ZIMMER BIOMET HOLDINGS, INC. quarterly report, Q3 FY2023

Zimmer Biomet Holdings, Inc. — Form 10-Q Summary

Reporting period: Three and nine months ended September 30, 2023. The interim financial statements are unaudited and presented primarily on a continuing-operations basis following the March 2022 spinoff of the spine and dental businesses into ZimVie.

Business Context and Reporting Period

Zimmer Biomet designs, manufactures and markets orthopedic reconstructive, sports medicine, biologics, extremities and trauma, craniomaxillofacial and thoracic, surgical, robotic and digital products. Reportable segments are Americas, EMEA and Asia Pacific. Management attributed sales growth to recovery in elective procedures, improved supply-chain execution, new product introductions and commercial execution.

Key Financial Metrics

Metric	Q3 2023	Q3 2022	9M 2023	9M 2022
Net sales	$1,753.6 million	$1,669.8 million	$5,454.1 million	$5,114.8 million
Operating profit	$266.6 million	$245.3 million	$923.5 million	$724.6 million
Operating margin	15.2%	14.7%	16.9%	14.2%
Net earnings attributable to Zimmer Biomet	$162.7 million	$194.0 million	$604.8 million	$361.9 million
Diluted EPS	$0.77	$0.92	$2.88	$1.72
Operating cash flow from continuing operations	Not separately provided	Not separately provided	$993.2 million	$1,112.0 million

Q3 net margin was approximately 9.3%, compared with approximately 11.6% in the prior-year quarter. Nine-month net margin was approximately 11.1%, compared with approximately 7.1% in the prior-year period.

Sales growth: Q3 sales increased 5.0%; nine-month sales increased 6.6%. U.S. sales rose 6.0% in Q3 and 7.8% year to date; international sales rose 3.6% and 5.1%, respectively.
Product categories: Q3 knees increased 7.5%, hips declined 0.6%, S.E.T. increased 3.3% and Other increased 17.2%. Nine-month changes were 10.6%, 4.0%, 2.1% and 10.0%, respectively.
Profitability: Q3 operating margin improved 50 basis points despite higher research and development spending, excess and obsolete inventory charges and commercial investments. Nine-month operating margin improved 270 basis points.
Expenses: Q3 R&D was $116.9 million, or 6.7% of sales, versus 6.1% in the prior-year quarter. Restructuring charges were $24.3 million versus $28.3 million. No significant quality-remediation expense was recognized in either 2023 period.
Cash generation and investment: Nine-month operating cash flow was $993.2 million. Investing cash outflows were $558.1 million, including $232.8 million for instruments, $228.3 million for property, plant and equipment, $86.4 million for intellectual property and $32.9 million for acquisitions.
Liquidity: Cash and cash equivalents were $292.1 million at September 30, 2023, down from $375.7 million at year-end 2022. The company reported $1.0 billion of availability under its 364-day facility and approximately $1.4 billion under its five-year revolving facility.
Debt: Total debt was approximately $5.5 billion, including $355.0 million classified as current and $5,127.4 million of long-term debt. Interest expense increased to $51.1 million in Q3 and $150.9 million year to date.
Capital returns: The company paid $150.7 million of dividends year to date and repurchased $281.9 million of common stock. The quarterly dividend was $0.24 per share, and $591.7 million remained authorized under the share-repurchase program.

Material Changes Versus the Prior Comparable Period

Q3 net earnings declined 16.1% despite 5.0% sales growth, primarily because Q3 2022 included an approximately $81 million favorable tax benefit and 2023 included greater R&D and commercial investment.
Nine-month net earnings increased 67.1%, benefiting from higher sales, lower litigation, restructuring and quality-remediation charges, and the absence of the $114.3 million unrealized loss on the ZimVie investment recognized in 2022.
Other income improved to $3.8 million in Q3 and $10.3 million year to date, compared with losses of $25.4 million and $124.1 million, respectively, in the prior-year periods. Zimmer Biomet disposed of its remaining ZimVie shares in February 2023.
Operating cash flow decreased $118.8 million year to date, primarily because of increased inventory investment and higher litigation, income-tax and bonus payments.
The company completed the Embody acquisition in February 2023 and another orthopedic acquisition in April 2023. Preliminary acquisition consideration included $154.5 million for Embody and $15.0 million for the April acquisition, with additional contingent consideration.
The company entered into new five-year and 364-day revolving credit agreements in July 2023 and established a $300.0 million uncommitted credit facility in August 2023. It had $55.0 million outstanding under the five-year facility and $300.0 million under the uncommitted facility at quarter-end.

Guidance, Outlook, Risks and Unusual Items

Management expected 2023 revenue growth to be supported by market growth, procedure-volume recovery, new products and commercial execution. Based on recent exchange rates, foreign currency was expected to reduce full-year 2023 sales growth by approximately 1.0%.
Management expected continued supply-chain and inflation pressure, higher net interest expense from elevated interest rates, lower quality-remediation expense and more favorable non-operating results following the ZimVie share disposition.
The company expects the 2021 restructuring plan to generate approximately $185 million of total pre-tax charges, with approximately $165 million incurred through September 30, 2023. The 2019 plan is expected to generate approximately $370 million of charges, with approximately $300 million incurred.
Tax matters remain material. The IRS has proposed adjustments for tax years 2010–2015, including a proposed approximately $370 million increase in U.S. federal tax expense for 2013 related to transfer pricing, before interest and penalties. Management disputes the proposed adjustments.
Accrued litigation liabilities were $241.4 million at September 30, 2023. Product-liability matters include Durom Cup, metal-reaction and Biomet metal-on-metal hip claims; the ultimate resolution remains uncertain.
An FDA warning letter concerning quality-system requirements at the Warsaw North Campus remained pending. Additional regulatory action could restrict manufacturing, marketing or sales and could materially affect results.
Contractual arrangements may require future payments ranging from $9 million to approximately $485 million, depending on milestones and other events.
After quarter-end, the company closed one acquisition and signed an agreement for another expected to close in Q4 2023. Initial cash consideration was approximately $102 million, with contingent consideration of up to $53 million.
The company stated that cash from operations, cash on hand and available revolving credit capacity should satisfy liquidity needs for at least the next twelve months, while noting that financing availability and terms are not assured.

Important Facts for Investors to Verify

Whether elective-procedure recovery, new products and robotic technology sustain sales growth, particularly in knees and the Other category.
Whether higher R&D, commercial investment, inventory costs, inflation and interest expense pressure future margins and cash conversion.
The timing and outcome of the IRS tax disputes, including potential interest, penalties and cash-tax effects.
Progress and financial exposure related to the pending FDA warning letter and other quality or regulatory matters.
Remaining restructuring charges, expected cost savings and whether savings targets are achieved.
Debt maturities, floating-rate exposure, compliance with the maximum 4.5-to-1 consolidated debt-to-EBITDA covenant and refinancing requirements.
Contingent consideration and integration risks associated with the 2023 acquisitions and the additional Q4 transactions.
Potential losses from product-liability litigation and whether accrued litigation liabilities adequately reflect ultimate obligations.