10-K 1 d842425d10k.htm 10-K 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, 2014

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.  þ

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 $17,501,425,466 (based on the closing price of these shares on the New York Stock Exchange on June 30, 2014 and assuming solely for the purpose of this calculation that all directors and executive officers of the registrant are “affiliates”). As of February 16, 2015, 169,902,991 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 2015 Annual Meeting of Stockholders

     Part III   


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ZIMMER HOLDINGS, INC.    2014 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 may be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as “may,” “will,” “can,” “should,” “would,” “could,” “anticipate,” “expect,” “plan,” “seek,” “believe,” “predict,” “estimate,” “potential,” “project,” “assume,” “guide,” “target,” “forecast,” “intend,” “strategy,” “is confident that,” “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      16   
Item 2.    Properties      17   
Item 3.    Legal Proceedings      17   
Item 4.    Mine Safety Disclosures      17   
PART II           18   
Item 5.    Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      18   
Item 6.    Selected Financial Data      19   
Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      20   
Item 7A.    Quantitative and Qualitative Disclosures About Market Risk      30   
Item 8.    Financial Statements and Supplementary Data      35   
Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      71   
Item 9A.    Controls and Procedures      71   
Item 9B.    Other Information      71   
PART III           72   
Item 10.    Directors, Executive Officers and Corporate Governance      72   
Item 11.    Executive Compensation      72   
Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      72   
Item 13.    Certain Relationships and Related Transactions and Director Independence      72   
Item 14.    Principal Accounting Fees and Services      72   
PART IV           73   
Item 15.    Exhibits, Financial Statement Schedules      73   

 

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ZIMMER HOLDINGS, INC.    2014 FORM 10-K ANNUAL REPORT

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.

On April 24, 2014, we entered into a definitive agreement to merge with LVB Acquisition, Inc. (LVB), the parent company of Biomet, Inc. (Biomet), in a cash and stock transaction valued at approximately $13.35 billion. We will pay $10.35 billion in cash, subject to certain adjustments, and issue 32.7 million shares of our common stock. In connection with the Biomet merger, we will pay off all of LVB’s outstanding funded debt, and the aggregate cash merger consideration will be reduced by such amount. The Biomet merger, which is subject to customary closing conditions and regulatory approvals, is expected to close in the first quarter of 2015. The merger will position the combined company as a leader in the $45 billion musculoskeletal industry. The Biomet merger is expected to be a transformational event for us and have significant effects on all aspects of our business. The description of our business in this report is for Zimmer on a standalone basis and does not address the consequences of the planned Biomet merger.

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 African markets; and Asia Pacific, which is comprised primarily of Japan and includes other Asian and Pacific markets.

We market and sell products through three principal channels: 1) direct to healthcare institutions, such as hospitals, referred to as 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 2014. 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 2014.

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, some 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 $2,594.2 million, or 56 percent, of 2014 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.

 

 

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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 $1,269.5 million, or 27 percent, of 2014 net sales, with France, Germany, Italy, Spain, Switzerland and the United Kingdom collectively accounting for 68 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 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 $809.6 million, or 17 percent, of 2014 net sales, with Japan being the largest market within this segment, accounting for 42 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. The knowledge and skills of these sales associates play a critical role in providing service, product information and support to surgeons. We have 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 seasonal in nature to some extent, 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 Southaven, Mississippi; and Carlsbad, California and internationally in Australia, Canada, China, France, Germany, India, Italy, Japan, Korea, Russia, South Africa, Spain, Switzerland, the United Kingdom, and various other countries.

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

Knees

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 knee portfolio also includes early intervention and joint preservation products, which seek to preserve the joint by repairing or regenerating damaged tissues and by treating osteoarthritis.

Our significant knee brands include the following:

 

Persona® The Personalized Knee System

 

NexGen® Complete Knee Solution

 

Natural-Knee® II System

 

Innex® Total Knee System

 

Zimmer® Unicompartmental High Flex Knee

 

Zimmer Patient Specific Instruments

 

Gel-One®1 Cross-linked Hyaluronate

Hips

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 Stem and CLS Brevius® Stem with Kinectiv Technology

 

Fitmore® Hip Stem

 

Avenir® Müller Stem

 

Wagner SL Revision® Hip Stem

 

Continuum® Acetabular System

 

Trilogy® IT Acetabular System

 

Allofit® IT Alloclassic Acetabular System

 

Trabecular MetalTM Modular Acetabular System

 

1 Registered trademark of Seikagaku Corporation

 

 

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Vivacit-E® Highly Crosslinked Polyethylene Liners

 

BIOLOX®2 delta Heads

Extremities

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

Our significant extremity brands include the following:

 

Zimmer Trabecular Metal Reverse Shoulder System

 

Bigliani/Flatow® Complete Shoulder Solution Family

 

Sidus® Stem-Free Shoulder

 

Zimmer Trabecular Metal Total Ankle

 

Zimmer Coonrad/Morrey Total Elbow 

 

Nexel® Total Elbow

DENTAL

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 prosthetic 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

 

Hex-Lock® Contour Abutment and Restorative Products

 

Puros® Allograft Products3

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

 

Zimmer Periarticular Locking Plate System

 

Zimmer Universal Locking System

 

Cable-Ready® Cable Grip System

SPINE

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.

