Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following information should be read in conjunction with the interim condensed consolidated financial statements and related 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. The following discussion may contain forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include those factors discussed in this Form 10-Q and in our Annual Report, particularly in “Cautionary Note Regarding Forward-Looking Statements” and “Risk Factors.”
OVERVIEW
ZimVie Inc. (“ZimVie,” “we,” “us,” “our” or the “Company”) was incorporated in the State of Delaware on July 30, 2021 as a wholly owned subsidiary of Zimmer Biomet Holdings, Inc. (“Zimmer Biomet” or “Parent”). We were formed solely for the purpose of effecting the distribution of our outstanding shares of common stock on a pro rata basis to holders of Zimmer Biomet common stock and to hold directly or indirectly the assets and liabilities associated with the dental and spine businesses of Zimmer Biomet prior to the distribution. The distribution was completed on March 1, 2022, and resulted in ZimVie becoming a standalone, publicly traded company. Prior to March 1, 2022, ZimVie’s financial statements were prepared on a carve-out basis and were derived from Zimmer Biomet’s consolidated financial statements and accounting records.
Following the distribution, Zimmer Biomet initially retained 19.7% of the outstanding shares of ZimVie common stock, and all transactions between ZimVie and Zimmer Biomet from the distribution to February 1, 2023 were reported as related party transactions. As of February 1, 2023, Zimmer Biomet had sold all of its 19.7% ownership in ZimVie and is no longer considered a related party. As such, transactions with Zimmer Biomet subsequent to February 1, 2023 are reported as third party transactions.
ZimVie is a leading medical technology company dedicated to enhancing the quality of life for dental and spine patients worldwide. We develop, manufacture and market a comprehensive portfolio of products and solutions designed to support dental tooth replacement and restoration procedures and treat a wide range of spine pathologies. We are well-positioned in the growing global dental implant, biomaterials and digital dentistry market with a strong presence in the tooth replacement market with market leading positions in certain geographies. Our broad portfolio also addresses all areas of spine with market leadership in cervical disc replacement and vertebral body tethering to treat pediatric scoliosis. Our operations are principally managed on a products basis and include two operating segments, 1) the dental products segment, and 2) the spine products segment.
In the dental products market, our core services include designing, manufacturing and distributing a comprehensive portfolio of dental implant solutions, biomaterials and digital dentistry solutions. Dental reconstructive implants are for individuals who are totally without teeth or are missing one or more teeth, dental prosthetic products are aimed at providing aesthetic and functional restoration to resemble the original teeth, and dental regenerative products are for soft tissue and bone rehabilitation.
In the spine products market, our core services include designing, manufacturing and distributing a full suite of spinal surgery solutions to treat patients with back or neck pain caused by degenerative conditions, deformities, tumors or traumatic injury of the spine. We also provide devices that promote bone healing.
We have a broad geographic revenue base, with meaningful exposure to both established and emerging markets. We have six manufacturing site locations, and a global presence in approximately 25 countries.
RESTRUCTURING AND OTHER COST REDUCTION INITIATIVES
2022 Programs
In June 2022, we initiated a restructuring plan with the objective of reducing costs and optimizing our global footprint. In addition, the national volume-based procurement (“VBP”) program for spine products in China took place in late September 2022, and we were not successful in our bid. As a result, after evaluating our alternatives, in the fourth quarter of 2022 we approved a plan to exit our spine products activities in China. For the three months ended March 31, 2023, we recorded charges of $1.1 million related to accelerated
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depreciation of fixed assets as we wind down our spine products operations in China. Annual 2022 spine product sales in China represented less than 1% of our consolidated annual sales.
During the three months ended March 31, 2023, we recorded pre-tax charges of $3.3 million related to these actions, and we have incurred pre-tax charges of $12.3 million from inception to date. We anticipate total charges related to these actions of approximately $14-15 million, including projects in process or under final evaluation. The restructuring charges incurred in the three months ended March 31, 2023 under this plan were primarily related to accelerated depreciation and impairment of assets. We anticipate incurring the remaining charges throughout 2023.
