10-K 1 d458588d10k.htm FORM 10-K Form 10-K
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For year ended December 31, 2012

Commission file number 001-16407

 

LOGO

ZIMMER HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   13-4151777
(State of Incorporation)   (IRS Employer Identification No.)
345 East Main Street Warsaw, Indiana   46580
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (574) 267-6131

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class   Name of each exchange on which registered
Common Stock, $.01 par value   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  þ        No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  ¨        No  þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  þ        No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  þ        No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

 

Large accelerated filer  þ

   Accelerated filer  ¨   Non-accelerated filer  ¨   Smaller reporting company  ¨
     (Do not check if a smaller reporting company)  

Indicate by checkmark whether the registrant is a shell company (as defined Exchange Act Rule 12b-2).  Yes  ¨        No  þ

The aggregate market value of shares held by non-affiliates was $11,217,437,561 (based on the closing price of these shares on the New York Stock Exchange on June 29, 2012 and assuming solely for the purpose of this calculation that all directors and executive officers of the registrant are “affiliates”). As of February 15, 2013, 169,354,131 shares of the registrant’s $.01 par value common stock were outstanding.

Documents Incorporated by Reference

 

Document

   Form 10-K  

Portions of the Proxy Statement with respect to the 2013 Annual Meeting of Stockholders

     Part III   

 

 


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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

Cautionary Note About Forward-Looking Statements

This Annual Report on Form 10-K includes “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. They often include words such as “may,” “will,” “should,” “would,” “could,” “anticipate,” “expect,” “plan,” “seek,” “believe,” “predict,” “estimate,” “potential,” “project,” “target,” “forecast,” “intend,” “strategy,” “future,” “opportunity,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. A detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in the section titled “Risk Factors” (refer to Part I, Item 1A of this report). Readers of this report are cautioned not to place undue reliance on these forward-looking statements. While we believe the assumptions on which the forward-looking statements are based are reasonable, there can be no assurance that these forward-looking statements will prove to be accurate. We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K.

 

Table of Contents    Page  
PART I           3  
Item 1.    Business      3  
Item 1A.    Risk Factors      9   
Item 1B.    Unresolved Staff Comments      14  
Item 2.    Properties      15  
Item 3.    Legal Proceedings      15  
Item 4.    Mine Safety Disclosures      15  
PART II           16   
Item 5.    Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      16   
Item 6.    Selected Financial Data      17   
Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      18   
Item 7A.    Quantitative and Qualitative Disclosures About Market Risk      28   
Item 8.    Financial Statements and Supplementary Data      32   
Item 9.    Changes in and Disagreements With Accountants on Accounting and Financial Disclosure      66   
Item 9A.    Controls and Procedures      66   
Item 9B.    Other Information      66   
PART III           67   
Item 10.    Directors, Executive Officers and Corporate Governance      67   
Item 11.    Executive Compensation      67   
Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      67   
Item 13.    Certain Relationships and Related Transactions and Director Independence      67  
Item 14.    Principal Accounting Fees and Services      67   
PART IV           68   
Item 15.    Exhibits, Financial Statement Schedules      68   

 

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PART I

 

ITEM 1.   Business

 

OVERVIEW

 

We are a global leader in the design, development, manufacture and marketing of orthopaedic reconstructive, spinal and trauma devices, biologics, dental implants and related surgical products. We also provide other healthcare related services. In this report, “Zimmer,” “we,” “us,” “our” and similar words refer collectively to Zimmer Holdings, Inc. and its subsidiaries. Zimmer Holdings refers to the parent company only.

Zimmer Holdings was incorporated in Delaware in 2001. Our history dates to 1927, when Zimmer Manufacturing Company, a predecessor, was founded in Warsaw, Indiana. On August 6, 2001, Zimmer Holdings was spun off from its former parent and became an independent public company.

CUSTOMERS, SALES AND MARKETING

 

Our primary customers include orthopaedic surgeons, neurosurgeons, oral surgeons, dentists, hospitals, stocking distributors, healthcare dealers and, in their capacity as agents, healthcare purchasing organizations or buying groups. These customers range from large multinational enterprises to independent clinicians and dentists.

We have operations in more than 25 countries and market products in more than 100 countries. We manage our operations through three major geographic segments – the Americas, which is comprised principally of the U.S. and includes other North, Central and South American markets; Europe, which is comprised principally of Europe and includes the Middle East and Africa markets; and Asia Pacific, which is comprised primarily of Japan and Australia and includes other Asian and Pacific markets.

We market and sell products through three principal channels: 1) direct to healthcare institutions, such as hospitals or direct channel accounts; 2) through stocking distributors and healthcare dealers; and 3) directly to dental practices and dental laboratories. With direct channel accounts, inventory is generally consigned to sales agents or customers. With sales to stocking distributors, healthcare dealers, dental practices and dental laboratories, title to product passes upon shipment or upon implantation of the product. Direct channel accounts represented approximately 75 percent of our net sales in 2012. No individual direct channel account, stocking distributor, healthcare dealer, dental practice or dental laboratory accounted for more than 1 percent of our net sales for 2012.

We stock inventory in our warehouse facilities and retain title to consigned inventory in sufficient quantities so that products are available when needed for surgical procedures. Safety stock levels are determined based on a number of factors, including demand, manufacturing lead times and quantities required to maintain service levels. We also carry trade accounts receivable balances based on credit terms that are generally consistent with local market practices.

We utilize a network of sales associates, sales managers and support personnel, most of whom are employed or contracted by independent distributors and sales agencies. We invest a significant amount of time and expense in training sales associates in how to use specific products and how to best inform surgeons of product features and uses. Sales force representatives must have strong technical selling skills and medical education to provide technical support for surgeons.

In response to the different healthcare systems throughout the world, our sales and marketing strategies and organizational structures differ by region. We utilize a global approach to sales force training, marketing and medical education to provide consistent, high quality service. Additionally, we keep current with key surgical developments and other issues related to orthopaedic surgeons, neurosurgeons, dentists and oral surgeons and the medical procedures they perform.

The following is a summary of our three reportable segments. See Note 17 to the consolidated financial statements for more information regarding our segments.

Americas.    The Americas is our largest geographic segment, accounting for $2,476.3 million, or 56 percent, of 2012 net sales, with the U.S. accounting for 92 percent of net sales in this region. The U.S. sales force consists of a combination of employees and independent sales agents, most of whom sell products exclusively for Zimmer. The sales force in the U.S. receives a commission on product sales and is responsible for many operating decisions and costs.

In this region, we contract with group purchasing organizations and managed care accounts and have promoted unit growth by offering volume discounts to customer healthcare institutions within a specified group. Generally, we are designated as one of several preferred purchasing sources for specified products, although members are not obligated to purchase our products. Contracts with group purchasing organizations generally have a term of three years, with extensions as warranted.

In the Americas, we monitor and rank independent sales agents and our direct sales force across a range of performance metrics, including the achievement of sales targets and maintenance of efficient levels of working capital.

Europe.    The European geographic segment accounted for $1,177.4 million, or 26 percent, of 2012 net sales, with France, Germany, Italy, Spain, Switzerland and the United Kingdom collectively accounting for 70 percent of net sales in the region. This segment also includes other key markets, including Benelux, Nordic, Central and Eastern Europe, the Middle East and Africa. Our sales force in this segment is comprised of direct sales associates, commissioned agents, independent distributors and sales support personnel. We emphasize the advantages of our clinically proven, established designs and innovative solutions and new and enhanced materials and surfaces. In most European countries, healthcare

 

 

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is sponsored by the government and therefore government budgets impact healthcare spending, which can affect our sales in this segment.

Asia Pacific.    The Asia Pacific geographic segment accounted for $818.0 million, or 18 percent, of 2012 net sales, with Japan being the largest market within this segment, accounting for 51 percent of the region’s sales. This segment also includes key markets such as Australia, New Zealand, Korea, China, Taiwan, India, Thailand, Singapore, Hong Kong and Malaysia. In Japan and most countries in the Asia Pacific region, we maintain a network of dealers, who act as order agents on behalf of hospitals in the region, and sales associates, who build and maintain relationships with orthopaedic surgeons, neurosurgeons and dental surgeons in their markets. These sales associates cover over 7,000 hospitals in the region. The knowledge and skills of these sales associates play a critical role in providing service, product information and support to surgeons. In 2012, we opened a research and development center in Beijing, China, which focuses on products and technologies designed to meet the unique needs of Asian patients and their healthcare providers.

SEASONALITY

 

Our business is somewhat seasonal in nature, as many of our products are used in elective 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.

DISTRIBUTION

 

We operate distribution facilities domestically in Warsaw, Indiana; Southaven, Mississippi; and Carlsbad, California and internationally in Australia, Austria, Belgium, Canada, the Czech Republic, China, Finland, France, Germany, Hong Kong, India, Italy, Japan, Korea, Malaysia, the Netherlands, New Zealand, Portugal, Russia, Singapore, South Africa, Spain, Sweden, Switzerland, Taiwan, Thailand and the United Kingdom.

We generally ship our orders via expedited courier. We do not consider our backlog of firm orders to be material to an understanding of our business.

PRODUCTS

 

Our products include orthopaedic reconstructive implants, spinal and trauma devices, biologics, dental implants and related surgical products.

Orthopaedic reconstructive implants

Knee Implants

Total knee replacement surgeries typically include a femoral component, a patella (knee cap), a tibial tray and an articular surface (placed on the tibial tray). Knee replacement surgeries include first-time, or primary, joint replacement procedures and revision procedures for the replacement, repair or enhancement of an implant or component from a previous procedure. There are also procedures for partial

reconstruction of the knee, which treat limited knee degeneration and involve the replacement of only one side, or compartment, of the knee with a unicompartmental knee prosthesis.

Our significant knee brands include the following:

 

NexGen® Complete Knee Solution

 

Natural-Knee® II System

 

Innex® Total Knee System

 

Persona™ The Personalized Knee System

 

Zimmer® Unicompartmental Knee System

 

Zimmer® Patient Specific Instruments

 

Zimmer® Segmental System

Hip Implants

Total hip replacement surgeries replace both the head of the femur and the socket portion of the pelvis (acetabulum) of the natural hip. Hip procedures include first time, or primary, joint replacement as well as revision procedures. Hip implant procedures involve the use of bone cement to attach or affix the prosthetic components to the surrounding bone, or are press-fit into bone, which means that they have a surface that bone affixes to through either ongrowth or ingrowth technologies.

Our significant hip brands include the following:

 

Zimmer® M/L Taper Hip Prosthesis and Zimmer M/L Taper Hip Prosthesis with Kinectiv® Technology

 

Alloclassic® (Zweymüller®) Hip System

 

CLS® Spotorno® Hip System and CLS Brevius® Hip Stem with Kinectiv Technology

 

Fitmore® Hip Stem

 

Continuum® Acetabular System

 

Trilogy® IT Acetabular System

 

Allofit® IT Alloclassic® Acetabular System

 

Trabecular MetalTM Modular Acetabular System

Extremity Implants

Our extremity portfolio, primarily shoulder and elbow products, is designed to treat arthritic conditions, soft tissue injuries and fractures.

Our significant extremity brands include the following:

 

Trabecular Metal Reverse Shoulder System

 

Bigliani/Flatow® Complete Shoulder Solution Family

 

Zimmer® Anatomical Shoulder™ System

 

Zimmer® Trabecular Metal Total Ankle

 

Coonrad/Morrey Total Elbow

Dental Implants

Our dental products division manufactures and/or distributes: (1) dental reconstructive implants — for individuals who are totally without teeth or are missing one or more teeth; (2) dental restorative products — aimed at providing a more natural restoration to resemble the original teeth; and (3) dental regenerative products — for soft tissue and bone rehabilitation.

Our significant dental brands include the following:

 

Tapered Screw-Vent® Implant System

 

 

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Zimmer® Hex-Lock® Contour Abutment and Restorative Products

 

Puros® Allograft Products1

Trauma

Trauma products include devices used to stabilize damaged or broken bones and their surrounding tissues to support the body’s natural healing processes. Fractures are most often stabilized using internal fixation devices such as plates, screws, nails, wires and pins, but may also be stabilized using external fixation devices. Biologics treatments are used in conjunction with traditional trauma devices to encourage healing and replace bone lost during an injury.

Our significant trauma brands include the following:

 

Zimmer® Natural Nail® System

 

NCB® Polyaxial Locking Plate System

 

XtraFix® External Fixation System

 

Zimmer® Periarticular Locking Plate System

 

Zimmer® Universal Locking System

 

Zimmer® Cable-Ready® System

Spine Implants

Our Spine products division designs, manufactures and distributes medical devices and surgical instruments to deliver comprehensive solutions for those with back or neck pain caused by degenerative conditions, deformities or traumatic injury of the spine.

Our significant spine brands include the following:

 

PathFinder NXT® Minimally Invasive Pedicle Screw System

 

Trabecular Metal Implants

 

Sequoia® Pedicle Screw System

 

Trinica® Select Anterior Cervical Plating System

 

Dynesys® Dynamic Stabilization System

Surgical

We develop, manufacture and market products that support reconstructive, trauma, spine and dental implant procedures, with a focus on bone cements, surgical wound site management and blood management.

Our significant surgical brands include the following:

 

PALACOS®2 Bone Cement

 

A.T.S.® Automatic Tourniquet Systems

 

Pulsavac® Plus, Pulsavac Plus AC and Pulsavac Plus LP Wound Debridement Systems

 

Zimmer® Blood Reinfusion System

 

Hemovac® Blood Management System

 

Zimmer® Universal Power System

Biologics

Our research and development efforts include a Biologics group based in Austin, Texas, with its own full-time staff and dedicated projects focusing on the development of a variety of

 

1 Manufactured for Zimmer Dental, Inc. by Tutogen Medical GmbH, an RTI Biologics, Inc. company

2 Registered trademark of Heraeus Kulzer GmbH

biologic technologies for joint preservation and other musculoskeletal applications. This group works on biological solutions to repair and regenerate damaged or degenerated musculoskeletal tissues using biomaterials/cell therapies which offer the possibility of treating damaged joints by biological repair rather than replacing them.

Significant biologics products we sell include the following:

 

DeNovo® NT Natural Tissue Graft

 

Chondrofix® Osteochondral Allograft

 

Gel-One®3 Cross-linked Hyaluronate

RESEARCH AND DEVELOPMENT

 

We have extensive research and development activities to develop new surgical techniques, materials, biologics and product designs. The research and development teams work closely with our strategic brand marketing function. The rapid commercialization of innovative new materials, biologics products, implant and instrument designs and surgical techniques remains one of our core strategies and continues to be an important driver of sales growth.

We are broadening our offerings in each of our product categories and exploring new technologies with possible applications in multiple areas. Our primary research and development facility is located in Warsaw, Indiana. We have other research and development personnel based in, among other places, Beijing, China; Winterthur, Switzerland; Austin, Texas; Minneapolis, Minnesota; Carlsbad, California; Dover, Ohio; and Parsippany, New Jersey. As of December 31, 2012, we employed more than 1,000 research and development employees worldwide.

We expect to continue to identify innovative technologies, which may include acquiring complementary products or businesses, establishing technology licensing arrangements or strategic alliances.

GOVERNMENT REGULATION AND COMPLIANCE

 

We are subject to government regulation in the countries in which we conduct business. In the U.S., numerous laws and regulations govern all the processes by which medical devices are brought to market. These include, among others, the Federal Food, Drug and Cosmetic Act and regulations issued or promulgated thereunder. The Food and Drug Administration (FDA) has enacted regulations that control all aspects of the development, manufacture, advertising, promotion and postmarket surveillance of medical products, including medical devices. In addition, the FDA controls the access of products to market through processes designed to ensure that only products that are safe and effective are made available to the public.

Most of our new products fall into an FDA classification that requires the submission of a Premarket Notification (510(k)) to the FDA. This process requires us to demonstrate that the device to be marketed is at least as safe and effective as, that is, substantially equivalent to, a legally marketed

 

3 Registered trademark of Seikagaku Corporation

 

 

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device. We must submit information that supports our substantial equivalency claims. Before we can market the new device, we must receive an order from the FDA finding substantial equivalence and clearing the new device for commercial distribution in the U.S.

Other devices we develop and market are in a category (class) for which the FDA has implemented stringent clinical investigation and Premarket Approval (PMA) requirements. The PMA process requires us to provide clinical and laboratory data that establishes that the new medical device is safe and effective. The FDA will approve the new device for commercial distribution if it determines that the data and information in the PMA application constitute valid scientific evidence and that there is reasonable assurance that the device is safe and effective for its intended use(s).

All of our devices marketed in the U.S. have been cleared or approved by the FDA, with the exception of some devices which were in commercial distribution prior to May 28, 1976. The FDA has grandfathered these devices, so new FDA submissions are not required.

Both before and after a product is commercially released, we have ongoing responsibilities under FDA regulations. The FDA reviews design and manufacturing practices, labeling and record keeping, and manufacturers’ required reports of adverse experiences and other information to identify potential problems with marketed medical devices. We are also subject to periodic inspection by the FDA for compliance with the FDA’s Quality System regulations among other FDA requirements, such as restrictions on advertising and promotion. The Quality System regulations govern the methods used in, and the facilities and controls used for, the design, manufacture, packaging and servicing of all finished medical devices intended for human use. If the FDA were to conclude that we are not in compliance with applicable laws or regulations, or that any of our medical devices are ineffective or pose an unreasonable health risk, the FDA could require us to notify healthcare professionals and others that the devices present unreasonable risks of substantial harm to the public health, order a recall, repair, replacement, or refund payment of such devices, detain or seize adulterated or misbranded medical devices, or ban such medical devices.

The FDA may also impose operating restrictions, enjoin and/or restrain certain conduct resulting in violations of applicable law pertaining to medical devices, and assess civil or criminal penalties against our officers, employees or us. The FDA may also recommend prosecution to the U.S. Department of Justice.

The FDA, in cooperation with U.S. Customs and Border Protection (CBP), administers controls over the import of medical devices into the U.S. The CBP imposes its own regulatory requirements on the import of our products, including inspection and possible sanctions for noncompliance. We are also subject to foreign trade controls administered by certain U.S. government agencies, including the Bureau of Industry and Security within the Commerce Department and the Office of Foreign Assets Control within the Treasury Department.

There are also requirements of state, local and foreign governments that we must comply with in the manufacture and marketing of our products.

In many of the foreign countries in which we market our products, we are subject to local regulations affecting, among other things, design and product standards, packaging requirements and labeling requirements. Many of the regulations applicable to our devices and products in these countries are similar to those of the FDA. The member countries of the European Union have adopted the European Medical Device Directive, which creates a single set of medical device regulations for products marketed in all member countries. Compliance with the Medical Device Directive and certification to a quality system enable the manufacturer to place a CE mark on its products. To obtain authorization to affix the CE mark to a product, a recognized European Notified Body must assess a manufacturer’s quality systems and the product’s conformity to the requirements of the Medical Device Directive. We are subject to inspection by the Notified Bodies for compliance with these requirements.