 

2 Registered trademark of CeramTec GmbH

3 Manufactured by RTI Surgical in Alachua, FL and Tutogen Medical GmbH, Germany (an RTI Surgical, Inc. company) and distributed by Zimmer Dental, Inc.

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 Plate 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, blood management and fluid waste management.

Our significant surgical brands include the following:

 

Transposal® and Transposal Ultra® Fluid Waste Management Systems

 

PALACOS®4 Bone Cement

 

A.T.S.® Automatic Tourniquet Systems

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, Montreal, Canada; Beijing, China; Winterthur, Switzerland; Austin, Texas; Minneapolis, Minnesota; Carlsbad, California; Philadelphia, Pennsylvania; Dover, Ohio; and Parsippany, New Jersey. As of December 31, 2014, we employed approximately 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

 

4 Registered trademark of Heraeus Medical GmbH

 

 

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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 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, state and foreign laws concerning healthcare fraud and abuse, including false claims and anti-kickback laws, as well as the U.S. Physician Payments Sunshine Act and similar state and foreign healthcare professional payment transparency 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, state attorneys general and various foreign government agencies. 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. 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.

 

 

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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, and Smith & Nephew plc.

In the Americas geographic segment, we and the DePuy Synthes Companies, Stryker Corporation, Biomet, and Smith & Nephew, Inc. (a subsidiary of Smith & Nephew plc) account for a large majority of the total reconstructive and trauma implant sales. There are also many smaller competitors actively engaging in this market. Some of these smaller competitors have success by focusing on smaller subsegments of the industry.

The European reconstructive implant and trauma product markets are more fragmented than those markets in 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), Limacorporate S.p.A., 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, 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 more developed healthcare markets 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), 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).

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.

The manufacturing operations at our 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, 2014, we employed approximately 10,000 employees worldwide, including approximately 1,000 employees dedicated to research and development. Approximately 5,600 employees are located within the U.S.

 

 

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and approximately 4,400 employees are located outside of the U.S., primarily throughout Europe and in Japan. We have approximately 4,200 employees dedicated to manufacturing our products worldwide. The Warsaw, Indiana production facility employs approximately 1,800 employees.

Approximately 190 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 19, 2015.

 

Name    Age        Position

David C. Dvorak

     51         President and Chief Executive Officer

James T. Crines

     55         Executive Vice President, Finance and Chief Financial Officer

Joseph A. Cucolo

     55         President, Americas

Derek M. Davis

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

Katarzyna Mazur-Hofsaess, M.D., Ph.D.

     51         President, Europe, Middle East and Africa

Stephen H.L. Ooi

     61         President, Asia Pacific

Chad F. Phipps

     43         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 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, 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.

Dr. Mazur-Hofsaess was appointed President, Europe, Middle East and Africa in April 2013. She is responsible for the sales,

marketing and distribution of products in the European, Middle Eastern and African (EMEA) regions. Dr. Mazur-Hofsaess joined Zimmer in February 2010 as Senior Vice President, EMEA Sales and Marketing and was appointed President, EMEA Reconstructive in February 2012. She has approximately 20 years’ experience within the pharmaceutical, diagnostics and medical device sectors. Prior to joining Zimmer, Dr. Mazur-Hofsaess served in various management positions with Abbott Laboratories since 2001, including service as Vice President, Diagnostics – Europe.

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

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 Corporate Compliance, 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.

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

 

 

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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.

Risks Relating to the Proposed Biomet Merger and the Combined Company Following the Merger

The following risk factors relate to certain risks and uncertainties associated with the pending Biomet merger

and the combined company following the merger. The following discussion does not, however, contain all risks and uncertainties that relate to Biomet and its business on a standalone basis, which additional risks and uncertainties may also affect our actual results and could harm our business, financial condition and results of operations following the completion of the Biomet merger.

There is no assurance when or if the merger will be completed. Any delay in completing the merger may substantially reduce the benefits that we expect to obtain from the merger.

Completion of the merger is subject to the satisfaction or waiver of a number of conditions. There can be no assurance that we and LVB will be able to satisfy the closing conditions or that closing conditions beyond our control will be satisfied or waived. We and LVB can agree at any time to terminate the merger agreement, even though LVB stockholders have approved the merger, and we and LVB can also terminate the merger agreement under other specified circumstances. If the merger and the integration of the companies’ respective businesses are not completed within the expected timeframe, such delay may materially and adversely affect the synergies and other benefits that we expect to achieve as a result of the merger and could result in additional transaction costs, loss of revenue or other effects associated with uncertainty about the merger.

We expect to incur substantial expenses related to the merger and the integration of Biomet.

We expect to incur substantial expenses in connection with the merger and the integration of Biomet. There are a large number of processes, policies, procedures, operations, technologies and systems that must be integrated, including purchasing, accounting and finance, sales, billing, payroll, manufacturing, marketing and employee benefits. While we expect to incur integration and restructuring costs following completion of the merger in 2015 that are estimated to exceed $400 million in the first two years post-merger, many of the expenses that will be incurred are, by their nature, difficult to estimate accurately. These expenses could, particularly in the near term, exceed the savings that we expect to achieve from elimination of duplicative expenses and the realization of economies of scale and cost savings. Although we expect that the realization of efficiencies related to the integration of the businesses may offset incremental transaction, merger-related and restructuring costs over time, we cannot give any assurance that this net benefit will be achieved in the near term, or at all.