The national VBP program for dental products in China took place in January 2023, and we were not successful in our bid. We are evaluating the impact of this result on our dental products business in China and reviewing our strategic alternatives. Annual 2022 dental product sales in China represented less than 1% of our consolidated annual sales.
2023 Program
In April 2023, we initiated additional restructuring activities to better position our organization for future success based on the current business environment. These initiatives have the overall objective of reducing our global cost structure and streamlining our organizational infrastructure across all regions, functions, and levels. As a result of this initiative, we expect an approximate 5% reduction in our global workforce, in addition to reductions in discretionary spending.
We expect this restructuring initiative will complement our initiatives to improve operating margins and cash flow, as well as provide us with the financial flexibility to continue to prioritize investments in our product offerings and technologies. We estimate that this program will generate $17-20 million in annualized net savings by 2024. We accrued $1.6 million in March 2023 for professional fees to assist in the evaluation of our global organization and cost structure, and we anticipate total charges related to the program of approximately $15-16 million, to be incurred in 2023 and 2024.
RESULTS OF OPERATIONS
Three Months Ended March 31, 2023 and 2022
Net Sales by Product Category
The following tables present net sales by product category and the components of the percentage changes (dollars in thousands):
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Three Months Ended March 31, |
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Foreign |
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2023 |
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2022 |
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% Inc (Dec) |
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Volume/Mix |
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Price |
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Exchange |
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Dental |
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$ |
120,170 |
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$ |
120,569 |
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(0.3 |
)% |
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2.0 |
% |
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(0.2 |
)% |
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(2.1 |
)% |
Spine |
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104,918 |
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114,113 |
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(8.1 |
) |
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|
(6.9 |
) |
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(0.9 |
) |
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(0.3 |
) |
Third Party Sales |
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225,088 |
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234,682 |
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(4.1 |
) |
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(2.3 |
) |
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(0.6 |
) |
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(1.2 |
) |
Related Party |
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339 |
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919 |
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(63.1 |
) |
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N/A |
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N/A |
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N/A |
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Total |
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$ |
225,427 |
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$ |
235,601 |
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(4.3 |
) |
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N/A |
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N/A |
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N/A |
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Demand (Volume/Mix) Trends
Demand in the dental product category increased in the three months ended March 31, 2023 compared to the same 2022 period, primarily due to higher demand for tooth replacement procedures combined with a growing digital dentistry market. Demand in the spine product category was negatively impacted in the three months ended March 31, 2023 compared to the same prior year period by increased competition and lower sales due to our exit from our spine products activities in China. This decline was partially offset by net spine product sales retained by Zimmer Biomet in the same 2022 period in certain geographies where our separation and transition activities extended beyond the distribution date that did not recur in 2023 (for more information, see "After Distribution - Interim Operating Agreements" in Note 12 to our condensed consolidated financial statements). Both segments were favorably impacted by one more selling day in the first quarter of 2023.
Pricing Trends
The dental product category experienced price improvement in certain geographic regions, including North America and Europe; however, there was an overall price decline due to the timing of price changes year-over-year in certain European countries. The spine product category continued to experience governmental healthcare cost pricing pressure efforts and similar efforts at local hospitals and health systems.
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Foreign Currency Exchange Rates
In countries where we have a subsidiary, we sell to customers in their local currencies. Accordingly, our net sales as reported in U.S. Dollars are affected by changes in foreign currency exchange rates. We are primarily exposed to foreign currency exchange rate risk with respect to net sales denominated in Euros, Chinese Renminbi, Israeli Shekel, New Zealand Dollar, Japanese Yen, Canadian Dollar and Swedish Krona. For the three months ended March 31, 2023, foreign exchange fluctuations had a negative effect on year-over-year sales, mainly due to the strengthening of the U.S. Dollar against the Euro.