Further, we are subject to various federal and state laws concerning healthcare fraud and abuse, including false claims and anti-kickback laws. These laws are administered by, among others, the U.S. Department of Justice, the Office of Inspector General of the Department of Health and Human Services and state attorneys general. Many of these agencies have increased their enforcement activities with respect to medical device manufacturers in recent years. Violations of these laws are punishable by criminal and/or civil sanctions, including, in some instances, fines, imprisonment and, within the U.S., exclusion from participation in government healthcare programs, including Medicare, Medicaid and Veterans Administration (VA) health programs.

Our operations in foreign countries are subject to the extraterritorial application of the U.S. Foreign Corrupt Practices Act (FCPA). Our global operations are also subject to foreign anti-corruption laws, such as the UK Bribery Act, among others. As part of our global compliance program, we seek to address anti-corruption risks proactively.

Our facilities and operations are also subject to complex federal, state, local and foreign environmental and occupational safety laws and regulations, including those relating to discharges of substances in the air, water and land, the handling, storage and disposal of wastes and the clean-up of properties by pollutants. We do not expect that the ongoing costs of compliance with these environmental requirements will have a material impact on our consolidated earnings, capital expenditures or competitive position.

COMPETITION

 

The orthopaedics and broader musculoskeletal care industry is highly competitive. In the global markets for reconstructive implants, trauma and related surgical products, our major competitors include: the DePuy Synthes Companies of Johnson & Johnson, Stryker Corporation, Biomet, Inc., Smith & Nephew plc, Wright Medical Group, Inc. and Tornier, Inc.

 

 

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In the Americas geographic segment, we and the DePuy Synthes Companies, Stryker Corporation, Biomet, Inc., Smith & Nephew, Inc. (a subsidiary of Smith & Nephew plc) and Wright Medical Group, Inc. account for a large majority of the total reconstructive and trauma implant sales.

The European reconstructive implant and trauma product markets are more fragmented than the Americas or the Asia Pacific segments. The variety of philosophies held by European surgeons regarding hip reconstruction, for example, has fostered the existence of many regional European companies, including Aesculap AG (a subsidiary of B. Braun), Waldemar LINK GmbH & Co., KG and Mathys AG, which, in addition to the global competitors, compete with us. Many hip implants sold in Europe are products developed specifically for the European market. We intend to continue to develop and produce specially tailored products to meet specific European needs.

In the Asia Pacific market for reconstructive implant and trauma products, we compete primarily with the DePuy Synthes Companies, Stryker Corporation, Smith & Nephew plc and Biomet, Inc., as well as regional companies, including Japan Medical Materials Corporation and Japan Medical Dynamic Marketing, Inc. Factors, such as the dealer system and complex regulatory environments, make it difficult for smaller companies, particularly those that are non-regional, to compete effectively with the market leaders in the Asia Pacific region.

In the spinal implant category, we compete globally primarily with the spinal and biologic business of Medtronic, Inc., the DePuy Synthes Companies, Stryker Corporation, Biomet Spine (a subsidiary of Biomet, Inc.), NuVasive, Inc. and Globus Medical, Inc.

In the dental implant category, we compete primarily with Nobel Biocare Holding AG, Straumann Holding AG, Dentsply International and Biomet 3i (a subsidiary of Biomet, Inc.).

Competition within the industry is primarily based on technology, innovation, quality, reputation and customer service. A key factor in our continuing success in the future will be our ability to develop new products and improve existing products and technologies.

MANUFACTURING AND RAW MATERIALS

 

We manufacture our products at various sites. Our significant manufacturing locations include Warsaw, Indiana; Winterthur, Switzerland; Ponce, Puerto Rico; Dover, Ohio; Carlsbad, California; Parsippany, New Jersey; Shannon, Ireland; and Beijing, China. We also strategically outsource some manufacturing to qualified suppliers who are highly capable of producing components.

We believe that our manufacturing facilities are among the best in our industry in terms of automation and productivity and have the flexibility to accommodate future growth. The manufacturing operations at these facilities are designed to incorporate the cellular concept for production and to implement tenets of a manufacturing philosophy focused on continuous improvement efforts in product quality, lead time reduction and capacity optimization. Our continuous

improvement efforts are driven by Lean and Six Sigma methodologies. In addition, at certain of our manufacturing facilities, many of the employees are cross-trained to perform a broad array of operations.

We generally target operating our manufacturing facilities at optimal levels of total capacity. We continually evaluate the potential to in-source and out-source production as part of our manufacturing strategy to provide value to our stakeholders.

We have improved our manufacturing processes to protect our profitability and offset the impact of inflationary costs. We have, for example, employed computer-assisted robots and multi-axis grinders to precision polish medical devices; automated certain manufacturing and inspection processes, including on-machine inspection and process controls; purchased state-of-the-art equipment; in-sourced core products and processes; and negotiated cost reductions from third-party suppliers.

We use a diverse and broad range of raw materials in the manufacturing of our products. We purchase all of our raw materials and select components used in manufacturing our products from external suppliers. In addition, we purchase some supplies from single sources for reasons of quality assurance, sole source availability, cost effectiveness or constraints resulting from regulatory requirements. We work closely with our suppliers to assure continuity of supply while maintaining high quality and reliability. To date, we have not experienced any significant difficulty in locating and obtaining the materials necessary to fulfill our production schedules.

INTELLECTUAL PROPERTY

 

Patents and other proprietary rights are important to the continued success of our business. We also rely upon trade secrets, know-how, continuing technological innovation and licensing opportunities to develop and maintain our competitive position. We protect our proprietary rights through a variety of methods, including confidentiality agreements and proprietary information agreements with vendors, employees, consultants and others who may have access to proprietary information. We own or control through licensing arrangements more than 4,500 issued patents and patent applications throughout the world that relate to aspects of the technology incorporated in many of our products.

EMPLOYEES

 

As of December 31, 2012, we employed more than 9,300 employees worldwide, including more than 1,000 employees dedicated to research and development. Approximately 5,000 employees are located within the U.S. and approximately 4,300 employees are located outside of the U.S., primarily throughout Europe and in Japan. We have approximately 3,800 employees dedicated to manufacturing our products worldwide. The Warsaw, Indiana production facility employs approximately 1,500 employees.

 

 

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Approximately 150 U.S. employees are members of a trade union covered by a collective bargaining agreement. We have a collective bargaining agreement with the United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied

Industrial and Service Workers International Union, AFL-CIO, CLC for and on behalf of Local 2737-15 covering employees at the Dover, Ohio facility, which continues in effect until May 15, 2015.

 

 

EXECUTIVE OFFICERS

The following table sets forth certain information with respect to our executive officers as of February 20, 2013.

 

Name    Age        Position

David C. Dvorak

     49         President and Chief Executive Officer

James T. Crines

     53         Executive Vice President, Finance and Chief Financial Officer

Joseph A. Cucolo

     53         President, Americas Sales

Derek M. Davis

     44         Vice President, Finance and Corporate Controller and Chief Accounting Officer

Jeffery A. McCaulley

     47         President, Zimmer Reconstructive

Bruno A. Melzi

     65         Chairman, Europe, Middle East and Africa

Stephen H.L. Ooi

     59         President, Asia Pacific

Jeffrey B. Paulsen

     52         Group President, Global Businesses

Chad F. Phipps

     41         Senior Vice President, General Counsel and Secretary

 

Mr. Dvorak was appointed President, Chief Executive Officer and a member of the Board of Directors in May 2007. From December 2005 to April 2007, he served as Group President, Global Businesses and Chief Legal Officer. Prior to that, he had served as Executive Vice President, Corporate Services, Chief Counsel and Secretary, as well as Chief Compliance Officer, since October 2003. Mr. Dvorak joined Zimmer in 2001.

Mr. Crines was appointed Executive Vice President, Finance and Chief Financial Officer in May 2007. From December 2005 to April 2007, he served as Senior Vice President, Finance, Operations and Corporate Controller and Chief Accounting Officer. Prior to that, he had served as Senior Vice President, Finance/Controller and Information Technology since October 2003. Mr. Crines joined Zimmer in 1995.

Mr. Cucolo was appointed President, Americas Sales in September 2012. He is responsible for sales and management of the direct and indirect sales channels in the Americas region, including the United States, Canada and Latin America. From 1997 until he joined Zimmer as President, Americas Sales, Mr. Cucolo was sole owner and President of Zimmer New England, Inc., an independent third-party distributor of Zimmer products in the northeast region of the United States. Prior to that, Mr. Cucolo was employed by Zimmer as a sales representative and territory manager in the New York area from 1987 to 1997.

Mr. Davis was appointed Vice President, Finance and Corporate Controller and Chief Accounting Officer in May 2007. He has responsibility for internal and external reporting, planning and analysis, and corporate and business unit accounting. From March 2006 to May 2007, he served as Director, Financial Planning and Accounting. Prior to that, he had served as Director, Finance, Operations and Logistics since December 2003. Mr. Davis joined Zimmer in 2003.

Mr. McCaulley was appointed President, Zimmer Reconstructive in November 2008. He has overall responsibility for the Global Reconstructive Division, including direct responsibility for Global Brand Management, Product Research and Development, Quality and Regulatory Affairs, and Medical Training and Education, as well as Americas Marketing Management. Prior to joining Zimmer, he served as President and Chief Executive Officer of the Health Division of Wolters

Kluwer from 2005, Vice President and General Manager of the Diabetes Division of Medtronic, Inc. from 2002, and spent 14 years with GE Healthcare in numerous positions of increasing responsibility, including President and Chief Executive Officer of GE Clinical Services from 2000.

Mr. Melzi was appointed Chairman, Europe, Middle East and Africa in October 2003. He is responsible for the sales, marketing and distribution of products in the European, Middle Eastern and African regions. Mr. Melzi joined Zimmer in 1990. Mr. Melzi has announced his intention to retire from his current positions as of March 31, 2013. We have entered into a post-retirement directorship agreement with Mr. Melzi, whereby he will perform consulting services for us for a three-year period beginning May 1, 2013.

Mr. Ooi was appointed President, Asia Pacific in December 2005. He is responsible for the sales, marketing and distribution of products in the Asia Pacific region. Prior to that, he had served as President, Australasia since September 2003. Mr. Ooi joined Zimmer in 1986.

Mr. Paulsen was appointed Group President, Global Businesses in December 2009. He has responsibility for Zimmer Spine, Zimmer Dental, Zimmer Trauma and Zimmer Surgical. Prior to joining Zimmer, Mr. Paulsen served as Chief Operating Officer of MPS Group, Inc., a privately held environmental services and facility management firm, from September 2008 to December 2009. Prior to that, he served as Group President of TriMas Corporation, a specialty manufacturing company, from January 2007 to June 2008. Previously, Mr. Paulsen had held a number of increasingly responsible executive roles at Stryker Corporation from 1996 to December 2006, including President, Orthopaedic Reconstructive Division.

Mr. Phipps was appointed Senior Vice President, General Counsel and Secretary in May 2007. He has global responsibility for our legal affairs and he serves as Secretary to the Board of Directors. Mr. Phipps also oversees our Government Affairs, Corporate Marketing and Communications and Public Relations activities. From December 2005 to May 2007, he served as Associate General Counsel and Corporate Secretary. Prior to that, he had served as Associate Counsel and Assistant Secretary since September 2003. Mr. Phipps joined Zimmer in 2003.

 

 

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AVAILABLE INFORMATION

 

Our Internet address is www.zimmer.com. We routinely post important information for investors on our website in the “Investor Relations” section, which may be accessed from our homepage at www.zimmer.com or directly at http://investor.zimmer.com. We use this website as a means of disclosing material, non-public information and for complying with our disclosure obligations under Regulation FD. Accordingly, investors should monitor the Investor Relations section of our website, in addition to following our press releases, Securities and Exchange Commission (SEC) filings, public conference calls, presentations and webcasts. Our goal is to maintain the Investor Relations website as a portal through which investors can easily find or navigate to pertinent information about us, free of charge, including:

 

our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), as soon as reasonably practicable after we electronically file that material with or furnish it to the SEC;

 

announcements of investor conferences and events at which our executives talk about our products and competitive strategies. Podcasts and archives of these events are also available;

 

press releases on quarterly earnings, product announcements, legal developments and other material news that we may post from time to time;

 

corporate governance information including our Corporate Governance Guidelines, Code of Business Conduct, Code of Ethics for Chief Executive Officer and Senior Financial Officers, information concerning our Board of Directors and its committees, including the charters of the Audit Committee, Compensation and Management Development Committee, Corporate Governance Committee and Research, Innovation and Technology Committee, and other governance-related policies;

 

stockholder services information, including ways to contact our transfer agent and information on how to sign up for direct deposit of dividends or enroll in our dividend reinvestment plan; and

 

opportunities to sign up for email alerts and RSS feeds to have information provided in real time.

The information available on our website is not incorporated by reference in, or a part of, this or any other report we file with or furnish to the SEC.

 

ITEM 1A.   Risk Factors

Risk factors which could cause actual results to differ from our expectations and which could negatively impact our financial condition and results of operations are discussed below and elsewhere in this report. Additional risks and uncertainties not presently known to us or that are currently not believed to be significant to our business may also affect our actual results and could harm our

business, financial condition and results of operations. If any of the risks or uncertainties described below or any additional risks and uncertainties actually occur, our business, results of operations and financial condition could be materially and adversely affected.

Our success depends on our ability to effectively develop and market our products against those of our competitors.

We operate in a highly competitive environment. Our present or future products could be rendered obsolete or uneconomical by technological advances by one or more of our present or future competitors or by other therapies, including biological therapies. To remain competitive, we must continue to develop and acquire new products and technologies. Competition is primarily on the basis of:

 

technology;

 

innovation;

 

quality;

 

reputation; and

 

customer service.

In markets outside of the U.S., other factors influence competition as well, including:

 

local distribution systems;

 

complex regulatory environments; and

 

differing medical philosophies and product preferences.

Our competitors may:

 

have greater financial, marketing and other resources than us;

 

respond more quickly to new or emerging technologies;

 

undertake more extensive marketing campaigns;

 

adopt more aggressive pricing policies; or

 

be more successful in attracting potential customers, employees and strategic partners.

Any of these factors, alone or in combination, could cause us to have difficulty maintaining or increasing sales of our products.

If we do not introduce new products in a timely manner, our products may become obsolete over time, customers may not buy our products and our revenue and profitability may decline.

Demand for our products may change, in certain cases, in ways we may not anticipate because of:

 

evolving customer needs;

 

changing demographics;

 

slowing industry growth rates;

 

declines in the reconstructive implant market;

 

the introduction of new products and technologies;

 

evolving surgical philosophies; and

 

evolving industry standards.

Without the timely introduction of new products and enhancements, our products may become obsolete over time. If that happens, our revenue and operating results would suffer. The success of our new product offerings will depend on several factors, including our ability to:

 

properly identify and anticipate customer needs;

 

commercialize new products in a timely manner;

 

manufacture and deliver instruments and products in sufficient volumes on time;

 

 

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differentiate our offerings from competitors’ offerings;

 

achieve positive clinical outcomes for new products;

 

satisfy the increased demands by healthcare payors, providers and patients for shorter hospital stays, faster post-operative recovery and lower-cost procedures;

 

innovate and develop new materials, product designs and surgical techniques; and

 

provide adequate medical education relating to new products.

In addition, new materials, product designs and surgical techniques that we develop may not be accepted quickly, in some or all markets, because of, among other factors:

 

entrenched patterns of clinical practice;

 

the need for regulatory clearance; and

 

uncertainty with respect to third-party reimbursement.

Moreover, innovations generally require a substantial investment in research and development before we can determine their commercial viability and we may not have the financial resources necessary to fund the production. In addition, even if we are able to successfully develop enhancements or new generations of our products, these enhancements or new generations of products may not produce revenue in excess of the costs of development and they may be quickly rendered obsolete by changing customer preferences or the introduction by our competitors of products embodying new technologies or features.

If third-party payors decline to reimburse our customers for our products or reduce reimbursement levels, the demand for our products may decline and our ability to sell our products profitably may be harmed.

We sell our products and services to hospitals, doctors, dentists and other healthcare providers, all of which receive reimbursement for the healthcare services provided to their patients from third-party payors, such as domestic and international government programs, private insurance plans and managed care programs. These third-party payors may deny reimbursement if they determine that a device used in a procedure was not in accordance with cost-effective treatment methods, as determined by the third-party payor, or was used for an unapproved indication. Third-party payors may also decline to reimburse for experimental procedures and devices. If our products are not considered cost-effective by third-party payors, our customers may not be reimbursed for our products.

In addition, third-party payors are increasingly attempting to contain healthcare costs by limiting both coverage and the level of reimbursement for medical products and services. If third-party payors reduce reimbursement levels to hospitals and other healthcare providers for our products, demand for our products may decline, or we may experience increased pressure to reduce the prices of our products, which could have a material adverse effect on our sales and results of operations.

We have also experienced downward pressure on product pricing and other effects of healthcare reform in our international markets. If key participants in government healthcare systems reduce the reimbursement levels for our products, our sales and results of operations may be adversely affected.

U.S. healthcare reform legislation includes provisions that may materially adversely affect our business and results of operations.

As the 2010 U.S. healthcare law continues to be phased in, we believe the law will have an impact on various aspects of our business operations. Imposition of the 2.3 percent medical device excise tax effective 2013 has forced, and will continue to force us to identify ways to reduce spending in other areas to offset the expected earnings impact due to the tax. We do not expect to be able to pass along the cost of the tax to hospitals, which continue to face cuts to their Medicare reimbursement per the healthcare law and the recently enacted fiscal cliff legislation. Nor do we expect to be able to offset the cost of the tax through higher sales volumes resulting from the expansion of health insurance coverage because of the demographics of the current uninsured population. The medical device excise tax regulations and interim guidance issued late 2012 by the U.S. Department of Treasury did little to lessen the burden of complying with the excise tax statute. In addition, the law’s Medicare payment reforms, such as accountable care organizations and bundled payments, could provide additional incentives for healthcare providers to reduce spending on our medical device products and reduce utilization of hospital procedures that use our products. Accordingly, while it is still too early to fully understand and predict the ultimate impact of the law on our business, ongoing implementation of this legislation could have a material adverse effect on our results of operations and cash flows.

The ongoing cost-containment efforts of healthcare purchasing organizations may have a material adverse effect on our results of operations.

Many customers for our products have formed group purchasing organizations in an effort to contain costs. Group purchasing organizations negotiate pricing arrangements with medical supply manufacturers and distributors, and these negotiated prices are made available to a group purchasing organization’s affiliated hospitals and other members. If we are not one of the providers selected by a group purchasing organization, affiliated hospitals and other members may be less likely to purchase our products, and, if the group purchasing organization has negotiated a strict compliance contract for another manufacturer’s products, we may be precluded from making sales to members of the group purchasing organization for the duration of the contractual arrangement. Our failure to respond to the cost-containment efforts of group purchasing organizations may cause us to lose market share to our competitors and could have a material adverse effect on our sales and results of operations.

We are subject to various governmental regulations relating to the manufacturing, labeling and marketing of our products, non-compliance with which could adversely affect our business, financial condition and results of operations.

