be used to meet these obligations.
- The company had $1.0 billion available under a 364-day revolving facility maturing August 19, 2022, and $1.5 billion available under a five-year revolving facility maturing August 20, 2026. No borrowings were outstanding under either facility at September 30, 2021.
- The company was in compliance with the revolving-credit covenants, including a consolidated indebtedness-to-EBITDA ratio requirement generally capped at 4.5 to 1.0.
- Nine-month investing cash outflow was $357.4 million, including $222.9 million of instrument additions and $108.9 million of property, plant and equipment additions.
- Nine-month financing cash outflow was $650.2 million, including $500.0 million of senior-note redemptions, $149.9 million of dividends and a $100.0 million deferred acquisition payment.
- The quarterly dividend was $0.24 per share. The company stated that future dividends remain subject to board approval and market conditions. The $1.0 billion share-repurchase authorization remained unused at September 30, 2021.
Material changes versus the prior comparable period
- Q3 profitability declined despite broadly flat sales, primarily because of higher litigation charges, ZimVie spinoff costs, higher R&D spending, lower selling prices and unfavorable hedge effects.
- Nine-month results improved substantially, with operating profit of $701.0 million versus an operating loss of $328.5 million in 2020, principally because 2020 included $645.0 million of impairment charges and higher pandemic-related fixed overhead and labor costs.
- Nine-month operating cash flow increased $354.1 million to $1,133.5 million, driven principally by the return to earnings and lower pandemic-related effects. The 2020 comparison also reflected different levels of receivables factoring.
- Q3 litigation-related charges increased to $43.6 million from $19.3 million; nine-month litigation charges decreased to $53.3 million from $100.4 million.
- The 2019 restructuring program generated $64.9 million of charges in the first nine months of 2021. Total estimated program charges were approximately $350 million to $400 million, with expected gross annual pretax savings of approximately $200 million to $300 million by the end of 2023.
- Segment reporting changed effective April 1, 2021 to reflect the planned ZimVie separation. Prior periods were reclassified, but segment comparisons should still be considered in light of the organizational changes.
Guidance, outlook, commentary and risks
- Management expected elective-procedure deferrals to continue in Q4 2021 because of the Delta variant and hospital staffing shortages. The company expected some deferred procedures to return but could not predict the timing.
- China sales were expected to be negatively affected by volume-based procurement, including distributor inventory reductions, pricing negotiations, channel-inventory revaluation and procedure deferrals. The company expected pressure on Asia Pacific knees and hips sales and pricing to continue into 2022.
- Management planned to continue investing in key R&D and commercial initiatives in anticipation of recovery in elective procedures. If currency rates remained near recent levels, management estimated a positive full-year 2021 sales effect of approximately 1.4% from foreign exchange.
- Management believed operating cash flow, cash on hand and available revolver capacity would satisfy liquidity requirements for at least the next twelve months, but noted that pandemic uncertainty could change funding needs.
- Material contingencies include a pending FDA warning letter and related quality remediation at the Warsaw North Campus. Adverse regulatory action could restrict manufacturing, marketing or sales.
- Major litigation matters include Durom Cup claims, Metal Reaction claims, Biomet metal-on-metal hip claims and Heraeus trade-secret proceedings. Estimated remaining liabilities were $51.3 million, $46.2 million and $60.2 million, respectively, for the three product-liability categories; the ultimate exposure may differ materially.
- The IRS has proposed tax adjustments for multiple years, including an estimated approximately $370 million increase in 2013 U.S. federal tax before interest and penalties. The company disputes the proposed adjustments and states that no payment is required until applicable proceedings are completed.
- Unrecognized future payments under development, distribution and other agreements could range from $0 to approximately $370 million, depending on milestones and other events.
Most important facts for investors to verify
- Whether elective-procedure volumes recover as expected and whether staffing constraints or new COVID-19 developments continue to suppress demand.
- The impact of China’s volume-based procurement program on pricing, distributor inventories, volumes and Asia Pacific margins.
- The company’s ability to refinance or repay the $1.0 billion-plus of debt obligations classified as current and due in 2022.
- Progress, costs, tax treatment, financing and required approvals for the planned ZimVie spinoff.
- Resolution and potential additional exposure from the FDA warning letter, quality remediation, product-liability litigation and Heraeus proceedings.
- The ultimate outcome of the IRS audits and proposed transfer-pricing adjustments.
- Whether restructuring savings materialize on the stated timeline and offset ongoing R&D, regulatory, litigation and spinoff costs.