Expenses as a Percent of Net Sales
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Three Months Ended March 31, |
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2023 |
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2022 |
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2023 vs. 2022 Inc (Dec) |
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Cost of products sold, excluding intangible asset amortization |
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31.4 |
% |
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36.1 |
% |
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(4.7 |
)% |
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Related party cost of products sold, excluding intangible asset amortization |
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0.1 |
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0.3 |
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(0.2 |
) |
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Intangible asset amortization |
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9.1 |
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8.9 |
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0.2 |
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Research and development |
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6.8 |
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7.5 |
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(0.7 |
) |
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Selling, general and administrative |
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56.8 |
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56.9 |
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(0.1 |
) |
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Restructuring and other cost reduction initiatives |
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2.2 |
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0.3 |
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1.9 |
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Acquisition, integration, divestiture and related |
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0.7 |
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3.8 |
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(3.1 |
) |
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Operating Loss |
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(7.2 |
) |
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(13.8 |
) |
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(6.6 |
) |
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Cost of Products Sold and Intangible Asset Amortization
The decrease in cost of products sold in dollars and as a percentage of net sales in the three months ended March 31, 2023 compared to the three months ended March 31, 2022 was primarily due to a reduction in inventory charges in the spine product category, as well as expense of $1.6 million in share-based compensation due to converted Zimmer Biomet awards recorded in the prior year period that did not recur (for more information, see Note 3 to our condensed consolidated financial statements).
Intangible asset amortization decreased slightly in dollars and increased slightly as a percentage of net sales in the three months ended March 31, 2023 as compared to the three months ended March 31, 2022, due to the relatively fixed nature of amortization expense period over period.
Operating Expenses
Research and development ("R&D") expenses as a percentage of net sales decreased in the three months ended March 31, 2023 compared to the same 2022 period, primarily due to less spend in the dental segment due to timing of new product launch initiatives. R&D expenses also decreased as a result of a decrease of $1.8 million in share-based compensation due to converted Zimmer Biomet awards recorded in the prior year period that did not recur (for more information, see Note 3 to our condensed consolidated financial statements).
Selling, general and administrative ("SG&A") expenses decreased slightly as a percentage of net sales in the three months ended March 31, 2023 as compared to the three months ended March 31, 2022, primarily as a result of decreases in variable selling expenses resulting from decreased sales, and indemnification of certain legal costs by Zimmer Biomet in the three months ended March 31, 2023, stricter cost containment measures on discretionary spending, and a $7.0 million decrease in share-based compensation due to converted Zimmer Biomet awards recorded in the prior year period that did not recur (for more information, see Note 3 to our condensed consolidated financial statements). These decreases were partially offset by increased general and administrative costs due to us being a standalone public company for the entire three-month period ended March 31, 2023 compared to the one-month period ended March 31, 2022 as well as increased medical education events in the 2023 period compared to the 2022 period.
Expenses related to restructuring and other cost reduction initiatives relate to our exit of our spine products business in China, our restructuring plan initiated in June 2022, and Zimmer Biomet's restructuring plans initiated in the fourth quarters of 2019 and 2021, and the restructuring activities we initiated in April 2023. We recognized expenses of $5.0 million and $0.7 million in the three months ended March 31, 2023 and 2022, respectively. These expenses primarily related to consulting fees, employee termination benefits, accelerated depreciation, impairment of assets and for the three months ended March 31, 2023, included $1.6 million accrued for professional services related to the development of the April 2023 global restructuring program. For more information regarding these expenses, see Note 13 to our condensed consolidated financial statements.
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Acquisition, integration, divestiture and related expenses decreased in the three months ended March 31, 2023 as compared to the three months ended March 31, 2022, due to less costs incurred in connection with building out capabilities necessary to becoming a standalone, public company.
Other Income (Expense), net, Interest Expense, net, and Income Taxes
Our non-operating other (expense) income, net, primarily relates to the remeasurement of monetary assets and liabilities that are denominated in a currency other than the subsidiary’s functional currency. Therefore, the income or expense varies based upon the volatility of foreign currency exchange rates.
Interest expense, net, in the three months ended March 31, 2023 increased compared to the same 2022 period, primarily due to higher average outstanding debt and increased interest rates.