The medical devices we design, develop, manufacture and market are subject to rigorous regulation by the FDA and numerous other federal, state and foreign governmental authorities. The process of obtaining regulatory approvals to

 

 

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market a medical device can be costly and time consuming and approvals might not be granted for future products on a timely basis, if at all. Delays in receipt of, or failure to obtain, approvals for future products could result in delayed realization of product revenues or in substantial additional costs.

Both before and after a product is commercially released, we have ongoing responsibilities under FDA regulations. Compliance with the FDA’s requirements, including the Quality System regulation, recordkeeping regulations, labeling and promotional requirements and adverse event reporting regulations, is subject to continual review and is monitored rigorously through periodic inspections by the FDA, which may result in observations on Form 483, and in some cases warning letters, that require corrective action, or other forms of enforcement. If the FDA were to conclude that we are not in compliance with applicable laws or regulations, or that any of our medical devices are ineffective or pose an unreasonable health risk, the FDA could ban such medical devices, detain or seize adulterated or misbranded medical devices, order a recall, repair, replacement, or refund of payment of such devices, refuse to grant pending premarket approval applications, refuse to provide certificates to foreign governments for exports, and/or require us to notify healthcare professionals and others that the devices present unreasonable risks of substantial harm to the public health. The FDA may also impose operating restrictions on a company-wide basis, enjoin and restrain certain violations of applicable law pertaining to medical devices and assess civil or criminal penalties against our officers, employees or us. The FDA may also recommend prosecution to the U.S. Department of Justice. Any adverse regulatory action, depending on its magnitude, may restrict us from effectively marketing and selling our products.

Our products and operations are also often subject to the rules of industrial standards bodies, such as the International Standards Organization. If we fail to adequately address any of these regulations, our business could be harmed.

We are subject to healthcare fraud and abuse regulations on an ongoing basis that could require us to change our business practices and restrict our operations in the future.

Our industry is subject to various federal and state laws pertaining to healthcare fraud and abuse, including false claims laws, the federal Anti-Kickback Statute, similar state laws and physician self-referral laws. Violations of these laws are punishable by criminal and/or civil sanctions, including, in some instances, fines, imprisonment and, within the U.S., exclusion from participation in government healthcare programs, including Medicare, Medicaid and Veterans Administration (VA) health programs. The interpretation and enforcement of these laws and regulations are uncertain and subject to rapid change.

New regulations related to conflict minerals may adversely affect the sourcing, availability and pricing of materials used in the manufacture of our products, may increase our costs, cause our profitability to decline and harm our reputation.

In August 2012, as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the SEC adopted new disclosure regulations for public companies that manufacture products that contain certain minerals and their derivatives, namely tin, tantalum, tungsten or gold, known as conflict minerals, if these minerals are necessary to the functionality or production of the company’s products. These regulations require such companies to report annually whether or not the minerals originate from the Democratic Republic of Congo (DRC) and adjoining countries and in some cases to perform extensive due diligence on their supply chains for the minerals. The implementation of these new requirements could adversely affect the sourcing, availability and pricing of conflict minerals used in the manufacture of medical devices, including our products. In addition, we may incur additional costs to comply with the disclosure requirements, including costs related to determining the source of any of the relevant minerals used in our products. Since our supply chain is complex, the procedures that we implement may not enable us to ascertain the origins for these minerals or determine that these minerals are DRC conflict free, which may harm our reputation. These new requirements also could have the effect of limiting the pool of suppliers from which we source these minerals, and we may be unable to obtain conflict-free minerals at competitive prices, which could increase our costs and adversely affect our manufacturing operations and our profitability.

We conduct a significant amount of our sales activity outside of the U.S., which subjects us to additional business risks and may cause our profitability to decline due to increased costs.

We sell our products in more than 100 countries and derived almost 50 percent of our net sales in 2012 from outside the U.S. We intend to continue to pursue growth opportunities in sales internationally, including in emerging markets, which could expose us to additional risks associated with international sales and operations. Our international operations are, and will continue to be, subject to a number of risks and potential costs, including:

 

changes in foreign medical reimbursement policies and programs;

 

unexpected changes in foreign regulatory requirements;

 

differing local product preferences and product requirements;

 

fluctuations in foreign currency exchange rates;

 

diminished protection of intellectual property in some countries outside of the U.S.;

 

trade protection measures and import or export requirements that may prevent us from shipping products to a particular market and may increase our operating costs;

 

foreign exchange controls that might prevent us from repatriating cash earned in countries outside the U.S.;

 

complex data privacy requirements and labor relations laws;

 

 

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extraterritorial effects of U.S. laws such as the Foreign Corrupt Practices Act;

 

effects of foreign anti-corruption laws, such as the UK Bribery Act;

 

difficulty in staffing and managing foreign operations;

 

labor force instability;

 

potentially negative consequences from changes in tax laws; and

 

political and economic instability.

Violations of foreign laws or regulations could result in fines, criminal sanctions against us, our officers or our employees, prohibitions on the conduct of our business and damage to our reputation.

We may have additional tax liabilities.

We are subject to income taxes in the U.S. and many foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. We regularly are under audit by tax authorities. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different from our historical income tax provisions and accruals. The results of an audit or litigation could have a material effect on our financial statements in the period or periods for which that determination is made.

We earn a significant amount of our operating income from outside the U.S., and any repatriation of funds representing earnings of foreign subsidiaries may significantly impact our effective tax rates. In addition, there have been proposals to change U.S. tax laws that would significantly impact how U.S. multinational corporations are taxed on foreign earnings. Although we cannot predict whether or in what form this proposed legislation will pass, if enacted it could have a material adverse impact on our tax expense and cash flow.

Challenging global economic conditions could adversely affect our results of operations.

During 2012, growth in the healthcare industry and our revenue growth were adversely affected by continuing challenges in the global economy. Although the U.S. economy is recovering from the worst recession in decades, unemployment remains high and consumer confidence remains low, resulting in reduced numbers of insured patients and the deferral of elective reconstructive procedures. Global economic conditions, particularly in Europe, our second-largest operating segment, remain uncertain. We believe that European austerity measures implemented to address the ongoing financial crisis contributed to decreased healthcare utilization and increased pricing pressure for some of our products. We cannot assure you that challenges in the global economy will not continue to negatively impact procedure volumes, average selling prices and reimbursement rates from third-party payors, any of which could adversely affect our results of operations. In addition, we have experienced delays in the collection of receivables from hospitals in certain countries that have national healthcare systems, including certain regions in Spain, Italy, Greece and Portugal, which are

the countries most directly affected by the Euro zone crisis. Repayment of these receivables is dependent upon the financial stability of the economies of those countries. Continuing high unemployment in the U.S., a worsening of the European financial crisis or a failure to receive payment of all or a significant portion of our European receivables could adversely affect our results of operations.

We are subject to risks arising from currency exchange rate fluctuations, which can increase our costs, cause our profitability to decline and expose us to counterparty risks.

A substantial portion of our foreign revenues is generated in Europe and Japan. The U.S. dollar value of our foreign-generated revenues varies with currency exchange rate fluctuations. Significant increases in the value of the U.S. dollar relative to the Euro or the Japanese Yen, as well as other currencies, could have a material adverse effect on our results of operations. Although we address currency risk management through regular operating and financing activities, and, on a limited basis, through the use of derivative financial instruments, those actions may not prove to be fully effective.

Pending and future product liability claims and litigation could adversely impact our financial condition and results of operations and impair our reputation.

Our business exposes us to potential product liability risks that are inherent in the design, manufacture and marketing of medical devices. In the ordinary course of business, we are the subject of product liability lawsuits alleging that component failures, manufacturing flaws, design defects or inadequate disclosure of product-related risks or product-related information resulted in an unsafe condition or injury to patients. As previously reported, we temporarily suspended the marketing and distribution of our Durom® Acetabular Component (Durom Cup) in the U.S. in July 2008. Subsequently, a number of product liability lawsuits and other claims have been asserted against us. We have settled some of these claims and the others are still pending. Additional claims may be asserted in the future. We are also currently defending a number of other product liability lawsuits and claims related to various other products. Any product liability claim brought against us, with or without merit, can be costly to defend. Product liability lawsuits and claims, safety alerts or product recalls, regardless of their ultimate outcome, could have a material adverse effect on our business and reputation and on our ability to attract and retain customers.

Although we maintain third-party product liability insurance coverage, we have substantial self-insured retention amounts that we must pay in full before obtaining any insurance proceeds to satisfy a judgment or settlement. Furthermore, even if any product liability loss is covered by our insurance, it is possible that claims against us may exceed the coverage limits of our insurance policies and we would have to pay the amount of any settlement or judgment that is in excess of our policy limits. Product liability claims in excess of applicable insurance could have a material adverse effect on our business, financial condition and results of operations.

 

 

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We are involved in legal proceedings that may result in adverse outcomes.

In addition to intellectual property and product liability claims and lawsuits, we are involved in various commercial litigation and claims and other legal proceedings that arise from time to time in the ordinary course of our business. Although we believe we have substantial defenses in these matters, litigation and other claims are subject to inherent uncertainties and management’s view of these matters may change in the future. Given the uncertain nature of legal proceedings generally, we are not able in all cases to estimate the amount or range of loss that could result from an unfavorable outcome. We could in the future incur judgments or enter into settlements of claims that could have a material adverse effect on our results of operations in any particular period.

We may fail to adequately protect our proprietary technology and other intellectual property, which would allow competitors or others to take advantage of our research and development efforts.

Our long-term success largely depends on our ability to market technologically competitive products. If we fail to obtain or maintain adequate intellectual property protection, we may not be able to prevent third parties from using our proprietary technologies. Also, our currently pending or future patent applications may not result in issued patents, and issued patents are subject to claims concerning priority, scope and other issues.

The U.S. Patent and Trademark Office and the courts have not consistently treated the breadth of claims allowed or interpreted in orthopaedic reconstructive implant and biotechnology patents. Future changes in, or unexpected interpretations of, the patent laws may adversely affect our ability to enforce our patent position.

In addition, intellectual property rights may be unavailable or of limited effect in some foreign countries. If we do not obtain sufficient international protection for our intellectual property, our competitiveness in international markets could be impaired, which could limit our growth and revenue.

We also attempt to protect our trade secrets, proprietary know-how and continuing technological innovation with security measures, including the use of confidentiality agreements with our employees, consultants and collaborators. These measures may prove to be ineffective and any remedies available to us may be insufficient to compensate our damages.

Pending and future intellectual property litigation and infringement claims could cause us to incur significant expenses or prevent us from selling our products.

A successful claim of patent or other intellectual property infringement against us could adversely affect our growth and profitability, in some cases materially. From time to time, we receive notices from third parties of potential infringement and receive claims of potential infringement. We may be unaware of intellectual property rights of others that may cover some of our technology. If someone claims that our products infringed their intellectual property rights, any resulting litigation could be costly and time consuming and would divert the attention of

management and key personnel from other business issues. If we were to lose such litigation involving material intellectual property rights, such loss could result in significant damage awards and injunctions that could prevent our manufacture and sale of affected products or require us to pay significant royalties in order to continue to manufacture or sell affected products.

If we fail to retain the independent agents and distributors upon whom we rely heavily to market our products, customers may not buy our products and our revenue and profitability may decline.

Our marketing success in the U.S. and abroad depends significantly upon our agents’ and distributors’ sales and service expertise in the marketplace. Many of these agents have developed professional relationships with existing and potential customers because of the agents’ detailed knowledge of products and instruments. A loss of a significant number of these agents could have a material adverse effect on our business and results of operations.

We depend on a limited number of suppliers for some key raw materials and outsourced activities.

We use a number of suppliers for raw materials that we need to manufacture our products and to outsource some key manufacturing activities. These suppliers must provide the materials and perform the activities to our standards for us to meet our quality and regulatory requirements. Some key raw materials and outsourced activities can only be obtained from a single source or a limited number of sources. A prolonged disruption or other inability to obtain these materials or outsource key manufacturing activities could materially and adversely affect our ability to satisfy demand for our products.

Future material impairments in the carrying value of our intangible assets, including goodwill, would negatively affect our operating results.

Our assets include intangible assets, primarily goodwill. The goodwill results from our acquisition activity and represents the excess of the consideration transferred over the fair value of the net assets acquired. We assess at least annually whether events or changes in circumstances indicate that the carrying value of our intangible assets may not be recoverable. If the operating performance at one or more of our business units falls significantly below current levels, if competing or alternative technologies emerge, or if market conditions or future cash flow estimates for one or more of our businesses decline, we could be required, under current U.S. accounting rules, to record a non-cash charge to operating earnings for the amount of the impairment. Any write-off of a material portion of our unamortized intangible assets would negatively affect our results of operations.

We are increasingly dependent on sophisticated information technology and if we fail to effectively maintain or protect the integrity of our information systems and data, our business could be adversely affected.

We are increasingly dependent on sophisticated information technology for our products and infrastructure. As a result of technology initiatives, recently enacted regulations, changes in our system platforms and integration of new

 

 

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business acquisitions, we have been consolidating and integrating the number of systems we operate and have upgraded and expanded our information systems capabilities. Our information systems require an ongoing commitment of significant resources to maintain, protect, and enhance existing systems and develop new systems to keep pace with continuing changes in information technology, evolving systems and regulatory standards, and the increasing need to protect patient and customer information. In addition, third parties may attempt to hack into our products or systems and may obtain data relating to patients with our products or our proprietary information. If we fail to maintain or protect our information systems and data integrity effectively, we could lose existing customers, have difficulty attracting new customers, have problems in determining product cost estimates and establishing appropriate pricing, have difficulty preventing, detecting, and controlling fraud, have disputes with customers, physicians, and other healthcare professionals, have regulatory sanctions or penalties imposed, have increases in operating expenses, incur expenses or lose revenues as a result of a data privacy breach, or suffer other adverse consequences. While we have invested heavily in the protection of data and information technology, there can be no assurance that our process of consolidating the number of systems we operate, upgrading and expanding our information systems capabilities, protecting and enhancing our systems and developing new systems to keep pace with continuing changes in information processing technology will be successful or that systems issues will not arise in the future. Any significant breakdown, intrusion, interruption, corruption,

or destruction of these systems could have a material adverse effect on our business.

We may make additional acquisitions or enter into strategic alliances that could increase our costs or liabilities or be disruptive.

We intend to continue to look for additional strategic acquisitions of other businesses that are complementary to our businesses and other companies with whom we could form strategic alliances or enter into other arrangements to develop or exploit intellectual property rights. These activities involve risks, including the following:

 

we may need to divert more management resources to integration than we planned, which may adversely affect our ability to pursue other more profitable activities;

 

the difficulties of integrating acquired businesses may be increased if we need to integrate geographically separated organizations, personnel with disparate business backgrounds and companies with different corporate cultures;

 

we may not recognize expected cost savings or the anticipated benefits of acquisitions or strategic alliances;

 

our acquisition candidates or strategic partners may have unexpected liabilities or prove unable to meet their obligations to us or the joint venture; and

 

the priorities of our strategic partners may prove incompatible with ours.

 

ITEM 1B.   Unresolved Staff Comments

Not Applicable.

 

 

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ITEM 2.   Properties

We have the following properties:

 

Location    Use    Owned /Leased      Square Feet  

Warsaw, Indiana

   Research & Development, Manufacturing, Warehousing, Marketing & Administration      Owned         1,400,000   

Warsaw, Indiana

   Corporate Headquarters & The Zimmer Institute      Owned         117,000   

Warsaw, Indiana

   Offices, Manufacturing & Warehousing      Leased         90,000   

Carlsbad, California

   Offices, Research & Development & Manufacturing      Leased         125,000   

Minneapolis, Minnesota

   Offices & Research & Development      Owned         51,000   

Southaven, Mississippi

   Distribution Center      Leased         189,000   

Dover, Ohio

   Research & Development, Manufacturing &      Owned         140,000   
   Warehousing      Leased         61,000   

Parsippany, New Jersey

   Office, Research & Development, Manufacturing, Warehousing & The Zimmer Institute      Leased         135,000   

Memphis, Tennessee

   Offices & Warehousing      Leased         30,000   

Austin, Texas

   Offices, Administration, Research & Development      Leased         70,000   

Sydney, Australia

   Offices & Warehousing      Leased         33,000   

Mississauga, Canada

   Offices & Warehousing      Leased         52,000   

Beijing, China

   Offices & Manufacturing      Leased         88,000   

Xianning, China

   Offices, Research & Development & Manufacturing      Leased         53,000   

Shanghai, China

   Offices & Warehousing      Leased         45,000   

Etupes, France

   Offices, Manufacturing & Warehousing      Owned         90,000   

Saint Priest, France

   Offices & Warehousing      Leased         13,000   

Eschbach, Germany

   Distribution Center      Owned         94,000   

Freiburg, Germany

   Offices & Warehousing      Leased         75,000   

Shannon, Ireland

   Offices & Manufacturing      Owned         125,000   

Milan, Italy

   Offices & Warehousing      Leased         55,000   

Gotemba, Japan

   Offices, Service Center & Warehousing      Owned         87,000   

Tokyo, Japan

   Offices & Warehousing      Leased         20,000   

Seoul, Korea

   Offices & Warehousing      Leased         33,000   

Ponce, Puerto Rico

   Offices, Manufacturing & Warehousing      Owned         225,000   

Singapore

   Offices & Warehousing      Leased         19,000   

Barcelona, Spain

   Offices & Warehousing      Leased         27,000   

Winterthur, Switzerland

   Offices, Research & Development & Manufacturing      Leased         394,000   

Münsingen, Switzerland

   Offices & Warehousing      Owned         76,000   

Swindon, United Kingdom

   Offices & Warehousing      Leased         10,000   

We believe the current facilities, including manufacturing, warehousing, research and development and office space, provide sufficient capacity to meet ongoing demands.

In addition to the above, we maintain more than 100 other offices and warehouse facilities in more than 25 countries around the world, including the U.S., Japan, Australia, France, Russia, India, Germany, Italy, Switzerland and China. We believe that all of the facilities and equipment are in good condition, well maintained and able to operate at present levels.

 

ITEM 3.   Legal Proceedings

Information pertaining to legal proceedings in which we are involved can be found in Note 19 to our consolidated financial statements (see Part II, Item 8 of this report).

 

ITEM 4.   Mine Safety Disclosures

Not Applicable.

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

PART II

 

ITEM 5.   Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock is traded on the New York Stock Exchange and the SIX Swiss Exchange under the symbol “ZMH.” The high and low sales prices for our common stock on the New York Stock Exchange and the dividends declared for the calendar quarters of fiscal years 2012 and 2011 are set forth as follows:

 

Quarterly High-Low Share Prices and Declared Dividends    High      Low      Declared
Dividends
 

Year Ended December 31, 2012:

        

First Quarter

   $ 64.81       $ 52.70       $   

Second Quarter

   $ 66.41       $ 58.23       $ 0.18   

Third Quarter

   $ 67.90       $ 57.46       $ 0.18   

Fourth Quarter

   $ 69.09       $ 61.97       $ 0.18   

Year Ended December 31, 2011:

        

First Quarter

   $ 65.22       $ 52.15       $   

Second Quarter

   $ 69.93       $ 59.49       $   

Third Quarter

   $ 66.03       $ 49.92       $   

Fourth Quarter

   $ 55.43       $ 47.00       $ 0.18   

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.