We and LVB may be unable to obtain the regulatory approvals required to complete the merger.

Completion of the merger is conditioned upon, among other conditions, the expiration or termination of any waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, the approval of the European Commission and the receipt of approval or expiration or termination of any waiting period under applicable antitrust, competition, fair trade or similar laws of Japan. We and LVB are pursuing all required consents, orders and approvals in accordance with the merger agreement. These consents,

 

 

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orders and approvals may impose conditions on or require divestitures relating to our or Biomet’s divisions, operations or assets, or may impose requirements, limitations or costs or place restrictions on the conduct of the combined company’s business. The merger agreement requires us and LVB, among other things, to accept all such conditions, divestitures, requirements, limitations, costs or restrictions that may be imposed by regulatory entities. Such conditions, divestitures, requirements, limitations, costs or restrictions may jeopardize or delay completion of the merger, may reduce the anticipated benefits of the merger or may result in the abandonment of the merger. Further, no assurance can be given that the required consents, orders and approvals will be obtained or that the required conditions to closing will be satisfied, and, even if all such consents, orders and approvals are obtained and such conditions are satisfied, no assurance can be given as to the terms, conditions and timing of such consents, orders and approvals.

The pendency of the merger could have an adverse effect on our and/or Biomet’s business, financial condition, results of operations or business prospects.

The pendency of the merger could disrupt our and/or Biomet’s businesses in the following ways, among others:

 

our and/or Biomet’s employees may experience uncertainty regarding their future roles in the combined company, which might adversely affect our and/or Biomet’s ability to retain, recruit and motivate key personnel;

 

the attention of our and/or Biomet’s management may be directed towards the completion of the merger and other transaction-related considerations and may be diverted from the day-to-day business operations of us and/or Biomet, as applicable, and matters related to the merger may require commitments of time and resources that could otherwise have been devoted to other opportunities that might have been beneficial to us and/or Biomet, as applicable; and

 

customers, suppliers and other third parties with business relationships with us and/or Biomet may decide not to renew or may decide to seek to terminate, change and/or renegotiate their relationships with us and/or Biomet as a result of the merger, whether pursuant to the terms of their existing agreements with us and/or Biomet or otherwise.

Any of these matters could adversely affect the businesses of, or harm the financial condition, results of operations or business prospects of, us and/or Biomet.

Failure to complete the merger could negatively impact our future business and financial results.

If the merger is not completed, our ongoing business may be adversely affected. We will be subject to several risks, including the following:

 

having to pay certain costs relating to the merger, such as legal, accounting, financial advisory, filing and printing fees; and

 

focusing our management on the merger instead of on pursuing other opportunities that could have been beneficial to us and our stockholders, without realizing any of the benefits of having the merger completed.

We cannot assure you that, if the merger is not completed, these risks will not materialize and will not materially adversely affect our business and financial results.

Successful integration of Biomet with us and successful operation of the combined company are not assured. Also, integrating our business with that of Biomet may divert the attention of management away from operations.

If the merger is completed, Biomet will become an indirect wholly owned subsidiary of ours, but will initially continue its operations on a basis that is separate from our operations. There can be no assurance that after the merger Biomet will be able to maintain and grow its business and operations. In addition, the market segments in which Biomet operates may experience declines in demand and/or new competitors. Integrating and coordinating certain aspects of the operations and personnel of Biomet with ours will involve complex operational, technological and personnel-related challenges. This process will be time-consuming and expensive, will disrupt the businesses of both companies and may not result in the full benefits expected by us and Biomet, including cost synergies expected to arise from supply chain efficiencies and overlapping general and administrative functions. The potential difficulties, and resulting costs and delays, include:

 

managing a larger combined company;

 

consolidating corporate and administrative infrastructures;

 

issues in integrating manufacturing, warehouse and distribution facilities, research and development and sales forces;

 

difficulties attracting and retaining key personnel;

 

loss of customers and suppliers and inability to attract new customers and suppliers;

 

unanticipated issues in integrating information technology, communications and other systems;

 

incompatibility of purchasing, logistics, marketing, administration and other systems and processes; and

 

unforeseen and unexpected liabilities related to the merger or Biomet’s business.

Additionally, the integration of our and Biomet’s operations, products and personnel may place a significant burden on management and other internal resources. The diversion of management’s attention, and any difficulties encountered in the transition and integration process, could harm the combined company’s business, financial condition and operating results.

We will incur substantial additional indebtedness in connection with the merger and may not be able to meet all of our debt obligations.

In connection with the merger, we entered into a $7.66 billion bridge credit agreement and a $4.35 billion bank credit agreement. Proceeds from the bank credit agreement and the anticipated issuance by us of up to $7.66 billion in aggregate principal amount of senior unsecured notes (or, if senior unsecured notes are not issued and sold prior to the closing date of the merger, drawings under the bridge credit agreement) will be used to finance, in part, the cash consideration for the merger, pay fees and the expenses incurred in connection with the merger and pay off all of

 

 

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Biomet’s funded debt. Our debt outstanding as of December 31, 2014 was approximately $1.43 billion and, immediately after the completion of the merger, the combined company’s debt is anticipated to be approximately $12.09 billion. As of December 31, 2014, our debt service obligations, comprised of principal and interest (excluding capital leases and equipment notes), during the next 12 months would, in the absence of the merger, have been approximately $64.0 million. As a result of the increase in debt related to the merger, demands on the combined company’s cash resources will increase after the completion of the merger. The increased level of debt could, among other things:

 

require the combined company to dedicate a large portion of its cash flow from operations to the servicing and repayment of its debt, thereby reducing funds available for working capital, capital expenditures, research and development expenditures and other general corporate requirements;

 

limit the combined company’s ability to obtain additional financing to fund future working capital, capital expenditures, research and development expenditures and other general corporate requirements;

 

limit the combined company’s flexibility in planning for, or reacting to, changes in its business and the industry in which we operate;

 

restrict the combined company’s ability to make strategic acquisitions or dispositions or to exploit business opportunities;

 

place the combined company at a competitive disadvantage compared to its competitors that have less debt;

 

adversely affect the combined company’s credit rating, with the result that the cost of servicing the combined company’s indebtedness might increase and its ability to obtain surety bonds could be impaired;

 

adversely affect the market price of our common stock; and

 

limit the combined company’s ability to apply proceeds from an offering or asset sale to purposes other than the servicing and repayment of debt.

If we are unable to obtain alternate financing through senior unsecured notes, it is unlikely that we will be able to repay the outstanding amounts under the bridge loan at maturity on the 364th day after completion of the merger. Any debt incurred to refinance the bridge loan may be on unfavorable terms.

The merger may cause dilution to our earnings per share, which may negatively affect the market price of our common stock.

Although we anticipate that the merger will have an immediate accretive impact on the combined company’s adjusted earnings per share, this expectation is based on factors that may not be realized and estimates that may materially change. We could also encounter additional transaction-related costs or other factors, such as the failure to realize all of the benefits anticipated to result from the merger. In addition, we expect that LVB stockholders and holders of LVB equity-based awards immediately prior to the merger will own, in the aggregate, approximately 16% of our outstanding shares after the merger, based on the number of outstanding shares of our common stock on December 31, 2014. Once

additional shares are issued in the merger, the combined company’s earnings per share may be lower than our adjusted earnings per share would have been in the absence of the merger. All of these factors could cause dilution to earnings per share or decrease or delay the expected accretive effect of the merger, and cause a decrease in the market price of our common stock. There can be no assurance that any increase in adjusted earnings per share will occur, even over the long term. Any increase in adjusted earnings per share as a result of the merger is likely to require us, among other things, to successfully manage the combined company’s operations to increase our consolidated earnings after the merger.

Risks Relating to Our Business Regardless of Whether the Proposed Biomet Merger is Consummated

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 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.

 

 

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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;

 

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.

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.

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

The Patient Protection and Affordable Care Act of 2010, as amended by the Health Care and Education Affordability Reconciliation Act of 2010 (collectively, the Affordable Care Act), was signed into law in March 2010 and mandates health insurance coverage and other healthcare reforms with staggered effective dates from 2010 to 2018. As part of the Affordable Care Act, in January 2013 we began paying a 2.3 percent medical device excise tax on the vast majority of our U.S sales. We continue to identify ways to reduce spending in other areas to offset the earnings impact due to the tax. We have not been able to pass along the cost of the tax to hospitals, which continue to face cuts to their Medicare reimbursement under the Affordable Care Act and other legislation. Nor have we been 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 subsequent guidance from the U.S. Department of Treasury have not lessened the burden of complying with the excise tax statute. In addition, without the implementation of proper safeguards, the Affordable Care Act’s Medicare payment reforms, such as accountable care organizations and bundled payments, could provide additional incentives for healthcare providers to reduce spending on some of 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 full impact of the Affordable Care Act on our business, ongoing implementation 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

 

 

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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 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 and could have a material adverse effect on our business, financial condition and results of operations.

In 2012, we received a warning letter from the FDA citing concerns relating to certain manufacturing and validation processes pertaining to Trilogy Acetabular System products manufactured at our Ponce, Puerto Rico manufacturing facility. As of December 31, 2014, the warning letter remains pending. Until the violations are corrected, we may become subject to additional regulatory action by the FDA, the FDA may refuse to grant premarket approval applications and/or the FDA may refuse to grant export certificates, any of which could have a material adverse effect on our business, financial condition and results of operations. Additional information regarding this and other FDA regulatory matters can be found in Note 19 to our consolidated financial statements (See Part II, Item 8 of this report).

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.

If we fail to comply with healthcare fraud and abuse laws and regulations, we could face substantial penalties and our business, operations and financial condition could be adversely affected.

Our industry is subject to various federal, state and foreign laws and regulations pertaining to healthcare fraud and abuse, including the federal False Claims Act, the federal Anti-Kickback Statute, the federal Stark law, the federal Physician Payments Sunshine Act and similar state and foreign 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.

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 2014 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.;

 

 

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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;

 

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.

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 are defending product liability lawsuits relating to the Durom® Acetabular Component (Durom Cup) and certain products within the NexGen Knee System. The majority of the Durom Cup cases are pending in a federal Multidistrict Litigation in the District of New Jersey (In Re: Zimmer Durom Hip Cup Products Liability Litigation) and the majority of the NexGen Knee System cases are pending in a federal Multidistrict Litigation in the Northern District of Illinois (In Re: Zimmer NexGen Knee Implant Products Liability Litigation). 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.