Our effective tax rate (“ETR”) on loss before income taxes was (15.3%) and 22.4% for the three months ended March 31, 2023 and 2022, respectively. In the three months ended March 31, 2023, the income tax expense was lower than the 21% U.S. federal statutory rate due to additional expense for increasing valuation allowances. In the three months ended March 31, 2022 the additional income tax benefit compared to the statutory rate was driven by the impact of losses recorded prior to the distribution that were calculated on a “carve-out” basis, which applied the accounting guidance as if we filed income tax returns on a standalone, separate return basis and are not reflective of the tax results we expect to generate in the future. Additionally, for the three months ended March 31, 2023 and 2022, profit in inventory recorded prior to the distribution is non-taxable as the inventory is sold post-separation to third parties, resulting in a significant benefit to the foreign rate differential.
During the three months ended March 31, 2022, income tax balances were adjusted to reflect the income tax positions after distribution, including those related to tax loss and credit carryforwards, other deferred tax assets and liabilities and valuation allowances. These separation-related adjustments resulted in a $3.9 million increase to the net deferred tax liability, primarily due to inventory and intangible assets transferred in the separation, tax rate changes and changes to the permanent reinvestment assertion in the post-separation environment. The increase in the net deferred tax liability was offset by a corresponding decrease in net parent investment.
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
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Net Sales |
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Operating Profit |
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Operating Profit as a Percentage of Net Sales |
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Three Months Ended March 31, |
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Three Months Ended March 31, |
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Three Months Ended March 31, |
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(dollars in thousands) |
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2023 |
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2022 |
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2023 |
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2022 |
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2023 |
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|
2022 |
|
Dental |
|
$ |
120,170 |
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$ |
120,569 |
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$ |
23,033 |
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$ |
25,659 |
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19.2 |
% |
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21.3 |
% |
Spine |
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104,918 |
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|
114,113 |
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10,235 |
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|
5,099 |
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9.8 |
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4.5 |
|
Sales in our dental segment in the three months ended March 31, 2023 decreased from the same prior year period, primarily due to changes in foreign exchange rates, partially offset by an increase in demand for tooth replacement procedures combined with a growing digital dentistry market. Sales in our spine segment in the three months ended March 31, 2023 decreased from the same prior year period, primarily due to increased competition and lower sales as a result of our exit from our spine products activities in China, partially offset by net spine product sales retained by Zimmer Biomet in the 2022 period in certain geographies where our separation and transition activities extended beyond the distribution date that did not recur in 2023 (for more information, see "After Distribution - Interim Operating Agreements" in Note 12 to our condensed consolidated financial statements).
In our dental segment, operating profit decreased for the three months ended March 31, 2023 compared to the same prior year period, primarily due to timing of new product launch initiatives. In our spine segment, operating profit increased for the three months ended March 31, 2023 compared to the same prior year period, primarily due to E&O inventory charges in the 2022 period that did not recur.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2023 and December 31, 2022, we had $66.4 million and $89.6 million, respectively, in cash and cash equivalents.
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Sources of Liquidity
Cash flows used in operating activities were $7.2 million and $9.9 million in the three months ended March 31, 2023 and March 31, 2022, respectively. An increase in cash used in working capital was primarily attributable to an increase in cash used for accounts payable, accrued liabilities and taxes and a decrease in cash provided by inventories, mostly offset by a decrease in cash used for prepayments and an increase in cash provided by accounts receivable.
Cash flows used in investing activities were $5.8 million in the three months ended March 31, 2023 compared to $8.1 million in the three months ended March 31, 2022. The decrease in cash used in investing activities was primarily related to the decrease in expenditures for instruments due to efforts to optimize our product portfolio and manufacturing and logistics network.
Cash flows used in financing activities were $10.9 million in the three months ended March 31, 2023 compared to cash flows provided by financing activities of $22.2 million in the three months ended March 31, 2022. In the current year period, we prepaid the debt repayments scheduled for the first half of 2024 (as discussed in Note 7 to our condensed consolidated financial statements). In the 2022 period, new borrowings under our Term Loan (as discussed in Note 7 to our condensed consolidated financial statements) were used primarily for a dividend paid to Zimmer Biomet at the time of the distribution.