The number of holders of our common stock on February 15, 2013 was approximately 237,000. On February 15, 2013, the closing price of the common stock, as reported on the New York Stock Exchange, was $75.90 per share.

The information required by this Item concerning equity compensation plans is incorporated by reference to Item 12 of this report.

The following table summarizes repurchases of common stock settled during the three months ended December 31, 2012:

 

      Total Number of
Shares Purchased
     Average Price
Paid per Share
     Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs (1)
     Approximate Dollar Value of
Shares that May Yet Be
Purchased Under Plans or
Programs (1)
 

October 2012

           $               $ 1,154,341,726   

November 2012

     1,108,700         64.93         1,108,700         1,082,354,658   

December 2012

     1,000,000         67.77         1,000,000         1,014,582,321   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     2,108,700       $ 66.28         2,108,700       $ 1,014,582,321   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes repurchases made under the current program authorizing $1.5 billion of repurchases through December 31, 2014.

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

ITEM 6.   Selected Financial Data

The financial information for each of the past five years ended December 31 is set forth below (in millions, except per share amounts):

 

        Summary of Operations    2012      2011      2010      2009      2008  

Net sales

   $ 4,471.7       $ 4,451.8       $ 4,220.2       $ 4,095.4       $ 4,121.1   

Net earnings of Zimmer Holdings, Inc.

     755.0         760.8         596.9         717.4         848.6   

Earnings per common share

              

Basic

   $ 4.32       $ 4.05       $ 2.98       $ 3.34       $ 3.73   

Diluted

     4.29         4.03         2.97         3.32         3.72   

Dividends declared per share of common stock

   $ 0.54       $ 0.18       $       $       $   

Average common shares outstanding

              

Basic

     174.9         187.6         200.0         215.0         227.3   

Diluted

     176.0         188.7         201.1         215.8         228.3   

Balance Sheet Data

              

Total assets

   $ 9,012.4       $ 8,515.3       $ 7,999.9       $ 7,785.5       $ 7,239.0   

Long-term debt

     1,720.8         1,576.0         1,142.1         1,127.6         460.1   

Other long-term obligations

     559.3         557.4         384.0         328.5         353.9   

Stockholders’ equity

     5,866.3         5,514.8         5,771.3         5,638.7         5,653.9   

 

 

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

ITEM 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis should be read in conjunction with the consolidated financial statements and the corresponding notes included elsewhere in this Form 10-K. 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. Certain amounts in the 2011 and 2010 consolidated financial statements have been reclassified to conform to the 2012 presentation.

EXECUTIVE LEVEL OVERVIEW

 

2012 Results

Our 2012 results reflect what we believe was above market sales growth in our Europe and Asia Pacific reporting segments and below market growth in our Americas reporting segment in the musculoskeletal markets in which we compete. As a result, 2012 net sales were flat when compared to 2011. We believe 2012 net sales reflected strong commercial execution in the Europe and Asia Pacific reporting segments and under-performance in some areas of the Americas reporting segment. We are focusing on improving those areas.

During 2012, we made substantial investments in a series of operational excellence initiatives. We began implementing these initiatives on a company-wide basis in 2010. They are intended to improve our future operating results and include centralizing or outsourcing certain functions, improving quality, distribution, sourcing, manufacturing and our information technology systems. We began realizing savings from these operational initiatives in 2012 as indicated in the 80 basis point decline in our selling, general and administrative (SG&A) expense as a percent of sales. Additionally, research and development (R&D) spending was lower in 2012 as we completed certain significant projects and realized some operational savings from these initiatives.

We also recognized unanticipated expenses in 2012 for goodwill impairment related to our U.S. Spine operations and “Certain claims”. However, this was partially offset by a favorable effective tax rate. We recorded a $34.3 million net tax benefit related to restructuring of certain international operations that resulted in the lower tax rate.

In total, our 2012 net earnings were slightly lower than 2011 primarily due to the significant investments in our operational excellence initiatives and were lower than we expected primarily due to the goodwill impairment.

2013 Outlook

We estimate our net sales will grow between 2 and 4 percent in 2013. This assumes the market for knee and hip procedures will remain stable and grow in low single digits. We expect pricing to have a negative effect on sales growth of approximately 2 percent, and foreign currency exchange rates

to have a negative effect on sales growth of approximately 0.5 percent based upon December 31, 2012 rates.

Assuming currency rates remain at December 31, 2012 levels, we expect our gross margin to be between 74.5 and 75.5 percent of sales in 2013. This range assumes that foreign currency hedge losses will be lower in 2013 than in 2012. The range also takes into consideration the impact of the new 2.3 percent excise tax on a majority of our U.S. sales resulting from U.S. healthcare reform. Pursuant to the tax regulations, the excise tax is imposed on the first sale in the U.S. by the manufacturer, producer or importer of a medical device to either a third party or an affiliated distribution entity. We distribute a majority of our musculoskeletal products through an affiliated distribution entity. Under U.S. GAAP, excise taxes incurred to get inventory to its current location can be included in the cost of the inventory. Accordingly, a majority of the excise tax will be capitalized in inventory and the expense will be deferred until that inventory is sold on a first-in-first-out basis. Therefore, while we started paying the tax in January 2013, it will not significantly increase our cost of products sold expense in our consolidated statement of earnings until later in the year. Once our cost of products sold starts reflecting this excise tax, we estimate the cost to be $10 to $15 million on a quarterly basis. The range of 74.5 to 75.5 percent does not take into consideration inventory step-up or other inventory charges related to acquisitions or operational excellence initiatives in 2013.

We do not expect to be able to offset the full impact of the excise tax on net earnings through higher pricing on our products or through higher sales volumes resulting from the expansion of health insurance coverage. However, we do expect to offset the tax with cost savings from our operational excellence initiatives.

We expect to continue making investments in R&D of approximately 5 percent of sales in 2013. SG&A as a percent of sales is expected to be between 39.5 and 40.0 percent in 2013 as we realize efficiencies from our operational excellence initiatives and further leverage revenue growth.

We expect to incur $120 to $130 million of expenses in 2013 related to our operational excellence initiatives. These programs are targeted at streamlining the organization and business processes. They are expected to be mostly completed in 2013. We also expect to incur $5 to $15 million for certain acquisition and integration costs connected with recent acquisitions. We expect to recognize the majority of these expenses in “Special items” on our statement of earnings, but some will be related to inventory and be reflected in costs of products sold. The gross margin and SG&A percentages discussed above do not include these expenses.

Assuming variable interest rates remain at December 31, 2012 levels, we expect interest income and expense, net, to be approximately $60 million in 2013, which is similar to 2012.

 

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

RESULTS OF OPERATIONS

 

Net Sales by Reportable Segment

The following tables present net sales by reportable segment and the components of the percentage changes (dollars in millions):

 

     Year Ended December 31,            Volume/
Mix
          Foreign
Exchange
 
      2012      2011      % Inc/(Dec)       Price    

Americas

   $ 2,476.3       $ 2,440.8         1     4     (2 )%      (1 )% 

Europe

     1,177.4         1,214.5         (3     4        (1     (6

Asia Pacific

     818.0         796.5         3        5        (2       

 

    

 

 

          

Total

   $ 4,471.7       $ 4,451.8                4        (2     (2

 

    

 

 

          

 

     Year Ended December 31,            Volume/
Mix
          Foreign
Exchange
 
      2011      2010      % Inc       Price    

Americas

   $ 2,440.8       $ 2,431.6         -     2     (2 )%     

Europe

     1,214.5         1,099.5         10        5               5   

Asia Pacific

     796.5         689.1         16        7        (1     10   

 

    

 

 

          

Total

   $ 4,451.8       $ 4,220.2         5        4        (1     2   

 

    

 

 

          

“Foreign Exchange” as used in the tables in this report represents the effect of changes in foreign currency exchange rates on sales growth.

Net Sales by Product Category

The following tables present net sales by product category and the components of the percentage changes (dollars in millions):

 

     Year Ended December 31,            Volume/
Mix
          Foreign
Exchange
 
      2012      2011      % Inc (Dec)       Price    

Reconstructive

              

Knees

   $ 1,814.8       $ 1,825.1         (1 )%      4     (3 )%      (2 )% 

Hips

     1,342.0         1,355.6         (1     4        (3     (2

Extremities

     173.8         163.4         6        9        (1     (2

 

    

 

 

          

Total

     3,330.6         3,344.1                4        (3     (1

 

    

 

 

          

Dental

     237.7         248.1         (4     (4     2        (2

Trauma

     307.9         285.8         8        10        (1     (1

Spine

     208.9         225.0         (7     (2     (4     (1

Surgical and other

     386.6         348.8         11        12               (1

 

    

 

 

          

Total

   $ 4,471.7       $ 4,451.8                4        (2     (2

 

    

 

 

          

 

     Year Ended December 31,            Volume/
Mix
          Foreign
Exchange
 
      2011      2010      % Inc (Dec)       Price    

Reconstructive

              

Knees

   $ 1,825.1       $ 1,789.9         2     1     (2 )%      3

Hips

     1,355.6         1,262.3         7        6        (2     3   

Extremities

     163.4         150.1         9        8        (1     2   

 

    

 

 

          

Total

     3,344.1         3,202.3         4        3        (2     3   

 

    

 

 

          

Dental

     248.1         219.0         13        5        7        1   

Trauma

     285.8         245.5         16        13               3   

Spine

     225.0         234.4         (4     (4     (2     2   

Surgical and other

     348.8         319.0         9        6               3   

 

    

 

 

          

Total

   $ 4,451.8       $ 4,220.2         5        4        (1     2   

 

    

 

 

          

 

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The following table presents net sales by product category by region (dollars in millions):

 

Year Ended December 31,    2012      2011      2010     

2012 vs. 2011

% Inc (Dec)

   

2011 vs. 2010

% Inc (Dec)

 

Reconstructive

             

Knees

             

Americas

   $ 1,058.9       $ 1,067.5       $ 1,110.5         (1 )%      (4 )% 

Europe

     447.3         462.6         418.7         (3     10   

Asia Pacific

     308.6         295.0         260.7         5        13   

Hips

             

Americas

     606.7         600.7         589.7         1        2   

Europe

     446.0         470.5         433.2         (5     9   

Asia Pacific

     289.3         284.4         239.4         2        19   

Extremities

             

Americas

     133.8         125.0         115.9         7        8   

Europe

     29.0         27.5         24.4         6        13   

Asia Pacific

     11.0         10.9         9.8         1        12   

 

    

 

 

    

 

 

      

Total

     3,330.6         3,344.1         3,202.3                4   

 

    

 

 

    

 

 

      

Dental

             

Americas

     137.8         134.7         113.9         2        18   

Europe

     79.8         85.3         80.0         (6     7   

Asia Pacific

     20.1         28.1         25.1         (29     12   

Trauma

             

Americas

     155.2         145.5         130.1         7        12   

Europe

     69.5         63.5         50.2         10        26   

Asia Pacific

     83.2         76.8         65.2         8        18   

Spine

             

Americas

     140.0         150.9         166.5         (7     (9

Europe

     49.3         53.5         51.5         (8     4   

Asia Pacific

     19.6         20.6         16.4         (5     25   

Surgical and other

             

Americas

     243.9         216.5         205.0         13        6   

Europe

     56.5         51.6         41.5         10        24   

Asia Pacific

     86.2         80.7         72.5         7        11   

 

    

 

 

    

 

 

      

Total

   $ 4,471.7       $ 4,451.8       $ 4,220.2                5   

 

    

 

 

    

 

 

      

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

Demand (Volume and Mix) Trends

Increased volume and changes in the mix of product sales contributed 4 percentage points of 2012 sales growth, which is the same rate of growth from 2011 compared to 2010.

Consistent with our expectations, procedure volumes in the broader musculoskeletal market remained stable in 2012 relative to 2011 at low to mid-single digit growth rates. We believe long-term indicators point toward sustained growth driven by an aging global population, growth in emerging markets, obesity, proven clinical benefits, new material technologies, advances in surgical techniques and more active lifestyles, among other factors. In addition, the ongoing shift in demand to premium products and the introduction of patient specific devices is expected to continue to positively affect sales growth.

Pricing Trends

Global average selling prices declined by 2 percent in 2012 compared to 2011. In all reporting segments, we continued to see pricing pressure from governmental healthcare cost containment efforts and from local hospitals and health systems. For example, in Japan a biennial price adjustment went into effect in April 2012 which lowered pricing. The Japan downward price adjustment was greater than we had anticipated coming into the year. For 2013, we estimate that selling prices will have a negative effect of approximately 2 percent.

Foreign Currency Exchange Rates

For 2012, foreign currency exchange rates resulted in a 2 percent decline in sales. This was most notable in Europe due to the strengthening of the U.S. Dollar versus the Euro year-over-year. If foreign currency exchange rates remain consistent with 2012 year end rates, we estimate that a stronger U.S. Dollar versus foreign currency exchange rates will have a negative effect in 2013 of approximately 0.5 percent on sales. We address currency risk through regular operating and financing activities and through the use of forward contracts and options solely to manage foreign currency volatility and risk. Changes to foreign currency exchange rates affect sales growth, but due to gains/losses on hedge contracts and options, which are recorded in cost of products sold, the effect on net earnings in the near term is expected to be minimal.

Knees

Knee sales experienced a 1 percent decline in 2012 compared to a 2 percent increase in 2011. However, most of that change was caused by the impact of fluctuations in foreign currency exchange rates. In Europe, changes in foreign currency exchange rates affected knee sales in 2012 and 2011 by negative 6 percent and positive 4 percent, respectively. In Asia Pacific, changes in foreign currency exchange rates had a minimal effect on knee sales in 2012 and had a positive 9 percent effect in 2011.

We estimate that industry procedure volumes were slightly positive on a global basis in 2012, while pricing was negative. We also believe our Europe and Asia Pacific reporting segments grew above the market, but in the Americas we were lower than the market due to underperformance in some areas. We are cautiously optimistic that volume/mix trends will continue to remain stable in 2013.

The NexGen Complete Knee Solution product line, including Gender Solutions® Knee Femoral Implants, the NexGen LPS-Flex Knee and the NexGen CR-Flex Knee, led knee sales in 2012. In addition, sales of our knee revision systems, the Zimmer Unicompartmental High Flex Knee and Zimmer Patient Specific Instruments exhibited growth.

Hips

Hip sales declined by 1 percent in 2012 compared to an increase of 7 percent in 2011. A significant portion of that change was caused by the impact of fluctuations in foreign currency exchange rates. In Europe, changes in foreign currency exchange rates affected hip sales in 2012 and 2011 by negative 6 percent and positive 6 percent, respectively. In Asia Pacific, changes in foreign currency exchange rates positively affected hip sales in 2012 and 2011 by 1 percent and 10 percent, respectively.

Also, we experienced some specific positive growth drivers in 2011, such as new product introductions and product specific issues at competitors. Without these factors in 2012, our results were more reflective of market growth. We estimate that industry procedure volumes were slightly positive on a global basis in 2012, while pricing was negative.

Sales in 2012 were driven primarily by the Zimmer M/L Taper Hip Prosthesis and the Zimmer M/L Taper Hip Prosthesis with Kinectiv Technology, Fitmore Hip Stems, and our Continuum Acetabular System, Trilogy IT Acetabular System and Allofit IT Alloclassic Acetabular System. Other leading products in our hips portfolio were the CLS Spotorno Stem from the CLS Hip System and the Alloclassic Zweymüller Hip Stem. We also commercialized our Vivacit-E® Highly Crosslinked Polyethylene Liners in 2012 and expect this to drive sales growth in 2013.

Extremities

Extremities delivered solid sales growth the past two years. The Zimmer Trabecular Metal Reverse Shoulder System led extremities sales. Reverse shoulder procedures continue to gain popularity as a solution for patients with rotator cuff damage.

Dental

Dental sales declined by 4 percent in 2012 compared to an increase of 13 percent in 2011. While the Americas sales increased in 2012, the overall performance of our dental franchise was impacted by several factors, including softening in certain international markets and lower inventory levels maintained by our stocking distributors. Also, Americas sales growth was aided by the acquisition of a small Brazilian dental

 

 

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company. Sales were led by the Tapered Screw-Vent Implant System. In addition, sales of our recently released Zimmer Trabecular Metal Dental Implant positively affected sales. 2011 sales were buoyed by a change in a distribution arrangement under which we started capturing end-user sales as compared to the prior agreement where we only received a commission on end-user sales.

Trauma

Trauma sales increased by 8 percent and 16 percent in 2012 and 2011, respectively, compared to the same prior year periods. In 2011, we continued the launch of the Zimmer Natural Nail System, which contributed significantly to our trauma sales in 2011 and 2012. In addition to the Zimmer Natural Nail System, the Zimmer Periarticular Locking Plates System led trauma sales, while sales of the Zimmer Universal Locking System also made a strong contribution in 2012.

Spine

We experienced mid-single digit sales declines in Spine each of the past two years. This product category continues to face challenges related to utilization, pricing pressure and payor approvals. Overall, solid sales of the PathFinder NXT and Sequoia Pedicle Screw Systems, our Universal ClampTM Spinal Fixation System and Trabecular Metal Technology products partly offset a decline in sales of the Dynesys System and other products.

Surgical and other

Surgical and other delivered solid sales growth the past two years. Surgical and other sales were led by PALACOS Bone Cement and tourniquet products. Our wound debridement products, powered instruments, DeNovo NT Natural Tissue Graft, Chondrofix Osteochondral Allograft and Gel-One Cross-linked Hyaluronate also made a positive contribution to sales results. Additionally, our January 2012 acquisition of Synvasive Technology, Inc. and October 2012 acquisition of Dornoch Medical Systems, Inc. provided growth in this product category.

The following table presents estimated* 2012 global market size and market share information (dollars in billions):

 

      Global
Market
Size
     Global Market
% Growth**
    Zimmer
Market
Share
    Zimmer
Market
Position
 

Reconstructive

         

Knees

   $ 7.3         3     25     1   

Hips

     6.4         1        21        2   

Extremities

     1.4         9        12        3   

 

        

Total

   $ 15.1         3        22        1   

 

        

Dental

   $ 3.3         (1     7        5   

Trauma

   $ 5.5         2        6        4   

Spine***

   $ 8.9                2        6   

 

* Estimates are not precise and are based on competitor annual filings, Wall Street equity research and Company estimates

** Excludes the effect of changes in foreign currency exchange rates on sales growth

*** Spine includes related orthobiologics

Expenses as a Percent of Net Sales

 

Year Ended December 31,    2012     2011     2010     2012 vs. 2011
Inc (Dec)
    2011 vs. 2010
Inc (Dec)
 

Cost of products sold

     25.2     25.2     24.0            1.2   

Research and development

     5.0        5.4        5.2        (0.4     0.2   

Selling, general and administrative        

     40.4        41.2        41.6        (0.8     (0.4

Certain claims

     0.3        3.5        1.8        (3.2     1.7   

Goodwill impairment

     2.1               4.8        2.1        (4.8

Special items

     3.5        1.7        0.8        1.8        0.9   

Operating margin

     23.4        23.0        21.7        0.4        1.3   

Cost of Products Sold

Gross margin was the same in 2012 compared to 2011. Our foreign currency hedging program had a favorable impact to gross margin in 2012. Under the program, for derivatives which qualify as hedges of future cash flows, the effective portion of changes in fair value is temporarily recorded in other comprehensive income and then recognized in cost of products sold when the hedged item affects earnings. Due to the strengthening of the U.S. Dollar in 2012, foreign currency hedge losses in costs of products sold were less in 2012 than they were in 2011. Additionally, lower inventory step-up charges from acquisitions were recognized in 2012 when compared to 2011 based on the timing of acquisitions. This favorability was offset by the effect of lower prices on gross margin.