We are substantially dependent on patent and other proprietary rights, and failing to protect such rights or to be successful in litigation related to our rights or the rights of others may result in our payment of significant monetary damages and/or royalty payments, negatively impact our ability to sell current or future products, or prohibit us from enforcing our patent and other proprietary rights against others.

Claims of intellectual property infringement and litigation regarding patent and other intellectual property rights are commonplace in our industry and are frequently time consuming and costly. At any given time, we may be involved as either plaintiff or defendant in a number of patent infringement actions, the outcomes of which may not be known for prolonged periods of time. While it is not possible to predict the outcome of patent and other intellectual property litigation, such litigation could result in our payment of significant monetary damages and/or royalty payments, negatively impact our ability to sell current or future products, or prohibit us from enforcing our patent and proprietary rights

 

 

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against others, which could have a material adverse effect on our business and results of operations.

Patents and other proprietary rights are essential to our business. We rely on a combination of patents, trade secrets and non-disclosure and other agreements to protect our proprietary intellectual property, and we will continue to do so. While we intend to defend against any threats to our intellectual property, these patents, trade secrets and other agreements may not adequately protect our intellectual property. Further, our currently pending or future patent applications may not result in patents being issued to us, patents issued to or licensed by us in the past or in the future may be challenged or circumvented by competitors, and such patents may be found invalid, unenforceable or insufficiently broad to protect our technology or to provide us with any competitive advantage. Third parties could obtain patents that may require us to negotiate licenses to conduct our business, and the required licenses may not be available on reasonable terms or at all.

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 non-disclosure and other agreements with our employees, consultants and collaborators. We cannot be certain that these agreements will not be breached, that we will have adequate remedies for any breach, that others will not independently develop substantially equivalent proprietary information, or that third parties will not otherwise gain access to our trade secrets or proprietary knowledge.

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 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 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 gain unauthorized access to our products or systems and may obtain data relating to patients 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 our data and information technology, there can be no assurance that our activities related to consolidating the number of systems we operate, upgrading and expanding our information systems capabilities, protecting and enhancing our systems and implementing new systems 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.

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 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

 

 

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ZIMMER HOLDINGS, INC.    2014 FORM 10-K ANNUAL REPORT

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.

The “conflict minerals” rule 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.

We are subject to the SEC’s rule regarding disclosure of the use of certain minerals, known as “conflict minerals” (tantalum, tin and tungsten (or their ores) and gold), which are mined from the Democratic Republic of the Congo and adjoining countries. We filed a report on Form SD with the SEC regarding such matters on June 2, 2014 and are required

to file on an annual basis going forward. This rule could adversely affect the sourcing, availability and pricing of materials used in the manufacture of our products, which could adversely affect our manufacturing operations and our profitability. In addition, we are incurring additional costs to comply with this rule, including costs related to determining the source of any relevant minerals and metals used in our products. We have a complex supply chain and we may not be able to sufficiently verify the origins of the minerals and metals used in our products through the due diligence procedures that we implement. As a result, we may face reputational challenges with our customers and other stakeholders.

 

Item 1B.   Unresolved Staff Comments

Not Applicable.

 

 

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ZIMMER HOLDINGS, INC.    2014 FORM 10-K ANNUAL REPORT
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         83,000   

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         138,000   
   Warehousing      Leased         64,000   

Parsippany, New Jersey

   Office, Research & Development, Manufacturing, Warehousing & The Zimmer Institute      Leased         132,000   

Memphis, Tennessee

   Offices & Warehousing      Leased         30,000   

Austin, Texas

   Offices, Administration, Research & Development      Leased         71,000   

Sydney, Australia

   Offices & Warehousing      Leased         60,000   

Mississauga, Canada

   Offices & Warehousing      Leased         52,000   

Beijing, China

   Offices & Manufacturing      Leased         89,000   

Shanghai, China

   Offices & Warehousing      Leased         52,000   

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         34,000   

Ponce, Puerto Rico

   Offices, Manufacturing & Warehousing      Owned         225,000   

Singapore

   Offices & Warehousing      Leased         19,000   

Barcelona, Spain

   Offices & Warehousing      Leased         30,000   

Winterthur, Switzerland

   Offices, Research & Development & Manufacturing      Leased         425,000   

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., Australia, Canada, China, France, Germany, India, Italy, Japan, Korea, Russia, South Africa, Spain, Switzerland, the United Kingdom. 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.    2014 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 2014 and 2013 are set forth as follows:

 

QUARTERLY HIGH-LOW SHARE PRICES AND DECLARED DIVIDENDS    High      Low      Declared
Dividends
 

Year Ended December 31, 2014:

        

First Quarter

   $ 98.95       $ 90.77       $ 0.22   

Second Quarter

   $ 108.33       $ 90.48       $ 0.22   

Third Quarter

   $ 105.68       $ 94.73       $ 0.22   

Fourth Quarter

   $ 116.14       $ 95.33       $ 0.22   

Year Ended December 31, 2013:

        

First Quarter

   $ 76.75       $ 67.34       $ 0.20   

Second Quarter

   $ 81.92       $ 72.31       $ 0.20   

Third Quarter

   $ 85.08       $ 74.85       $ 0.20   

Fourth Quarter

   $ 93.70       $ 80.55       $ 0.20   

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. As further discussed in Item 7 of this report, our debt facilities restrict the payment of dividends under certain circumstances.