Liquidity and Capital Resources
For additional information regarding our current debt arrangements, including the term loan amortization schedule, see Note 10 to our consolidated financial statements included in our Annual Report. In addition, for information regarding our other material estimated future cash requirements under our contractual obligations and certain other commitments, see “Material Cash Requirements” in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report. There have been no material changes to such information except as set forth herein.
We believe that available cash and cash equivalents, cash flows generated through operations and cash available under our revolving credit facility will be sufficient to meet our liquidity needs, including capital expenditures, for at least the next 12 months.
CRITICAL ACCOUNTING ESTIMATES
Our financial results are affected by the selection and application of accounting policies and methods and 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. Critical accounting estimates are those that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition and results of operations. There were no changes in the three-month period ended March 31, 2023 to the application of our critical accounting estimates as described in our Annual Report.
ACCOUNTING DEVELOPMENTS
See Note 1 to our condensed consolidated financial statements for information on how recent accounting pronouncements have affected or may affect our financial position, results of operations or cash flows.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Market Risk
We are exposed to certain market risks as part of our ongoing business operations, including risks from changes in foreign currency exchange rates, interest rates and commodity prices that could affect our financial condition, results of operations and cash flows.
Foreign Currency Exchange 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. We are primarily exposed to foreign currency exchange rate risk with respect to transactions and net assets denominated in Euros, Chinese Renminbi, Israeli Shekel, New Zealand Dollar, Japanese Yen, Canadian Dollar and Swedish Krona. We manage our foreign currency exposure centrally, on a combined basis, which allows us to net exposures and to take advantage of any natural offsets. To reduce the uncertainty of foreign currency exchange rate movements on transactions denominated in foreign currencies, we enter into derivative financial instruments in the form of foreign currency exchange forward contracts with major financial institutions. These forward contracts are designed to reduce the foreign exchange impact monetary assets and liabilities in non-functional currencies have on our financial results. Realized and unrealized gains and losses on these contracts are recognized in other income (expense), net.
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Commodity Price Risk
We purchase raw material commodities such as cobalt chrome, titanium, tantalum, polymer and sterile packaging. We enter into supply contracts generally with terms of 12 to 24 months, where available, on these commodities to alleviate the effect of market fluctuations in prices. As part of our risk management program, we perform sensitivity analyses related to potential commodity price changes. A 10% price change across all these commodities would not have a material effect on our condensed consolidated financial position, results of operations or cash flows.
Interest Rate Risk
Our interest expense and related risks as reported in our condensed consolidated statements of operations are growing due to the Credit Agreement. As of March 31, 2023 we had $525.9 million of floating rate debt potentially subject to the adjusted term secured overnight financing rate ("SOFR"). A hypothetical increase of 100 basis points in SOFR to our floating rate debt would, among other things, increase our annual pre-tax loss by $5.3 million.
Credit Risk
Financial instruments, which potentially subject us to concentrations of credit risk, are primarily cash and cash equivalents, derivative instruments and accounts receivable.
We place our cash and cash equivalents with highly rated financial institutions and limit the amount of credit exposure to any one entity. We believe we do not have any significant credit risk on our cash and cash equivalents.
Our concentrations of credit risks with respect to trade accounts receivable is 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 dental practices in the 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. Our ability to collect accounts receivable in some countries depends in part upon the financial stability of these hospital and healthcare sectors and the respective countries’ national economic and healthcare systems. Most notably, in Europe healthcare is typically sponsored by the government. Since we sell products to public hospitals in those countries, we are indirectly exposed to government budget constraints. To the extent the respective governments’ ability to fund their public hospital programs deteriorates, we may have to record significant bad debt expenses in the future.
While we are exposed to risks from the broader healthcare industry in Europe and around the world, there is no significant net exposure due to any individual customer. Exposure to credit risk is controlled through credit approvals, credit limits and monitoring procedures, and we believe that reserves for losses are adequate.