Gross margin declined in 2011 from 2010. The most significant impact on gross margin in 2011 was from our foreign currency hedging program. Due to the weakening of the U.S. Dollar in 2011, we recognized foreign currency hedge losses in costs of products sold versus hedge gains in 2010. Also in 2011, lower selling prices, higher average costs per unit sold, and higher inventory step-up charges all contributed to lower gross margins.

The following table reconciles the gross margin changes for 2012 and 2011:

 

Year Ended December 31,    2012     2011  

Prior year gross margin

     74.8     76.0

Lower average selling prices

     (0.5     (0.2

Average cost per unit

     (0.1     (0.2

Excess and obsolete inventory

     (0.1       

Foreign currency exchange impact, net

     0.4        (1.0

Inventory step-up

     0.2        (0.2

Other

     0.1        0.4   

 

 

Current year gross margin

     74.8     74.8

 

 

Operating Expenses

R&D expenses and R&D as a percent of sales decreased in 2012 compared to 2011 after increases in 2011 when compared to 2010. In 2012, R&D spending benefitted from the effect of our operational excellence initiatives, as well as a natural decline related to certain large projects that achieved full commercialization, including Persona, The Personalized Knee System, and the Trabecular Metal Total Ankle, among other products. The increase in 2011 was in line with our strategy to

 

 

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invest in new product development activities across nearly all of our product categories, as well as to increase spending on external research, clinical, regulatory and quality initiatives. We expect R&D spending in 2013 to be approximately 5 percent of sales for the year.

In 2012, SG&A decreased in dollars terms and as a percent of sales. Changes in foreign currency exchange rates due to the strengthening of the U.S. Dollar relative to 2011 lowered SG&A expense.

Absent the effects of foreign currency exchange rates, selling and distribution expenses were higher due to higher sales. Other unfavorable items included increased intangible amortization from business combinations, higher employee recruiting and relocation costs, increased legal costs and higher bad debt expense. These were offset by favorable product liability claims, lower instrument excess and obsolescence charges and lower advertising spend. SG&A as a percent of sales decreased 80 basis points compared to the prior year, reflecting disciplined discretionary spending and the effect of our operational excellence initiatives, which has lowered expenses such as salaries, wages and benefits.

In 2011, SG&A increased in dollar terms, but decreased as a percent of sales from 2010. The increase in dollars was primarily due to variable selling and distribution expenses from higher sales, increased intangible asset amortization from acquisitions completed in December 2010 and higher bad debt expenses primarily from our Europe operating segment. These were partially offset by lower product liability charges recorded in SG&A related to the Durom Cup. For more information regarding Durom Cup claims, see Note 19 to the consolidated financial statements. SG&A as a percent of sales in 2011 decreased by 40 basis points from 2010 reflecting disciplined spending and the effect of our operational excellence initiatives.

“Certain claims” expense is a provision for estimated liabilities to Durom Cup patients undergoing revision surgeries. Provisions of $157.8 million, $75.0 million, $35.0 million and $69.0 million were originally recorded during 2011, 2010, 2009 and 2008, respectively, with an additional $15.0 million recorded during 2012, bringing the total provision to $351.8 million for these claims, excluding a subset of Durom Cup claims that were recorded in SG&A. The additional expense in 2012 was primarily for more estimated claims outside the U.S. than were previously expected, as well as higher estimated legal costs. For more information regarding these claims, see Note 19 to the consolidated financial statements.

In connection with our annual goodwill impairment tests performed in the fourth quarters of 2012 and 2010, we noted that the carrying values of the net assets of our U.S. Spine reporting unit were in excess of the reporting unit’s estimated fair value. As a result, we recorded goodwill impairment charges of $96.0 million and $204.0 million in 2012 and 2010, respectively. For more information regarding goodwill impairment and the factors that led to the impairment, see Note 9 to the consolidated financial statements.

“Special items” expenses for the years ended December 31, 2012, 2011 and 2010 were $155.4 million, $75.2 million, and $34.7 million, respectively.

“Special items” in 2012 included significant expenses incurred for consulting and professional fees and dedicated project personnel for our operational excellence initiatives. These initiatives are intended to improve our future operating results and include centralizing or outsourcing certain functions, improving quality, distribution, sourcing, manufacturing and our information technology systems. Other significant expenses in 2012 were from impairments from intangible assets acquired in business combinations, settlement of various legal matters, including royalty disputes, and severance expenses related to various organizational changes as well as facility closures.

“Special items” in 2011 resulted from a continued reduction in management layers and restructuring in certain areas, resulting in $23.1 million of severance and termination-related expenses. In 2011, we also incurred $26.0 million in consulting and professional fees associated with acquisitions and our operational excellence initiatives. As a result of our acquisitions and operational excellence initiatives, we also incurred asset impairments, facility and employee relocation costs, contract termination expenses and other costs.

“Special items” in 2010 included expenses related to restructuring of our information technology infrastructure as well as our management structure. This resulted in $7.7 million of asset impairment charges and $6.7 million of employee severance and termination-related expenses. In 2010, we also incurred consulting and professional fees, facility and employee relocation costs, contract termination expenses and other various expenses resulting from acquisitions. “Special items” also included the impairment of an available-for-sale security that was acquired as part of a business acquisition and certain litigation related matters.

See Note 2 to the consolidated financial statements for more information regarding “Special items” charges.

Interest Income, Interest Expense, Income Taxes and Net Earnings

Interest expense increased in 2012 compared to 2011 primarily due to the $550 million offering of senior notes we completed in November 2011. Interest expense decreased in 2011 compared to 2010 as the result of interest rate swap agreements we entered into in late 2010 and early 2011 to convert a portion of our fixed-rate debt into variable-rate debt. Interest income has increased the last two years due to higher balances of cash and cash equivalents and short-term and long-term investments upon which interest income is being earned.

Our effective tax rate (ETR) on earnings before income taxes for the years ended December 31, 2012, 2011 and 2010 was 24.0 percent, 22.4 percent and 30.6 percent, respectively. The variation of our ETR has largely been affected by “Certain claims”, goodwill impairment charges and a $34.3 million benefit from the recognition of deferred tax assets related to a

 

 

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legal entity restructuring. “Certain claims” expense favorably affects our ETR because it lowers the income within our U.S. operations relative to our foreign operations. Goodwill impairment charges negatively affect our ETR because no tax benefit is recorded on such charges. Additionally, in 2011 and 2010 our ETR was favorably impacted by the resolution of certain tax contingencies. These discrete items account for the majority of the variation in our ETRs in the past three years.

Our ETR for 2013 will reflect certain tax benefits resulting from the enactment in January 2013 of U.S. federal laws extending the R&D credit and other tax benefits applicable to us. The extension applies to both 2012 and 2013, and as a result of the timing of the law’s enactment, the 2012 tax year benefits must be recognized in the first quarter of 2013 for financial reporting purposes. As a result, our 2013 financial results will reflect a reduction to our ETR of approximately 0.3 percent related to the 2012 tax year benefits.

As a result of the revenues and expenses discussed previously, net earnings in 2012 decreased 1 percent compared to 2011. In 2011, net earnings increased 27 percent compared to 2010. Basic and diluted earnings per share increased 7 percent and 6 percent, respectively, in 2012 compared to 2011, while 2011 basic and diluted earnings per share increased 36 percent from 2010. The disproportionate change in earnings per share as compared to net earnings is attributed to the effect of share repurchases.

Non-GAAP operating performance measures

We use non-GAAP financial measures to evaluate our operating performance that differ from financial measures determined in accordance with U.S. generally accepted accounting principles (GAAP). Our non-GAAP financial measures exclude the impact of inventory step-up and other inventory charges, “Special items,” “Certain claims,” goodwill impairment, and the taxes on those items in addition to certain other tax adjustments. We use this information internally and believe it is helpful to investors because it allows more meaningful period-to-period comparisons of our ongoing operating results, it helps to perform trend analysis and to better identify operating trends that may otherwise be masked or distorted by these types of items, and it provides a higher degree of transparency of certain items. Certain of these non-GAAP financial measures are used as metrics for our incentive compensation programs.

Our non-GAAP adjusted net earnings used for internal management purposes for the years ended December 31, 2012, 2011 and 2010 were $932.5 million, $905.6 million, and $871.6 million, respectively, and our non-GAAP adjusted diluted earnings per share were $5.30, $4.80, and $4.33, respectively.

The following are reconciliations from our GAAP net earnings and diluted earnings per share to our non-GAAP adjusted net earnings and non-GAAP adjusted diluted earnings per share used for internal management purposes (in millions, except per share amounts).

 

Year ended December 31,    2012     2011     2010  

Net Earnings of Zimmer Holdings, Inc.

   $ 755.0      $ 760.8      $ 596.9   

Inventory step-up and other inventory charges

     4.8        11.4        1.4   

Certain claims

     15.0        157.8        75.0   

Goodwill impairment

     96.0               204.0   

Special items

     155.4        75.2        34.7   

Taxes on above items and other certain tax adjustments*

     (93.7     (99.6     (40.4

 

   

 

 

   

 

 

 

Adjusted Net Earnings

   $ 932.5      $ 905.6      $ 871.6   

 

   

 

 

   

 

 

 

 

* The tax effect is calculated based upon the statutory rates for the jurisdictions where the items were incurred.

 

Year ended December 31,    2012     2011     2010  

Diluted EPS

   $ 4.29      $ 4.03      $ 2.97   

Inventory step-up and other inventory charges

     0.03        0.06        0.01   

Certain claims

     0.09        0.84        0.37   

Goodwill impairment

     0.54               1.01   

Special items

     0.88        0.40        0.17   

Taxes on above items and other certain tax adjustments*

     (0.53     (0.53     (0.20

 

   

 

 

   

 

 

 

Adjusted Diluted EPS

   $ 5.30      $ 4.80      $ 4.33   

 

   

 

 

   

 

 

 

 

* The tax effect is calculated based upon the statutory rates for the jurisdictions where the items were incurred.

LIQUIDITY AND CAPITAL RESOURCES

 

Cash flows provided by operating activities were $1,151.9 million in 2012, compared to $1,176.9 million in 2011. The principal source of cash from operating activities in 2012 was net earnings. Non-cash charges included in net earnings accounted for another $454.1 million of operating cash. All other items of operating cash flows in 2012 were outflows of $55.1 million of cash. The lower cash flows provided by operating activities in 2012 were primarily due to increased investments in inventory to support significant new product launches and increased product liability payments. We paid approximately $90 million, $60 million and $45 million in 2012, 2011 and 2010, respectively, related to Durom Cup product liability claims. We estimate the net remaining liability after insurance recovery for Durom Cup claims as of December 31, 2012, is $162.8 million. We expect to pay the majority of this amount over the next five years.

 

 

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At December 31, 2012, we had 64 days of sales outstanding in trade accounts receivable, which was the same as December 31, 2011. At December 31, 2012, we had 301 days of inventory on hand, an increase of 24 days compared to December 31, 2011. Days of inventory on hand have increased due to significant new product launches.

Cash flows used in investing activities were $592.1 million in 2012, compared to $624.4 million in 2011. Additions to instruments and additions to other property, plant and equipment did not change significantly year-over-year. In 2013, instrument additions are expected to be in a range of $125 to $145 million and property, plant and equipment additions are expected to be in a range of $115 to $135 million. We feel this level of capital spending is necessary to support new product-related investments and replacement of older machinery and equipment. We invest some of our cash and cash equivalents in highly-rated debt securities. The purchases and any sales or maturities of these investments are reflected as cash flows from investing activities. The timing of these investments can vary from year to year depending on the maturity of the debt securities and other cash and cash equivalent needs. Acquired intellectual property rights relate to lump-sum payments made to certain healthcare professionals and institutions in place of future royalty payments that otherwise would have been due under the terms of prior contractual arrangements. In the past three years, we have made various business acquisitions including Dornoch Medical Systems, Inc., Synvasive Technology, Inc., ExtraOrtho, Inc., Beijing Montagne Medical Device Co., Ltd., Sodem Diffusion S.A. and certain foreign-based distributors.

Cash flows used in financing activities were $436.5 million for 2012, compared to $455.8 million in 2011. In 2012, we returned cash to our stockholders in the form of cash dividends of $94.4 million and share repurchases of $485.6 million. In 2012 as it relates to our senior credit facility, we converted some of the outstanding debt to a term loan and we borrowed $100.0 million to repurchase shares as well as fund other corporate cash needs. We plan to repay that $100.0 million in the first quarter of 2013. In 2011, we issued senior unsecured notes in public offerings and used some of the proceeds to repurchase shares.

In 2012, we paid cash dividends quarterly, starting in April, at an annualized rate of $0.72 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 December 2012, our Board of Directors declared a cash dividend of $0.18 per share that was paid in January 2013.

We have four tranches of senior notes outstanding: $250 million aggregate principal amount of 1.4 percent notes due November 30, 2014, $500 million aggregate principal amount of 4.625 percent notes due November 30, 2019, $300 million aggregate principal amount of 3.375 percent notes due November 30, 2021 and $500 million aggregate principal amount of 5.75 percent notes due November 30, 2039. Interest on each series is payable on May 30 and November 30 of each year until maturity.

We may redeem the senior notes at our election in whole or in part at any time prior to maturity at a redemption price equal to the greater of 1) 100 percent of the principal amount of the notes being redeemed; or 2) the sum of the present values of the remaining scheduled payments of principal and interest (not including any portion of such payments of interest accrued as of the date of redemption), discounted to the date of redemption on a semi-annual basis at the Treasury Rate (as defined in the debt agreement), plus 15 basis points in the case of the 2014 notes, 20 basis points in the case of the 2019 and 2021 notes, and 25 basis points in the case of the 2039 notes. We would also pay the accrued and unpaid interest on the senior notes to the redemption date.

In May 2012, we entered into a new five-year $1,350 million revolving, multi-currency, Senior Credit Facility maturing May 9, 2017. The Senior Credit Facility replaced a previous credit facility with similar terms that was due to mature on November 30, 2012. As of December 31, 2012, we had $100.0 million outstanding under the Senior Credit Facility and an availability of $1,250.0 million.

We and certain of our wholly owned foreign subsidiaries are the borrowers under the Senior Credit Facility. Borrowings under the Senior Credit Facility bear interest at a LIBOR-based rate plus an applicable margin determined by reference to our senior unsecured long-term credit rating and the amounts drawn under the Senior Credit Facility, at an alternate base rate, or at a fixed-rate determined through a competitive bid process. The Senior Credit Facility contains customary affirmative and negative covenants and events of default for an unsecured financing arrangement, including, among other things, limitations on consolidations, mergers and sales or transfers of assets. Financial covenants include a maximum leverage ratio of 3.0 to 1.0. If we fall below an investment grade credit rating, additional restrictions would result, including restrictions on investments, payment of dividends and stock repurchases. We were in compliance with all covenants under the Senior Credit Facility as of December 31, 2012. Commitments under the Senior Credit Facility are subject to certain fees, including a facility and a utilization fee. Borrowings under the Senior Credit Facility at December 31, 2012 are U.S. Dollar-based.

Borrowings of 11.7 billion Japanese Yen outstanding under the previous credit facility were converted to the Senior Credit Facility. On May 24, 2012, we refinanced these borrowings by entering into a separate Term Loan agreement with one of the lenders under the Senior Credit Facility for 11.7 billion Japanese Yen and we repaid the outstanding borrowings under the Senior Credit Facility.

The Term Loan will mature on May 31, 2016. Borrowings under the Term Loan bear interest at a fixed rate of 0.61 percent per annum until maturity.

We also have available uncommitted credit facilities totaling $79.1 million.

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.

 

 

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As of December 31, 2012, we had short-term and long-term investments in debt securities with a fair value of $915.7 million. These investments are in debt securities of many different issuers and therefore we have no significant concentration of risk with a single issuer. All of these debt securities remain highly-rated and we believe the risk of default by the issuers is low.

As of December 31, 2012, $1,063.1 million of our cash and cash equivalents and short-term and long-term investments are held in jurisdictions outside of the U.S. and are expected to be indefinitely reinvested for continued use in foreign operations. Repatriation of these assets to the U.S. may have tax consequences. $829.8 million of this amount 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 may use excess cash to repurchase common stock under our share repurchase program. As of December 31, 2012, $1,014.6 million remained authorized under a $1.5 billion repurchase program, which will expire on December 31, 2014.

Management believes that cash flows from operations and available borrowings under the Senior Credit Facility are sufficient to meet our working capital, capital expenditure and debt service needs, as well as return cash to stockholders in the form of dividends and share repurchases. Should investment opportunities arise, we believe that our earnings, balance sheet and cash flows will allow us to obtain additional capital, if necessary.

CONTRACTUAL OBLIGATIONS

 

We have entered into contracts with various third parties in the normal course of business that will require future payments. The following table illustrates our contractual obligations (in millions):

 

Contractual Obligations    Total      2013     

2014

and

2015

    

2016

and

2017

    

2018

and
Thereafter

 

Long-term debt

   $ 1,688.6       $       $ 250.0       $ 138.6       $ 1,300.0   

Interest payments

     1,045.4         67.7         132.0         126.4         719.3   

Operating leases

     192.0         45.9         59.5         39.5         47.1   

Purchase obligations

     12.0         12.0                           

Other long-term liabilities

     295.7                 148.1         106.7         40.9   

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

   $ 3,233.7       $ 125.6       $ 589.6       $ 411.2       $ 2,107.3   

 

    

 

 

    

 

 

    

 

 

    

 

 

 

$48.1 million of the other long-term liabilities on our balance sheet as of December 31, 2012, are liabilities related to defined benefit pension plans. Defined benefit plan liabilities are based upon the underfunded status of the respective plans; they are not based upon future contributions. Due to uncertainties regarding future plan asset performance, changes in interest rates and our intentions with respect to voluntary contributions, we are unable to reasonably estimate future contributions beyond 2013. Therefore, this table does not include any amounts related to future contributions to our

plans. See Note 14 to our consolidated financial statements for further information on our defined benefit plans.

Also included in other long-term liabilities on our balance sheet are liabilities related to unrecognized tax benefits and corresponding interest and penalties thereon. Due to the uncertainties inherent in these liabilities, such as the ultimate timing and resolution of tax audits, we are unable to reasonably estimate the amount or period in which potential tax payments related to these positions will be made. Therefore, this table does not include any obligations related to unrecognized tax benefits. See Note 15 to our consolidated financial statements for further information on these unrecognized tax benefits.