The number of holders of our common stock on February 16, 2015 was approximately 237,703. On February 19, 2015, the closing price of our common stock, as reported on the New York Stock Exchange, was $120.20 per share.

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

 

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ZIMMER HOLDINGS, INC.    2014 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):

 

      2014      2013      2012      2011      2010  

STATEMENT OF EARNINGS DATA

              

Net sales

   $ 4,673.3       $ 4,623.4       $ 4,471.7       $ 4,451.8       $ 4,220.2   

Net earnings of Zimmer Holdings, Inc.

     720.1         761.0         755.0         760.8         596.9   

Earnings per common share

              

Basic

   $ 4.26       $ 4.49       $ 4.32       $ 4.05       $ 2.98   

Diluted

     4.19         4.43         4.29         4.03         2.97   

Dividends declared per share of common stock

   $ 0.88       $ 0.80       $ 0.54       $ 0.18       $   

Average common shares outstanding

              

Basic

     169.0         169.6         174.9         187.6         200.0   

Diluted

     171.7         171.8         176.0         188.7         201.1   

BALANCE SHEET DATA

              

Total assets

   $ 9,634.7       $ 9,580.6       $ 9,012.4       $ 8,515.3       $ 7,999.9   

Long-term debt

     1,425.5         1,672.3         1,720.8         1,576.0         1,142.1   

Other long-term obligations

     648.6         576.6         559.3         557.4         384.0   

Stockholders’ equity

     6,522.6         6,300.1         5,866.3         5,514.8         5,771.3   

 

 

 

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ZIMMER HOLDINGS, INC.    2014 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 2013 and 2012 consolidated financial statements have been reclassified to conform to the 2014 presentation.

Forward-looking financial information provided in this management’s discussion and analysis does not include estimated results of operations, cash flows or financial position related to the pending Biomet merger, except for certain costs and expenses we expect to incur that are necessary to consummate the merger and that we will incur for integration planning prior to the merger closing. The Biomet merger is expected to be a transformational event for us and have significant effects on all aspects of our business. This management’s discussion and analysis of our historical financial condition and results of operations on a standalone basis is not indicative of the financial condition and results of operations for future periods on a combined company basis following the merger.

EXECUTIVE LEVEL OVERVIEW

 

2014 Results

Our 2014 sales results reflected increased growth as compared with 2013. Sales from recent product introductions, such as Persona The Personalized Knee System, as well as a stable joint replacement market, drove sales volume and product mix growth. This was partially offset by continued pricing pressure, negative effects from changes in foreign currency exchange rates, and a year-over-year decline in sales of our Transposal Fluid Waste Management System.

Despite the increase in net sales, net earnings decreased, driven by increased spending on our operational excellence initiatives, integration planning expenses related to the pending Biomet merger, a $70.0 million contingent legal liability recognized in 2014, and increased debt issuance costs and unused commitment fees recognized on new debt facilities that we entered into in May 2014 in order to fund the pending Biomet merger.

2015 Outlook

The pending Biomet merger, which we expect to close in the first quarter of 2015, will have a significant impact on our 2015 operating results. This report does not include guidance for 2015 on a combined company basis.

However, for Zimmer on a standalone basis, we project that our net sales will face significant headwinds from the U.S. Dollar strengthening against the Euro, Japanese Yen and various other currencies around the world based upon recent foreign currency exchange rates. Additionally for net sales, we expect to experience volume and mix growth from a stable joint replacement market and continued pricing pressure.

In regards to expenses on a Zimmer standalone basis, due to our hedging program, we project that the expected decrease in net sales caused by changes in foreign currency exchange rates will be partially offset by hedge gains to be recognized in 2015. We expect research and development (R&D) spending will remain similar compared to prior years as a percentage of net sales. For our selling, general and administrative (SG&A) expenses, we expect to continue to realize efficiencies from our operational excellence initiatives. However, since many of our fixed SG&A expenses are denominated in U.S. Dollars, such as corporate and business unit headquarter expenses and intangible asset amortization, our SG&A expenses may not decrease in similar proportion to net sales decreases expected from changes in foreign currency exchange rates.

 

 

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
 
      2014      2013      % Inc/(Dec)       Price    

Americas

   $ 2,594.2       $ 2,619.8         (1 )%      2     (3 )%     

Europe

     1,269.5         1,212.6         5        7        (2       

Asia Pacific

     809.6         791.0         2        9        (1     (6

 

    

 

 

          

Total

   $ 4,673.3       $ 4,623.4         1        4        (2     (1

 

    

 

 

          

 

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ZIMMER HOLDINGS, INC.    2014 FORM 10-K ANNUAL REPORT
     Year Ended December 31,            Volume/
Mix
          Foreign
Exchange
 
      2013      2012      % Inc/(Dec)       Price    

Americas

   $ 2,619.8       $ 2,476.3         6     8     (2 )%     

Europe

     1,212.6         1,177.4         3        2        (1     2   

Asia Pacific

     791.0         818.0         (3     8        (1     (10

 

    

 

 

          

Total

   $ 4,623.4       $ 4,471.7         3        7        (2     (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
 
      2014      2013      % Inc (Dec)       Price    

Reconstructive

              

Knees

   $ 1,965.8       $ 1,909.9         3     7     (3 )%      (1 )% 

Hips

     1,326.4         1,330.5                4        (3     (1

Extremities

     204.3         193.8         5        9        (3     (1

 

    

 

 

          

Total

     3,496.5         3,434.2         2        6        (3     (1

 

    

 

 

          

Dental

     242.8         239.3         1        2               (1

Trauma

     316.7         315.6                3        (1     (2

Spine

     207.2         202.3         2        5        (2     (1

Surgical and other

     410.1         432.0         (5     (3            (2

 

    

 

 

          

Total

   $ 4,673.3       $ 4,623.4         1        4        (2     (1

 

    

 

 

          

 

     Year Ended December 31,            Volume/
Mix
          Foreign
Exchange
 
      2013      2012      % Inc (Dec)       Price    

Reconstructive

              

Knees

   $ 1,909.9       $ 1,833.8         4     7     (2 )%      (1 )% 

Hips

     1,330.5         1,342.0         (1     3        (2     (2

Extremities

     193.8         173.8         11        14        (2     (1

 

    

 

 

          

Total

     3,434.2         3,349.6         3        6        (2     (1

 

    

 

 

          

Dental

     239.3         237.7         1                      1   

Trauma

     315.6         307.9         2        6        (1     (3

Spine

     202.3         208.9         (3     (1     (2       

Surgical and other

     432.0         367.6         18        21               (3

 

    

 

 

          

Total

   $ 4,623.4       $ 4,471.7         3        7        (2     (2

 

    

 

 

          

 

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ZIMMER HOLDINGS, INC.    2014 FORM 10-K ANNUAL REPORT

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

 

     Year Ended December 31,  
      2014      2013      2012      2014 vs. 2013
% Inc (Dec)
    2013 vs. 2012
% Inc (Dec)
 

Reconstructive

             

Knees

             

Americas

   $ 1,157.4       $ 1,135.3       $ 1,077.9         2     5

Europe

     498.6         468.3         447.3         6        5   

Asia Pacific

     309.8         306.3         308.6         1        (1

Hips

             

Americas

     607.8         621.0         606.7         (2     2   

Europe

     448.9         445.0         446.0         1          

Asia Pacific

     269.7         264.5         289.3         2        (9

Extremities

             

Americas

     149.6         148.1         133.8         1        11   

Europe

     40.6         34.0         29.0         19        17   

Asia Pacific

     14.1         11.7         11.0         20        7   

 

    

 

 

    

 

 

      

Total

     3,496.5         3,434.2         3,349.6         2        3   

 

    

 

 

    

 

 

      

Dental

             

Americas

     142.1         141.6         137.8                3   

Europe

     80.3         78.6         79.8         2        (2

Asia Pacific

     20.4         19.1         20.1         7        (5

Trauma

             

Americas

     147.3         155.6         155.2         (5       

Europe

     82.1         76.4         69.5         8        10   

Asia Pacific

     87.3         83.6         83.2         4          

Spine

             

Americas

     131.3         129.6         140.0         1        (7

Europe

     50.8         49.8         49.3         2        1   

Asia Pacific

     25.1         22.9         19.6         10        17   

Surgical and other

             

Americas

     258.7         288.6         224.9         (10     28   

Europe

     68.2         60.5         56.5         13        7   

Asia Pacific

     83.2         82.9         86.2                (4

 

    

 

 

    

 

 

      

Total

   $ 4,673.3       $ 4,623.4       $ 4,471.7         1        3   

 

    

 

 

    

 

 

      

 

Demand (Volume and Mix) Trends

Increased volume and changes in the mix of product sales contributed 4 percentage points of year-over-year sales growth in 2014, which was a lower growth rate than experienced in 2013 compared to 2012. In 2013, accelerated growth was fueled by the introduction of new products, such as Persona The Personalized Knee System and the Transposal Fluid Waste Management System. In 2014, while new products continued to drive sales growth, their impact on a year-over-year basis was not as significant.

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, demand for clinically proven premium products and patient specific devices are expected to continue to positively affect sales growth in markets that recognize the value of these advanced technologies.

Pricing Trends

Global selling prices had a negative effect of 2 percent on year-over-year sales during 2014. The negative 2 percent was

consistent with prior years as we continued to experience pricing pressure from governmental healthcare cost containment efforts and from local hospitals and health systems. For 2015, we expect continued pricing pressure similar to prior years.

Foreign Currency Exchange Rates

For 2014, foreign currency exchange rates resulted in a 1 percent decrease in sales, driven by the strengthening of the U.S. Dollar versus the Japanese Yen as well as a few other currencies in other regions in which we operate. If foreign currency exchange rates remain consistent with December 31, 2014 rates, we estimate that a stronger dollar versus foreign currency exchange rates will have a greater negative effect on sales in 2015 than in 2014. We address currency risk through regular operating and financing activities and through the use of foreign currency forward contracts and foreign currency 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 partially offset.

 

 

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Sales by Product Category

Knees

Knee sales increased 3 percent in 2014 compared to a 4 percent increase in 2013. Our Knee product category has benefited from recent product introductions, such as Persona The Personalized Knee System and joint preservation solutions. However, the volume/mix growth from new product introductions has been tempered by pricing pressure in all our reporting segments.

In 2014, we continued a broader launch of Persona The Personalized Knee System. We intend to continue to deploy implant and instrument sets for this knee system to all geographic regions in 2015 and beyond. Our NexGen Complete Knee Solution product line is still our leading global knee system in terms of sales. Products driving growth in this category, in addition to Persona The Personalized Knee System, included the Zimmer Unicompartmental High Flex Knee and our joint preservation solutions.