We have entered into various agreements 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 to maintain exclusive rights to distribute a product. Since there is uncertainty on the timing or whether such payments will have to be made, we have not included them in this table. These payments could range from $0 to $54 million.

CRITICAL ACCOUNTING ESTIMATES

 

Our financial results are affected by the selection and application of accounting policies and methods. Significant accounting policies which require management’s judgment are discussed below.

Excess Inventory and Instruments – We must determine as of each balance sheet date how much, if any, of our inventory may ultimately prove to be unsaleable or unsaleable at our carrying cost. Similarly, we must also determine if instruments on hand will be put to productive use or remain undeployed as a result of excess supply. Accordingly, inventory and instruments are written down to their net realizable value. To determine the appropriate net realizable value, we evaluate current stock levels in relation to historical and expected patterns of demand for all of our products and instrument systems and components. The basis for the determination is generally the same for all inventory and instrument items and categories except for work-in-process inventory, which is recorded at cost. Obsolete or discontinued items are generally destroyed and completely written off. Management evaluates the need for changes to inventory and instruments net realizable values based on market conditions, competitive offerings and other factors on a regular basis.

Income Taxes – Our income tax expense, deferred tax assets and liabilities and reserves for unrecognized tax benefits reflect management’s best assessment of estimated future taxes to be paid. We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgments and estimates are required in determining the consolidated income tax expense.

We estimate income tax expense and income tax liabilities and assets by taxable jurisdiction. Realization of deferred tax assets in each taxable jurisdiction is dependent on our ability to generate future taxable income sufficient to realize the

 

 

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benefits. We evaluate deferred tax assets on an ongoing basis and provide valuation allowances unless we determine it is “more likely than not” that the deferred tax benefit will be realized. Federal income taxes are provided on the portion of the income of foreign subsidiaries that is expected to be remitted to the U.S.

The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our global operations. We are subject to regulatory review or audit in virtually all of those jurisdictions and those reviews and audits may require extended periods of time to resolve. We record our income tax provisions based on our knowledge of all relevant facts and circumstances, including existing tax laws, our experience with previous settlement agreements, the status of current examinations and our understanding of how the tax authorities view certain relevant industry and commercial matters.

We recognize tax liabilities in accordance with the Financial Accounting Standards Board’s (FASB) guidance on income taxes and we adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which they are determined.

Commitments and Contingencies – Accruals for product liability and other claims are established with the assistance of internal and external legal counsel based on current information and historical settlement information for claims, related legal fees and for claims incurred but not reported. We use an actuarial model to assist management in determining an appropriate level of accruals for product liability claims. Historical patterns of claim loss development over time are statistically analyzed to arrive at factors which are then applied to loss estimates in the actuarial model.

In addition to our general product liability, we have recorded provisions totaling $403.2 million related to the Durom Cup, including $15.0 million in 2012. See Note 19 to our consolidated financial statements for further discussion of the Durom Cup.

Goodwill and Intangible Assets – We evaluate the carrying value of goodwill and indefinite life intangible assets annually, or whenever events or circumstances indicate the carrying value may not be recoverable. We evaluate the carrying value of finite life intangible assets whenever events or circumstances indicate the carrying value may not be recoverable. Significant assumptions are required to estimate

the fair value of goodwill and intangible assets, most notably estimated future cash flows generated by these assets. As such, these fair valuation measurements use significant unobservable inputs. Changes to these assumptions could require us to record impairment charges on these assets.

In the fourth quarter of 2012, we determined our U.S. Spine reporting unit’s carrying value was in excess of its estimated fair value. Fair value was determined using an equal weighting of income and market approaches. Fair value under the income approach was determined by discounting to present value the estimated future cash flows of the reporting unit. Fair value under the market approach utilized the guideline public company methodology, which uses valuation indicators determined from other businesses that are similar to our U.S. Spine reporting unit.

As a result, we recorded a goodwill impairment charge for the U.S. Spine reporting unit of $96.0 million in 2012. In 2010, we also recorded an impairment charge related to this reporting unit of $204.0 million. See Note 8 to our consolidated financial statements for further discussion and the factors that contributed to these impairment charges and the factors that could lead to further impairment.

We have six other reporting units with goodwill assigned to them. We estimated the fair value of those reporting units using the income approach by discounting to present value the estimated future cash flows of the reporting unit, or by doing a qualitative assessment of changes in fair value from the prior year’s income approach. For each of those six reporting units, the estimated fair value substantially exceeded the carrying value.

Share-based Payment – We measure share-based payment expense at the grant date based on the fair value of the award and recognize expense over the requisite service period. Determining the fair value of share-based awards at the grant date requires judgment, including estimating the expected life of stock options and the expected volatility of our stock. Additionally, we must estimate the amount of share-based awards that are expected to be forfeited. We estimate expected volatility based upon the implied volatility of actively traded options on our stock. The expected life of stock options and estimated forfeitures are based upon our employees’ historical exercise and forfeiture behaviors. The assumptions used in determining the grant date fair value and the expected forfeitures represent management’s best estimates.

RECENT ACCOUNTING PRONOUNCEMENTS

 

See Note 2 to our consolidated financial statements to see how recent accounting pronouncements have affected or may affect our financial position, results of operations or cash flows.

 

 

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ITEM 7A.   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. We manage our exposure to these and other market risks through regular operating and financing activities and through the use of derivative financial instruments. We use derivative financial instruments solely as risk management tools and not for speculative investment purposes.

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, Swiss Francs, Japanese Yen, British Pounds, Canadian Dollars, Australian Dollars, Korean Won, Swedish Krona, Czech Koruna, Thai Baht, Taiwan Dollars, South African Rand, Russian Rubles and Indian Rupees. We manage the 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 and options with major financial institutions. These forward contracts and options are designed to hedge anticipated foreign currency transactions, primarily intercompany sale and purchase transactions, for periods consistent with commitments. Realized and unrealized gains and losses on these contracts and options that qualify as cash flow hedges are temporarily recorded in other comprehensive income, then recognized in cost of products sold when the hedged item affects net earnings.

For contracts outstanding at December 31, 2012, we had obligations to purchase U.S. Dollars and sell Euros, Japanese Yen, British Pounds, Canadian Dollars, Australian Dollars, Korean Won, Swedish Krona, Czech Koruna, Thai Baht, Taiwan Dollars, South African Rand, Russian Rubles and Indian Rupees and purchase Swiss Francs and sell U.S. Dollars at set maturity dates ranging from January 2013 through June 2015. The notional amounts of outstanding forward contracts entered into with third parties to purchase U.S. Dollars at December 31, 2012 were $1,548.8 million. The notional amounts of outstanding forward contracts entered into with third parties to purchase Swiss Francs at December 31, 2012 were $303.9 million. The weighted average contract rates outstanding at December 31, 2012 were Euro:USD 1.33, Swiss

Franc:USD 1.08, USD:Japanese Yen 78.27, British Pound:USD 1.58, USD:Canadian Dollar 1.01, Australian Dollar:USD 0.96, USD:Korean Won 1,169, USD:Swedish Krona 6.85, USD:Czech Koruna 18.66, USD:Thai Baht 32.09, USD:Taiwan Dollar 29.01, USD:South African Rand 8.72, USD:Russian Ruble 33.42 and USD:Indian Ruppee 54.58.

We maintain written policies and procedures governing our risk management activities. Our policy requires that critical terms of hedging instruments be the same as hedged forecasted transactions. On this basis, with respect to cash flow hedges, changes in cash flows attributable to hedged transactions are generally expected to be completely offset by changes in the fair value of hedge instruments. As part of our risk management program, we also perform sensitivity analyses to assess potential changes in revenue, operating results, cash flows and financial position relating to hypothetical movements in currency exchange rates. A sensitivity analysis of changes in the fair value of foreign currency exchange forward contracts outstanding at December 31, 2012 indicated that, if the U.S. Dollar uniformly changed in value by 10 percent relative to the various currencies, with no change in the interest differentials, the fair value of those contracts would increase or decrease earnings before income taxes in periods through June 2016, depending on the direction of the change, by the following average approximate amounts (in millions):

 

Currency    Average
Amount
 

Euro

   $ 68.2   

Swiss Franc

     30.0   

Japanese Yen

     35.1   

British Pound

     14.5   

Canadian Dollar

     11.4   

Australian Dollar

     12.5   

Korean Won

     3.2   

Swedish Krona

     3.0   

Czech Koruna

     0.6   

Thai Baht

     1.2   

Taiwan Dollars

     2.1   

South African Rand

     0.7   

Russian Rubles

     2.1   

Indian Rupees

     1.0   

Any change in the fair value of foreign currency exchange forward contracts as a result of a fluctuation in a currency exchange rate is expected to be largely offset by a change in the value of the hedged transaction. Consequently, foreign currency exchange contracts would not subject us to material risk due to exchange rate movements because gains and losses on these contracts offset gains and losses on the assets, liabilities and transactions being hedged.

 

 

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We had net investment exposures to net foreign currency denominated assets and liabilities of $2,494.5 million at December 31, 2012, primarily in Euros and Japanese Yen. $1,320.9 million of the net asset exposure at December 31, 2012 relates to goodwill recorded in the Europe and Asia Pacific geographic segments.

We enter into foreign currency forward exchange contracts with terms of one month to manage currency exposures for monetary assets and liabilities denominated in a currency other than an entity’s functional currency. As a result, foreign currency remeasurement gains/losses recognized in earnings are generally offset with gains/losses on the foreign currency forward exchange contracts in the same reporting period.

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 fluctuation in prices. As part of our risk management program, we perform sensitivity analyses related to potential commodity price changes. A 10 percent price change across all these commodities would not have a material effect on our consolidated financial position, results of operations or cash flows.

INTEREST RATE RISK

 

In the normal course of business, we are exposed to market risk from changes in interest rates that could affect our results of operations and financial condition. We manage our exposure to interest rate risks through our regular operations and financing activities.

We invest our cash and cash equivalents primarily in highly-rated corporate commercial paper and bank deposits. We also have short-term and long-term investments in highly-rated corporate debt securities, U.S. government and agency debt securities, U.S. government treasury funds, municipal bonds, foreign government debt securities, commercial paper and certificates of deposit. The primary investment objective is to ensure capital preservation of our invested principal funds. Currently, we do not use derivative financial instruments in our investment portfolio.

We are exposed to interest rate risk on our debt obligations and our cash and cash equivalents. Presently, all of our debt outstanding under the Senior Credit Facility bears interest at short-term variable rates.

In 2010, we entered into interest rate swap agreements with a consolidated notional amount of $250 million that hedge a portion of our $500 million 4.625 percent Senior Notes due November 30, 2019. On the interest rate swap agreements outstanding as of December 31, 2012, we receive a fixed interest rate of 4.625 percent and we pay variable interest equal to the three-month LIBOR plus an average of 133 basis points.

The interest rate swap agreements are to manage our exposure to interest rate movements by converting fixed-rate debt into variable-rate debt. The objective of the instruments is to more closely align interest expense with interest income received on cash and cash equivalents.

These derivative instruments are designated as fair value hedges under U.S. GAAP. Changes in the fair value of the derivative instrument are recorded in earnings and are offset by gains or losses on the underlying debt instrument.

Based upon our overall interest rate exposure as of December 31, 2012, a change of 10 percent in interest rates, assuming the amount outstanding remains constant, would not have a material effect on net interest expense. This analysis does not consider the effect of the change in the level of overall economic activity that could exist in such an environment.

CREDIT RISK

 

Financial instruments, which potentially subject us to concentrations of credit risk, are primarily cash and cash equivalents, short-term and long-term investments, derivative instruments, counterparty transactions and accounts receivable.

We place our investments in highly-rated financial institutions or highly-rated debt securities 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 and investments.

We are exposed to credit loss if the financial institutions or counterparties issuing the debt security fail to perform. However, this loss is limited to the amounts, if any, by which the obligations of the counterparty to the financial instrument contract exceed our obligation. We also minimize exposure to credit risk by dealing with a diversified group of major financial institutions. We manage credit risk by monitoring the financial condition of our counterparties using standard credit guidelines. We do not anticipate any nonperformance by any of the counterparties.

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 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.

 

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

The ongoing financial crisis in the Euro zone continues to impact the indirect credit exposure we have to those governments through their public hospitals. We have experienced an increasing number of days sales outstanding in some European countries compared to levels in 2010. As of December 31, 2012, in Greece, Italy, Portugal and Spain, countries that have been widely recognized as presenting the highest risk, our gross short-term and long-term trade accounts receivable combined were $209.2 million. With allowances for doubtful accounts of $7.8 million recorded in those countries, the net balance was $201.4 million, representing 24 percent of our total consolidated short-term and long-term trade accounts receivable balance, net. Italy and Spain account for $191.6 million of that net amount. We are actively monitoring the situations in these countries. We maintain contact with these customers on a regular basis. We

continue to receive payments, albeit at a slower rate than in the past. We believe our allowance for doubtful accounts is adequate in these countries, as ultimately we believe the governments in these countries will be able to pay. As evidence of this, in Spain we received significant payments in July 2012, to settle certain past due accounts receivable. To the extent these 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.

 

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

Management’s Report on Internal Control Over Financial Reporting

 

The management of Zimmer Holdings, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f) or 15d-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, the company’s principal executive and principal financial officers and effected by the company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles and includes those policies and procedures that:

 

   

Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company;

 

   

Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and

 

   

Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, the company’s internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The company’s management assessed the effectiveness of the company’s internal control over financial reporting as of December 31, 2012. In making this assessment, the company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.

Based on that assessment, management has concluded that, as of December 31, 2012, the company’s internal control over financial reporting is effective based on those criteria.

The company’s independent registered public accounting firm has audited the effectiveness of the company’s internal control over financial reporting as of December 31, 2012, as stated in its report which appears in Item 8 of this Annual Report on Form 10-K.

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

ITEM 8.   Financial Statements and Supplementary Data

 

Zimmer Holdings, Inc.

Index to Consolidated Financial Statements

       
Financial Statements:    Page  

Report of Independent Registered Public Accounting Firm

     33   

Consolidated Statements of Earnings for the Years Ended December 31, 2012, 2011 and 2010

     34   

Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2012, 2011 and 2010

     35   

Consolidated Balance Sheets as of December 31, 2012 and 2011

     36   

Consolidated Statements of Stockholders’ Equity for the Years Ended December  31, 2012, 2011 and 2010

     37   

Consolidated Statements of Cash Flows for the Years Ended December 31, 2012, 2011 and 2010

     38   

Notes to Consolidated Financial Statements

     39   

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

Report of Independent Registered Public Accounting Firm

 

To the Stockholders and Board of Directors of Zimmer Holdings, Inc.:

 

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Zimmer Holdings, Inc. and its subsidiaries at December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

LOGO

PricewaterhouseCoopers LLP

Chicago, Illinois

February 27, 2013

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

Consolidated Statements of Earnings

 

 

      (in millions, except per share amounts)  
For the Years Ended December 31,    2012     2011     2010  

Net Sales

     $4,471.7      $ 4,451.8      $ 4,220.2   

Cost of products sold

     1,125.2        1,122.0        1,012.2   

 

   

 

 

   

 

 

 

Gross Profit

     3,346.5        3,329.8        3,208.0   

 

   

 

 

   

 

 

 

Research and development

     225.6        238.4        218.5   

Selling, general and administrative

     1,807.1        1,834.3        1,759.1   

Certain claims (Note 19)

     15.0        157.8        75.0   

Goodwill impairment (Note 8)

     96.0               204.0   

Special items (Note 2)

     155.4        75.2        34.7   

 

   

 

 

   

 

 

 

Operating expenses

     2,299.1        2,305.7        2,291.3   

 

   

 

 

   

 

 

 

Operating Profit

     1,047.4        1,024.1        916.7   

Interest income

     15.6        10.1        3.7   

Interest expense

     (72.9     (55.3     (60.2

 

   

 

 

   

 

 

 

Earnings before income taxes

     990.1        978.9        860.2   

Provision for income taxes

     237.2        218.9        263.3   

 

   

 

 

   

 

 

 

Net earnings

     752.9        760.0        596.9   

Less: Net loss attributable to noncontrolling interest

     (2.1     (0.8       

 

   

 

 

   

 

 

 

Net Earnings of Zimmer Holdings, Inc.

   $ 755.0      $ 760.8      $ 596.9   

 

   

 

 

   

 

 

 

Earnings Per Common Share – Basic

   $ 4.32      $ 4.05      $ 2.98   

 

   

 

 

   

 

 

 

Earnings Per Common Share – Diluted

   $ 4.29      $ 4.03      $ 2.97   

 

   

 

 

   

 

 

 

Weighted Average Common Shares Outstanding

      

Basic

     174.9        187.6        200.0   

Diluted

     176.0        188.7        201.1   

Cash Dividends Declared Per Common Share

     $0.54        $0.18      $   

The accompanying notes are an integral part of these consolidated financial statements.

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

Consolidated Statements of Comprehensive Income

 

 

      (in millions)  
For the Years Ended December 31,    2012     2011     2010  

Net Earnings

   $ 752.9      $ 760.0      $ 596.9   

Other Comprehensive Income (Loss):

      

Foreign currency cumulative translation adjustments

     46.1        4.6        (38.6

Unrealized cash flow hedge gains/(losses), net of tax effects of (4.3) in 2012, 4.3 in 2011 and 10.1 in 2010

     10.9        (30.6     21.6   

Reclassification adjustments on cash flow hedges, net of tax effects of (8.9) in 2012, (16.7) in 2011 and (4.3) in 2010

     3.3        24.5        (11.6

Unrealized gains/(losses) on securities, net of tax effects of 0.0 in 2012, 0.0 in 2011 and 0.3 in 2010

     0.4        0.2        (0.8

Reclassification adjustments on securities, net of tax effects of (1.2) in 2010

                   2.2   

Adjustments to prior service cost and unrecognized actuarial assumptions, net of tax effects of (8.5) in 2012, 23.0 in 2011 and 4.4 in 2010

     11.8        (48.3     (10.4

 

   

 

 

   

 

 

 

Total Other Comprehensive Income (Loss)

     72.5        (49.6     (37.6

 

   

 

 

   

 

 

 

Comprehensive Income

     825.4        710.4        559.3   

Comprehensive Loss Attributable to Noncontrolling Interest

     (2.2     (0.9       

 

   

 

 

   

 

 

 

Comprehensive Income Attributable to Zimmer Holdings, Inc.

   $ 827.6      $ 711.3      $ 559.3   

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

Consolidated Balance Sheets

 

 

      (in millions)  
As of December 31,    2012     2011  

ASSETS

    

Current Assets:

    

Cash and cash equivalents

   $ 884.3      $ 768.3   

Short-term investments

     671.6        455.5   

Accounts receivable, less allowance for doubtful accounts

     884.6        838.8   

Inventories

     995.3        929.8   

Prepaid expenses and other current assets

     76.3        73.7   

Deferred income taxes

     196.6        210.5   

 

   

 

 

 

Total Current Assets

     3,708.7        3,276.6   

Property, plant and equipment, net

     1,210.7        1,207.3   

Goodwill

     2,571.8        2,626.0   

Intangible assets, net

     740.7        798.5   

Other assets

     780.5        606.9   

 

   

 

 

 

Total Assets

   $ 9,012.4      $ 8,515.3   

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current Liabilities:

    

Accounts payable

   $ 184.1      $ 143.3   

Income taxes

     22.8        8.6   

Short-term debt

     100.1        143.3   

Other current liabilities

     559.0        571.9   

 

   

 

 

 

Total Current Liabilities

     866.0        867.1   

Other long-term liabilities

     559.3        557.4   

Long-term debt

     1,720.8        1,576.0   

 

   

 

 

 

Total Liabilities

     3,146.1        3,000.5   

 

   

 

 

 

Commitments and Contingencies (Note 19)

    

Stockholders’ Equity:

    

Common stock, $0.01 par value, one billion shares authorized,
257.1 million (255.9 million in 2011) issued

     2.6        2.5   

Paid-in capital

     3,500.6        3,399.2   

Retained earnings

     7,085.9        6,426.8   

Accumulated other comprehensive income

     343.9        271.4   

Treasury stock, 85.5 million shares (77.9 million shares in 2011)

     (5,072.1     (4,592.7

 

   

 

 

 

Total Zimmer Holdings, Inc. stockholders’ equity

     5,860.9        5,507.2   

Noncontrolling interest

     5.4        7.6   

 

   

 

 

 

Total Stockholders’ Equity

     5,866.3        5,514.8   

 

   

 

 

 

Total Liabilities and Stockholders’ Equity

   $ 9,012.4      $ 8,515.3   

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

Consolidated Statements of Stockholders’ Equity

 

 

     (in millions)  
    Zimmer Holdings, Inc. Stockholders              
                            Accumulated                          
                            Other                       Total  
    Common Shares     Paid-in     Retained     Comprehensive     Treasury Shares     Noncontrolling     Stockholders’  
     Number     Amount     Capital     Earnings     Income     Number     Amount     Interest     Equity  

Balance January 1, 2010

    254.1      $ 2.5      $ 3,214.6      $ 5,102.5      $ 358.6        (49.9   $ (3,039.5   $      $ 5,638.7   

Net earnings

                         596.9                                    596.9   

Other comprehensive loss

                                (37.6                          (37.6

Stock compensation plans, including tax benefits

    0.5               78.9                                           78.9   

Share repurchases

                                       (9.1     (505.6            (505.6

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance December 31, 2010

    254.6        2.5        3,293.5        5,699.4        321.0        (59.0     (3,545.1            5,771.3   

Net earnings

                         760.8                             (0.8     760.0   

Other comprehensive loss

                                (49.6                   (0.1     (49.7

Business combination with a noncontrolling interest

                                                     8.5        8.5   

Cash dividend declared of $0.18 per share of common stock

                         (32.1                                 (32.1

Stock compensation plans, including tax benefits

    1.3               105.7        (1.3                   2.4               106.8   

Share repurchases

                                       (18.9     (1,050.0            (1,050.0

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance December 31, 2011

    255.9        2.5        3,399.2        6,426.8        271.4        (77.9     (4,592.7     7.6        5,514.8   

Net earnings

                         755.0                             (2.1     752.9   

Other comprehensive income

                                72.5                      (0.1     72.4   

Cash dividend declared of $0.54 per share of common stock

                         (93.3                                 (93.3

Stock compensation plans, including tax benefits

    1.2        0.1        101.4        (2.6            0.1        6.2               105.1   

Share repurchases

                                       (7.7     (485.6            (485.6

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance December 31, 2012

    257.1      $ 2.6      $ 3,500.6      $ 7,085.9      $ 343.9        (85.5   $ (5,072.1   $ 5.4      $ 5,866.3   

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

Consolidated Statements of Cash Flows

 

 

      (in millions)  
For the Years Ended December 31,    2012     2011     2010  

Cash flows provided by (used in) operating activities:

      

Net earnings

   $ 752.9      $ 760.0      $ 596.9   

Adjustments to reconcile net earnings to net cash provided by operating activities:

      

Depreciation and amortization

     363.1        359.9        340.2   

Goodwill impairment

     96.0               204.0   

Share-based compensation

     55.0        60.5        62.0   

Income tax benefit from stock option exercises

     11.0        12.9        4.2   

Excess income tax benefit from stock option exercises

     (2.7     (5.0     (1.3

Inventory step-up and other inventory charges

     4.8        11.4        1.4   

Deferred income tax provision

     (64.8     (19.7     (72.5

Changes in operating assets and liabilities, net of acquired assets and liabilities

      

Income taxes payable

     59.2        14.6        7.7   

Receivables

     (45.5     (63.2     (33.0

Inventories

     (67.5     7.2        25.8   

Accounts payable and accrued liabilities

     47.8        20.0        (0.8

Other assets and liabilities

     (57.4     18.3        58.9   

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     1,151.9        1,176.9        1,193.5   

 

   

 

 

   

 

 

 

Cash flows provided by (used in) investing activities:

      

Additions to instruments

     (148.9     (155.4     (192.5

Additions to other property, plant and equipment

     (114.7     (113.8     (79.2

Acquisition of intellectual property rights

     (0.9     (18.9     (8.5

Purchases of investments

     (1,130.1     (662.1     (413.3

Sales of investments

     878.5        394.8        67.5   

Other business combination investments

     (59.0     (56.8     (82.6

Investments in other assets

     (17.0     (12.2     (18.3

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (592.1     (624.4     (726.9

 

   

 

 

   

 

 

 

Cash flows provided by (used in) financing activities:

      

Proceeds from issuance of notes

            549.3          

Net proceeds (payments) under revolving credit facilities

     (50.1     0.5        (2.2

Proceeds from term loans

     147.3                 

Dividends paid to stockholders

     (94.4              

Debt issuance costs

     (3.3     (4.0       

Proceeds from employee stock compensation plans

     46.9        43.4        16.9   

Excess income tax benefit from stock option exercises

     2.7        5.0        1.3   

Repurchase of common stock

     (485.6     (1,050.0     (505.6

 

   

 

 

   

 

 

 

Net cash used in financing activities

     (436.5     (455.8     (489.6

 

   

 

 

   

 

 

 

Effect of exchange rates on cash and cash equivalents

     (7.3     2.7        0.2   

 

   

 

 

   

 

 

 

Increase (decrease) in cash and cash equivalents

     116.0        99.4        (22.8

Cash and cash equivalents, beginning of year

     768.3        668.9        691.7   

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of year

   $ 884.3      $ 768.3      $ 668.9   

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

Notes to Consolidated Financial Statements

 

 

 

1. BUSINESS

 

We design, develop, manufacture and market orthopaedic reconstructive, spinal and trauma devices, biologics, dental implants and related surgical products. We also provide other healthcare related services. Orthopaedic reconstructive devices restore function lost due to disease or trauma in joints such as knees, hips, shoulders and elbows. Dental reconstructive implants restore function and aesthetics in patients who have lost teeth due to trauma or disease. Spinal devices are utilized by orthopaedic surgeons and neurosurgeons in the treatment of degenerative diseases, deformities and trauma in all regions of the spine. Trauma products are devices used primarily to reattach or stabilize damaged bone and tissue to support the body’s natural healing process. Our related surgical products include surgical supplies and instruments designed to aid in orthopaedic surgical procedures and post-operation rehabilitation. We have operations in more than 25 countries and market our products in more than 100 countries. We operate in a single industry but have three reportable geographic segments, the Americas, Europe and Asia Pacific.

The words “we,” “us,” “our” and similar words refer to Zimmer Holdings, Inc. and its subsidiaries. Zimmer Holdings refers to the parent company only.

 

2. SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation – The consolidated financial statements include the accounts of Zimmer Holdings and its subsidiaries in which it holds a controlling financial interest. Investments in companies in which we exercise significant influence over the operating and financial affairs, but do not control, are accounted for under the equity method. Under the equity method, we record the investment at cost and adjust the carrying amount of the investment by our proportionate share of the investee’s net earnings or losses. All significant intercompany accounts and transactions are eliminated. The consolidated financial statements for some of our international subsidiaries are for an annual period that ended on December 25, 2012, 2011 and 2010. Certain amounts in the 2011 and 2010 consolidated financial statements have been reclassified to conform to the 2012 presentation.

Use of Estimates – The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the U.S. which 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. Actual results could differ from those estimates.

Foreign Currency Translation – The financial statements of our foreign subsidiaries are translated into U.S. dollars using period-end exchange rates for assets and liabilities and average

exchange rates for operating results. Unrealized translation gains and losses are included in accumulated other comprehensive income in stockholders’ equity. When a transaction is denominated in a currency other than the subsidiary’s functional currency, we recognize a transaction gain or loss when the transaction is settled. Foreign currency transaction gains and losses included in net earnings for the years ended December 31, 2012, 2011 and 2010 were not significant.

Revenue Recognition – We sell product through three principal channels: 1) direct to healthcare institutions, referred to as direct channel accounts; 2) through stocking distributors and healthcare dealers; and 3) directly to dental practices and dental laboratories. The direct channel accounts represent approximately 75 percent of our net sales. Through this channel, inventory is generally consigned to sales agents or customers so that products are available when needed for surgical procedures. No revenue is recognized upon the placement of inventory into consignment as we retain title and maintain the inventory on our balance sheet. Upon implantation, we issue an invoice and revenue is recognized. Pricing for products is generally predetermined by contracts with customers, agents acting on behalf of customer groups or by government regulatory bodies, depending on the market. Price discounts under group purchasing contracts are generally linked to volume of implant purchases by customer healthcare institutions within a specified group. At negotiated thresholds within a contract buying period, price discounts may increase.

Sales to stocking distributors, healthcare dealers, dental practices and dental laboratories account for approximately 25 percent of our net sales. With these types of sales, revenue is recognized when title to product passes, either upon shipment of the product or in some cases upon implantation of the product. Product is generally sold at contractually fixed prices for specified periods. Payment terms vary by customer, but are typically less than 90 days.

If sales incentives are earned by a customer for purchasing a specified amount of our product, we estimate whether such incentives will be achieved and, if so, recognize these incentives as a reduction in revenue in the same period the underlying revenue transaction is recognized. Occasionally products are returned and, accordingly, we maintain an estimated sales return reserve that is recorded as a reduction in revenue. Product returns were not significant for the years ended December 31, 2012, 2011 and 2010.

Taxes collected from customers and remitted to governmental authorities are presented on a net basis and excluded from revenues.

Shipping and Handling – Amounts billed to customers for shipping and handling of products are reflected in net sales and are not significant. Expenses incurred related to shipping and handling of products are reflected in selling, general and administrative and were $139.5 million, $142.1 million and

 

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

Notes to Consolidated Financial Statements (Continued)

 

 

$129.1 million for the years ended December 31, 2012, 2011 and 2010, respectively.

Research and Development  –  We expense all research and development costs as incurred. Research and development costs include salaries, prototypes, depreciation of equipment used in research and development, consultant fees and service fees paid to collaborative partners. Where contingent milestone payments are due to third parties under research and development arrangements, the milestone payment obligations are expensed when the milestone results are achieved.

Litigation – We record a liability for contingent losses, including future legal costs, settlements and judgments, when we consider it is probable a liability has been incurred and the amount of the loss can be reasonably estimated.

Special Items – We recognize expenses resulting directly from our business combinations, employee termination benefits, certain contract terminations, consulting and professional fees and asset impairment charges connected with global restructuring and operational excellence initiatives, and other items as “Special items” in our consolidated statement of earnings. “Special items” included (in millions):

 

For the Years Ended December 31,    2012     2011      2010  

Impairment of assets

   $ 14.6      $ 8.4       $ 11.4   

Consulting and professional fees

     90.1        26.0         4.9   

Employee severance and retention, including share-based compensation acceleration

     8.2        23.1         6.7   

Dedicated project personnel

     15.1        3.2         2.0   

Information technology integration

            0.5         0.1   

Relocated facilities

     1.8                0.2   

Distributor acquisitions

     0.8        2.0         1.9   

Certain litigation matters

     13.7        0.1         (0.3

Contract terminations

     6.6        6.3         3.9   

Contingent consideration adjustments

     (2.8               

Accelerated software amortization

     4.5                  

Other

     2.8        5.6         3.9   

 

   

 

 

    

 

 

 

Special items

   $ 155.4      $ 75.2       $ 34.7   

 

   

 

 

    

 

 

 

Impairment of assets relates to impairment of intangible assets that were acquired in business combinations or impairment of other assets related to various reasons.

Consulting and professional fees relate to third-party consulting, professional fees and contract labor related to our operational excellence initiatives, third-party consulting fees related to certain information system implementations, third-party integration consulting performed in a variety of areas such as tax, compliance, logistics and human resources for our business combinations, third-party fees related to severance and termination benefits matters and legal fees related to certain product liability matters. Our operational excellence initiatives are across the company and include improvements in quality, distribution, sourcing, manufacturing, and information technology, among other areas.

In 2012, 2011 and 2010, we terminated some employees as we reduced management layers, restructured certain areas, announced closures of certain facilities, and commenced initiatives to focus on business opportunities that best support our strategic priorities. In 2012, 2011 and 2010, approximately

400, 500 and 60 positions, respectively, from across the globe were affected by these actions. As a result of these changes in our work force and headcount reductions from acquisitions, we incurred expenses related to severance benefits, redundant salaries as we worked through transition periods, share-based compensation acceleration and other employee termination-related costs. The majority of these termination benefits were provided in accordance with our existing or local government policies and are considered ongoing benefits. These costs were accrued when they became probable and estimable and were recorded as part of other current liabilities. The majority of these costs were paid during the year they were incurred.

Dedicated project personnel are the salary, benefits, travel expenses and other costs directly associated with employees who are 100 percent dedicated to our operational excellence initiatives or integration of acquired businesses.

Information technology integration relates to the non-capitalizable costs associated with integrating the information systems of acquired businesses.

Relocated facilities expenses are the moving costs and the lease expenses incurred during the relocation period related to relocating certain office facilities.

Over the past few years we have acquired a number of U.S. and foreign-based distributors. We have incurred various costs related to the consummation and integration of those businesses.

Certain litigation matters relate to costs and adjustments recognized during the year for the estimated or actual settlement of various legal matters, including royalty disputes, patent litigation matters, commercial litigation matters and matters arising from our acquisitions of certain competitive distributorships in prior years.

Contract termination costs relate to terminated agreements in connection with the integration of acquired companies and changes to our distribution model as part of business restructuring and operational excellence initiatives. The terminated contracts primarily relate to sales agents and distribution agreements.

Contingent consideration adjustments are the changes in the fair value of contingent consideration obligations to be paid to the prior owners of acquired businesses.

Accelerated software amortization is the incremental amortization caused by changing the estimated life of certain software. In 2012, we approved a plan to replace certain software. As a result, the estimated economic useful life of the existing software was decreased to represent the period of time expected to implement replacement software. As a result, the amortization from the shortened life of this software is substantially higher than the previous amortization being recognized.

Cash and Cash Equivalents – We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. The carrying amounts reported in the balance sheet for cash and cash equivalents are valued at cost, which approximates their fair value.

 

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

Notes to Consolidated Financial Statements (Continued)

 

 

Investments – We invest our excess cash and cash equivalents in debt securities. Our investments include corporate debt securities, U.S. government and agency debt securities, municipal bonds, foreign government debt securities, commercial paper and certificates of deposit and are classified and accounted for as available-for-sale. Available-for-sale debt securities are recorded at fair value on our consolidated balance sheet. Investments with a contractual maturity of less than one year are classified as short-term investments on our consolidated balance sheet, or in other non-current assets if the contractual maturity is greater than one year. Changes in fair value for available-for-sale securities are recorded, net of taxes, as a component of accumulated other comprehensive loss on our consolidated balance sheet. We review our investments for other-than-temporary impairment at each reporting period. If an unrealized loss for any investment is considered to be other-than-temporary, the loss will be recognized in the consolidated statement of earnings in the period the determination is made. See Note 7 for more information regarding our investments.

Accounts Receivable – Accounts receivable consists of trade and other miscellaneous receivables. We grant credit to customers in the normal course of business and maintain an allowance for doubtful accounts for potential credit losses. We determine the allowance for doubtful accounts by geographic market and take into consideration historical credit experience, creditworthiness of the customer and other pertinent information. We make concerted efforts to collect all accounts receivable, but sometimes we have to write-off the account against the allowance when we determine the account is uncollectible. The allowance for doubtful accounts was $22.8 million and $17.2 million as of December 31, 2012 and 2011, respectively.

Inventories – Inventories are stated at the lower of cost or market, with cost determined on a first-in first-out basis.

Property, Plant and Equipment – Property, plant and equipment is carried at cost less accumulated depreciation. Depreciation is computed using the straight-line method based on estimated useful lives of ten to forty years for buildings and improvements and three to eight years for machinery and equipment. Maintenance and repairs are expensed as incurred. We review property, plant and equipment for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. An impairment loss would be recognized when estimated future undiscounted cash flows relating to the asset are less than its carrying amount. An impairment loss is measured as the amount by which the carrying amount of an asset exceeds its fair value.

Software Costs – We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use when both the preliminary project stage is completed and it is probable that the software will be used as intended. Capitalized software costs generally include external direct

costs of materials and services utilized in developing or obtaining computer software and compensation and related benefits for employees who are directly associated with the software project. Capitalized software costs are included in property, plant and equipment on our balance sheet and amortized on a straight-line or weighted average estimated user basis when the software is ready for its intended use over the estimated useful lives of the software, which approximate three to ten years.

Instruments – Instruments are hand-held devices used by surgeons during total joint replacement and other surgical procedures. Instruments are recognized as long-lived assets and are included in property, plant and equipment. Undeployed instruments are carried at cost or realizable value. Instruments in the field are carried at cost less accumulated depreciation. Depreciation is computed using the straight-line method based on average estimated useful lives, determined principally in reference to associated product life cycles, primarily five years. We review instruments for impairment whenever events or changes in circumstances indicate that the carrying value of an instrument may not be recoverable. Depreciation of instruments is recognized as selling, general and administrative expense.

Goodwill – Goodwill is not amortized but is subject to annual impairment tests. Goodwill has been assigned to reporting units. We perform annual impairment tests by either comparing a reporting unit’s estimated fair value to its carrying amount or doing a qualitative assessment of a reporting unit’s fair value from the last quantitative assessment to determine if there is potential impairment. We may do a qualitative assessment when the results of the previous quantitative test indicated the reporting unit’s estimated fair value was significantly in excess of the carrying value of its net assets and we do not believe there have been significant changes in the reporting unit’s operations that would significantly decrease its estimated fair value or significantly increase its net assets. If a quantitative assessment is performed, the fair value of the reporting unit and the implied fair value of goodwill are determined based upon a discounted cash flow analysis and/or use of a market approach by looking at market values of comparable companies. Significant assumptions are incorporated into our discounted cash flow analyses such as estimated growth rates and risk-adjusted discount rates. We perform this test in the fourth quarter of the year or whenever events or changes in circumstances indicate that the carrying value of the reporting unit’s assets may not be recoverable. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the reporting unit goodwill is less than the carrying value of the reporting unit goodwill. During the years ended December 31, 2012 and 2010, we recorded goodwill impairment charges of $96.0 million and $204.0 million, respectively, related to our U.S. Spine reporting unit. See Note 9 for more information regarding goodwill and goodwill impairment.

 

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

Notes to Consolidated Financial Statements (Continued)

 

 

Intangible Assets – Intangible assets are initially measured at their fair value. We have determined the fair value of our intangible assets either by the fair value of the consideration exchanged for the intangible asset or the estimated after-tax discounted cash flows expected to be generated from the intangible asset. Intangible assets with an indefinite life, including certain trademarks and trade names, are not amortized. Indefinite life intangible assets are assessed annually to determine whether events and circumstances continue to support an indefinite life. Intangible assets with a finite life, including core and developed technology, certain trademarks and trade names, customer-related intangibles, intellectual property rights and patents and licenses are amortized on a straight-line basis over their estimated useful life, ranging from less than one year to 40 years. Intangible assets with a finite life are tested for impairment whenever events or circumstances indicate that the carrying amount may not be recoverable.

Intangible assets with an indefinite life are tested for impairment annually or whenever events or circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognized if the carrying amount exceeds the estimated fair value of the asset. The amount of the impairment loss to be recorded would be determined based upon the excess of the asset’s carrying value over its fair value. The fair values of indefinite lived intangible assets are determined based upon a discounted cash flow analysis using the relief from royalty method or a qualitative assessment may be performed for any changes to the asset’s fair value from the last quantitative assessment. The relief from royalty method estimates the cost savings associated with owning, rather than licensing, assets. Significant assumptions are incorporated into these discounted cash flow analyses such as estimated growth rates, royalty rates and risk-adjusted discount rates. We may do a qualitative assessment when the results of the previous quantitative test indicated the asset’s fair value was significantly in excess of its carrying value.

In determining the useful lives of intangible assets, we consider the expected use of the assets and the effects of obsolescence, demand, competition, anticipated technological advances, changes in surgical techniques, market influences and other economic factors. For technology-based intangible assets, we consider the expected life cycles of products, absent unforeseen technological advances, which incorporate the corresponding technology. Trademarks and trade names that do not have a wasting characteristic (i.e., there are no legal, regulatory, contractual, competitive, economic or other factors which limit the useful life) are assigned an indefinite life. Trademarks and trade names that are related to products expected to be phased out are assigned lives consistent with the period in which the products bearing each brand are expected to be sold. For customer relationship intangible assets, we assign useful lives based upon historical levels of customer attrition. Intellectual property rights are assigned useful lives that approximate the contractual life of any related

patent or the period for which we maintain exclusivity over the intellectual property.

Income Taxes – We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

We reduce our deferred tax assets by a valuation allowance if it is more likely than not that we will not realize some portion or all of the deferred tax assets. In making such determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations. In the event we were to determine that we would be able to realize our deferred income tax assets in the future in excess of their net recorded amount, we would make an adjustment to the valuation allowance which would reduce the provision for income taxes. Federal income taxes are provided on the portion of the income of foreign subsidiaries that is expected to be remitted to the U.S.

We operate on a global basis and are subject to numerous and complex tax laws and regulations. Our income tax filings are regularly under audit in multiple federal, state and foreign jurisdictions. Income tax audits may require an extended period of time to reach resolution and may result in significant income tax adjustments when interpretation of tax laws or allocation of company profits is disputed. Because income tax adjustments in certain jurisdictions can be significant, we record accruals representing management’s best estimate of the probable resolution of these matters. To the extent additional information becomes available, such accruals are adjusted to reflect the revised estimated probable outcome.

Derivative Financial Instruments – We measure all derivative instruments at fair value and report them on our consolidated balance sheet as assets or liabilities. We maintain written policies and procedures that permit, under appropriate circumstances and subject to proper authorization, the use of derivative financial instruments solely for hedging purposes. The use of derivative financial instruments for trading or speculative purposes is prohibited by our policy. See Note 13 for more information regarding our derivative and hedging activities.

Other Comprehensive Income – Other comprehensive income refers to revenues, expenses, gains and losses that under generally accepted accounting principles are included in comprehensive income but are excluded from net earnings as these amounts are recorded directly as an adjustment to stockholders’ equity. Other comprehensive income is

 

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

Notes to Consolidated Financial Statements (Continued)

 

 

comprised of foreign currency translation adjustments, unrealized gains and losses on cash flow hedges, unrealized gains and losses on available-for-sale securities and amortization of prior service costs and unrecognized gains and losses in actuarial assumptions.

Treasury Stock – We account for repurchases of common stock under the cost method and present treasury stock as a reduction of stockholders’ equity. We reissue common stock held in treasury only for limited purposes.

Noncontrolling Interest – In 2011, we made an investment in a company in which we acquired a controlling financial interest, but not 100 percent of the equity. Further information related to the noncontrolling interests of that investment has not been provided as it is not significant to our consolidated financial statements.

Accounting Pronouncements – In 2011, the Financial Accounting Standards Board (FASB) issued an accounting standard update (ASU) requiring companies to present net income and other comprehensive income in either a single continuous statement or in two separate, but consecutive, statements of net income and of comprehensive income. This requirement became effective for us January 1, 2012. The ASU changes the presentation, but not the accounting requirements, of other comprehensive income and therefore had no effect on our financial position, results of operations or cash flows.

In 2012, the FASB issued an ASU that allowed companies when performing their annual indefinite lived intangible asset impairment test to do a qualitative assessment to evaluate whether impairment has occurred versus performing a quantitative calculation of estimated fair value. We elected to early adopt this standard and performed a qualitative assessment on one of our intangible assets that in the prior year had an estimated fair value that was substantially in excess of its carrying value. This ASU just changed the methodology of testing for impairment and would not affect the outcome of impairment testing. Therefore, it did not have an effect on our financial position, results of operations or cash flows.

There are no other recently issued accounting pronouncements that we have not yet adopted that are expected to have a material effect on our financial position, results of operations or cash flows.

3. SHARE-BASED COMPENSATION

 

Our share-based payments primarily consist of stock options, restricted stock, restricted stock units (RSUs), and an employee stock purchase plan. Share-based compensation expense is as follows (in millions):

 

For the Years Ended December 31,    2012     2011     2010  

Stock options

   $ 32.4      $ 41.7      $ 47.6   

RSUs and other

     22.6        18.8        14.4   

 

   

 

 

   

 

 

 

Total expense, pre-tax

     55.0        60.5        62.0   

Tax benefit related to awards

     (16.6     (17.8     (16.2

 

   

 

 

   

 

 

 

Total expense, net of tax

   $ 38.4      $ 42.7      $ 45.8   

 

   

 

 

   

 

 

 

Share-based compensation cost capitalized as part of inventory for the years ended December 31, 2012, 2011 and 2010 was $6.1 million, $8.8 million, and $12.2 million, respectively. As of December 31, 2012 and 2011, approximately $3.3 million and $4.8 million of capitalized costs remained in finished goods inventory.

Stock Options

We had two equity compensation plans in effect at December 31, 2012: the 2009 Stock Incentive Plan (2009 Plan) and the Stock Plan for Non-Employee Directors. The 2009 Plan succeeds the 2006 Stock Incentive Plan (2006 Plan) and the TeamShare Stock Option Plan (TeamShare Plan). No further awards have been granted under the 2006 Plan or under the TeamShare Plan since May 2009, and shares remaining available for grant under those plans have been merged into the 2009 Plan. Vested and unvested stock options and unvested restricted stock and RSUs previously granted under the 2006 Plan, the TeamShare Plan and another prior plan, the 2001 Stock Incentive Plan, remained outstanding as of December 31, 2012. We have reserved the maximum number of shares of common stock available for award under the terms of each of these plans. We have registered 57.9 million shares of common stock under these plans. The 2009 Plan provides for the grant of nonqualified stock options and incentive stock options, long-term performance awards in the form of performance shares or units, restricted stock, RSUs and stock appreciation rights. The Compensation and Management Development Committee of the Board of Directors determines

 

 

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Notes to Consolidated Financial Statements (Continued)

 

 

the grant date for annual grants under our equity compensation plans. The date for annual grants under the 2009 Plan to our executive officers is expected to occur in the first quarter of each year following the earnings announcements for the previous quarter and full year. The Stock Plan for Non-Employee Directors provides for awards of stock options, restricted stock and RSUs to non-employee directors. It has been our practice to issue shares of common stock upon exercise of stock options from previously unissued shares, except in limited circumstances where they are issued from treasury stock. The total number of awards which may be granted in a given year and/or over the life of the plan under each of our equity compensation plans is limited. At December 31, 2012, an aggregate of 8.7 million shares were available for future grants and awards under these plans.

Stock options granted to date under our plans generally vest over four years and generally have a maximum contractual life of 10 years. As established under our equity compensation plans, vesting may accelerate upon retirement after the first anniversary date of the award if certain criteria are met. We recognize expense related to stock options on a straight-line basis over the requisite service period, less awards expected to be forfeited using estimated forfeiture rates. Due to the accelerated retirement provisions, the requisite service period of our stock options range from one to four years. Stock options are granted with an exercise price equal to the market price of our common stock on the date of grant, except in limited circumstances where local law may dictate otherwise.

 

 

A summary of stock option activity for the year ended December 31, 2012 is as follows (options in thousands):

 

           Weighted
Average
Exercise
     Weighted
Average
Remaining
Contractual
     Intrinsic
Value
 
      Stock Options     Price      Life      (in millions)  

Outstanding at January 1, 2012

     16,748      $ 68.04         

Options granted

     1,720        64.26         

Options exercised

     (933     46.05         

Options cancelled

     (239     60.21         

Options expired

     (658     75.43         

 

         

Outstanding at December 31, 2012

     16,638      $ 68.74         4.8       $ 64.2   

 

   

 

 

    

 

 

    

 

 

 

Vested or expected to vest as of December 31, 2012

     16,169      $ 68.94         4.7       $ 61.9   

 

   

 

 

    

 

 

    

 

 

 

Exercisable at December 31, 2012

     12,977      $ 71.34         3.9       $ 38.0   

 

   

 

 

    

 

 

    

 

 

 

 

We use a Black-Scholes option-pricing model to determine the fair value of our stock options. Expected volatility was derived from the implied volatility of traded options on our stock that were actively traded around the grant date of the stock options with exercise prices similar to the stock options and maturities of over one year. The expected term of the stock options has been derived from historical employee exercise behavior. The risk-free interest rate was determined using the implied yield currently available for zero-coupon U.S. government issues with a remaining term approximating the expected life of the options. We began paying dividends in 2012. Accordingly, prior to 2012 we assumed no dividend yield. Starting in 2012, the dividend yield was determined by using an estimated annual dividend and dividing it by the market price of our stock on the grant date.

The following table presents information regarding the weighted average fair value for stock options granted, the assumptions used to determine fair value, and the intrinsic value of options exercised in the indicated year:

 

        
For the Years Ended December 31,    2012     2011     2010  

Dividend yield

     1.1     %        %   

Volatility

     25.6     26.1     26.3

Risk-free interest rate

     1.5     2.2     2.8

Expected life (years)

     6.1        6.1        5.9   

Weighted average fair value of options granted

   $ 15.40      $ 18.33      $ 18.17   

Intrinsic value of options exercised (in millions)

   $ 17.1      $ 27.5      $ 8.5   

As of December 31, 2012, there was $38.4 million of unrecognized share-based payment expense related to nonvested stock options granted under our plans. That expense is expected to be recognized over a weighted average period of 2.5 years.

 

 

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ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

Notes to Consolidated Financial Statements (Continued)

 

 

RSUs

We have awarded RSUs to our employees. The terms of the awards have been three to five years. Some of the awards have only service conditions while some have performance and market conditions as well. The service condition awards vest ratably on the anniversary date of the award. The awards that have performance and market conditions vest all at once on the third anniversary date. Future service conditions may be waived if an employee retires after the first anniversary date of the award, but performance and market conditions continue to apply. Accordingly, the requisite service period used for share-based payment expense ranges from one to five years.

A summary of nonvested RSU activity for the year ended December 31, 2012 is as follows (in thousands):

 

           Weighted Average
Grant Date
 
      RSUs     Fair Value  

Outstanding at January 1, 2012

     1,187      $ 56.25   

Granted

     685        65.91   

Vested

     (299     52.92   

Forfeited

     (363     64.58   

 

   

Outstanding at December 31, 2012

     1,210        60.03   

 

   

For the RSUs with service conditions only, the fair value of the awards was determined based upon the fair market value of our common stock on the date of grant. For the RSUs with market conditions, a Monte Carlo valuation technique was used to simulate the market conditions of the awards. The outcome of the simulation was used to determine the fair value of the awards.

We are required to estimate the number of RSUs that will vest and recognize share-based payment expense on a straight-line basis over the requisite service period. As of December 31, 2012, we estimate that approximately 1,113,000 outstanding RSUs will vest. If our estimate were to change in the future, the cumulative effect of the change in estimate will be recorded in that period. Based upon the number of RSUs that we expect to vest, the unrecognized share-based payment expense as of December 31, 2012 was $38.9 million and is expected to be recognized over a weighted-average period of 2.3 years. The fair value of RSUs vesting during the years ended December 31, 2012, 2011 and 2010 based upon our stock price on the date of vesting was $18.9 million, $11.8 million and $3.2 million, respectively.

 

4. INVENTORIES

 

Inventories consisted of the following (in millions):

 

As of December 31,    2012      2011  

Finished goods

   $ 786.3       $ 743.0   

Work in progress

     52.3         47.8   

Raw materials

     156.7         139.0   

 

    

 

 

 

Inventories

   $ 995.3       $ 929.8   

 

    

 

 

 

Amounts charged to the consolidated statement of earnings for excess and obsolete inventory in the years ended December 31, 2012, 2011 and 2010 were $55.1 million, $47.6 million and $45.8 million, respectively.

 

5. PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment consisted of the following (in millions):

 

As of December 31,    2012     2011  

Land

   $ 22.1      $ 22.3   

Building and equipment

     1,232.8        1,196.8   

Capitalized software costs

     241.8        208.4   

Instruments

     1,579.8        1,509.2   

Construction in progress

     117.8        76.4   

 

   

 

 

 
     3,194.3        3,013.1   

Accumulated depreciation

     (1,983.6     (1,805.8

 

   

 

 

 

Property, plant and equipment, net

   $ 1,210.7      $ 1,207.3   

 

   

 

 

 

Depreciation expense was $266.0 million, $266.1 million and $247.9 million for the years ended December 31, 2012, 2011 and 2010, respectively.

 

6. ACQUISITIONS

 

We made a number of business acquisitions during the years 2012, 2011 and 2010. In January 2012, we acquired Synvasive Technology, Inc. (Synvasive). The Synvasive acquisition enhanced our product portfolio through the addition of the STABLECUT® surgical saw blades, as well as the eLIBRA® Dynamic Knee Balancing SystemTM for soft tissue balancing. In October 2012, we acquired Dornoch Medical Systems, Inc. (Dornoch). The Dornoch acquisition enhances our product portfolio through the addition of a medical waste fluid management and disposal technology. In November 2011, we acquired ExtraOrtho, Inc. (ExtraOrtho). The ExtraOrtho acquisition enhances our position in the estimated $820 million external fixation market. In December 2010, we acquired Beijing Montagne Medical Device Co., Ltd. (Montagne) and Sodem Diffusion S.A. (Sodem). The Montagne acquisition makes us a significant provider of orthopaedic solutions in China and provides product lines tailored exclusively to the rapidly growing Chinese market. The Sodem acquisition broadens our portfolio of surgical power tools and strengthens our position in the estimated $1 billion surgical power tool market. Additionally, we have acquired a number of foreign-based distributors during the three year period.

The results of operations of the acquired companies have been included in our consolidated results of operations subsequent to the transaction dates, and the respective assets and liabilities of the acquired companies have been recorded at their estimated fair values in our consolidated statement of financial position as of the transaction dates, with any excess purchase price being recorded as goodwill. Pro forma financial

 

 

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Table of Contents
ZIMMER HOLDINGS, INC.    2012 FORM 10-K ANNUAL REPORT

 

Notes to Consolidated Financial Statements (Continued)

 

 

information and other information required have not been included as the acquisitions, individually and in the aggregate, did not have a material impact upon our financial position or results of operations.

 

7. INVESTMENTS

 

We invest in short and long-term investments classified as available-for-sale securities. Information regarding our investments is as follows (in millions):

 

 

     Amortized
Cost
     Gross Unrealized     Fair
value
 
         Gains      Losses    

As of December 31, 2012

          

Corporate debt securities

   $ 383.6       $ 0.3       $ (0.1   $ 383.8   

U.S. government and agency debt securities

     295.8         0.1                295.9   

Foreign government debt securities

     5.0                        5.0   

Commercial paper

     138.7                        138.7   

Certificates of deposit

     92.2         0.1                92.3   

 

    

 

 

    

 

 

   

 

 

 

Total short and long-term investments

   $ 915.3       $ 0.5       $ (0.1   $ 915.7   

 

    

 

 

    

 

 

   

 

 

 

As of December 31, 2011

          

Corporate debt securities

   $ 324.8       $ 0.2       $ (0.3   $ 324.7   

U.S. government and agency debt securities

     177.1         0.1                177.2   

Municipal bonds

     1.0                        1.0   

Foreign government debt securities

     6.8                        6.8   

Commercial paper

     74.5                        74.5   

Certificates of deposit

     88.5                        88.5   

 

    

 

 

    

 

 

   

 

 

 

Total short and long-term investments

   $ 672.7       $ 0.3       $ (0.3   $ 672.7   

 

    

 

 

    

 

 

   

 

 

 

The following table shows the fair value and gross unrealized losses for all available-for-sale securities in an unrealized loss position deemed to be temporary (in millions):

 

     As of December 31, 2012     As of December 31, 2011  
      Fair
Value
    

Unrealized

Losses

    Fair
value
    

Unrealized

Losses

 

Corporate debt securities

   $ 144.2       $ (0.1   $ 164.5       $ (0.3

All securities in the table above have been in an unrealized loss position for less than twelve months. A total of 79 securities were in an unrealized loss position as of December 31, 2012.

The unrealized losses on our investments in corporate debt securities were caused by increases in interest yields resulting from changes in the global credit markets. We believe the unrealized losses associated with our available-for-sale securities as of December 31, 2012 are temporary because we do not intend to sell these investments before maturity, and we do not believe we will be required to sell them before recovery of their amortized cost basis.

The amortized cost and fair value of our available-for-sale fixed-maturity securities by contractual maturity are as follows (in millions):

 

As of December 31, 2012    Amortized Cost     

Fair

Value

 

Due in one year or less

   $ 671.3       $ 671.6   

Due after one year through two years

     244.0         244.1   

 

    

 

 

 

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