In Europe, changes in foreign currency exchange rates affected Knee sales in 2014 and 2013 by negative 1 percent and positive 2 percent, respectively. In Asia Pacific, changes in foreign currency exchange rates had negative effects on Knee sales of 5 percent and 9 percent in 2014 and 2013, respectively.

Hips

Hip sales were flat in 2014 after a decline of 1 percent in 2013. Positive volume and mix trends continue to be offset by pricing pressure.

Leading hip stem sales were the Zimmer M/L Taper Hip Prosthesis, the Zimmer M/L Taper Hip Prosthesis with Kinectiv Technology, the CLS Spotorno Stem from the CLS Hip System, the Alloclassic Zweymüller Hip Stem and the Fitmore Hip Stem. Products experiencing growth in this category included the Avenir Müller Stem, the Wagner SL Revision Hip Stem, the Continuum Acetabular System, the Trilogy IT Acetabular System, the Allofit IT Alloclassic Acetabular System, Vivacit-E Highly Crosslinked Polyethylene Liners and BIOLOX delta Heads.

In Europe, changes in foreign currency exchange rates affected Hip sales in 2014 and 2013 by negative 1 percent and positive 2 percent, respectively. In Asia Pacific, changes in foreign currency exchange rates had negative effects on Hip sales of 6 percent and 11 percent in 2014 and 2013, respectively.

Extremities

Extremities sales increased 5 percent in 2014 compared to an 11 percent increase in 2013. The sales increase in both years reflected growth from our shoulder systems, such as the Zimmer Trabecular Metal Reverse Shoulder System and the

Sidus Stem-Free Shoulder, and a broader product portfolio to compete in the foot and ankle and hand and wrist areas of the Extremities category. The broader portfolio includes the Zimmer Trabecular Metal Total Ankle and products from the acquisition of NORMED Medizin-Technik GmbH in June 2013.

Dental

Dental sales increased 1 percent in 2014, which was the same as the prior year sales growth. Increased sales of dental reconstructive implants and digital solutions have been partially offset by decreases in restorative products. Sales were led by the Tapered Screw-Vent Implant System. In our Dental product category, in certain markets, especially in our Asia Pacific region, our customers are distributors. The timing of distributor purchases can have a significant influence on sales in those markets in any particular year.

Trauma

Trauma sales were flat in 2014 and increased by 2 percent in 2013. New product launches, especially in our Europe and Asia Pacific reporting segments, positively affected sales in both years. The Zimmer Natural Nail System and Zimmer Periarticular Locking Plates System led Trauma sales.

Spine

Spine sales increased 2 percent in 2014 after a decline of 3 percent in 2013. In 2014, we continued to focus on and had success in commercializing offerings across our core fusion portfolio and market adjacencies, including minimally invasive surgeries. Solid sales of the PathFinder NXT Minimally Invasive Pedicle Screw System and Trabecular Metal Technology products were partially offset by a decline in sales of other spine products.

Surgical and other

Surgical and other sales declined by 5 percent in 2014 after an 18 percent sales increase in 2013. The primary cause of the sales fluctuations in this product category was the Transposal Fluid Waste Management System. This system is comprised of a capital equipment component that is used with a one-time use disposable manifold component. In 2013, our system benefitted from commercial disruption experienced by a competitive product, increasing demand for the capital equipment component. With that competitive product back on the market in 2014 and since many customers bought our capital equipment component in 2013, sales of the capital equipment component decreased significantly in 2014. However, this decrease was partially offset by an increase in sales of the related disposable manifold component. Other products leading sales in this category were PALACOS Bone Cement, tourniquets and wound debridement devices.

 

 

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ZIMMER HOLDINGS, INC.    2014 FORM 10-K ANNUAL REPORT

The following table presents estimated* 2014 global market size and market share information (dollars in billions):

 

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

Reconstructive

         

Knees

   $ 7.6         3     26     1   

Hips

     6.5         2        21        2   

Extremities

     1.9         12        11        6   

 

        

Total

   $ 16.0         4        22        1   

 

        

Dental

   $ 3.4         3        7        5   

Trauma

   $ 5.9         5        5        4   

Spine***

   $ 9.0         2        2        8   

 

* 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,  
      2014     2013     2012     2014 vs. 2013
Inc (Dec)
    2013 vs. 2012
Inc (Dec)
 

Cost of products sold

     26.7     27.8     25.2     (1.1     2.6   

Research and development            

     4.0        4.4        5.0        (0.4     (0.6

Selling, general and administrative

     39.0        39.7        40.4        (0.7     (0.7

Certain claims

     0.5        1.0        0.3        (0.5     0.7   

Goodwill impairment

                   2.1               (2.1

Special items

     7.6        4.7        3.5        2.9        1.2   

Operating margin

     22.1        22.4        23.4        (0.3     (1.0

Cost of Products Sold

The following table sets forth the factors that contributed to the gross margin changes in each of 2014 and 2013 compared to the prior year:

 

     Year Ended December 31,  
               2014              2013  

Prior year gross margin

     72.2     74.8

Lower average selling prices

     (0.6     (0.4

Average cost per unit

     0.4        (1.2

Excess and obsolete inventory

     0.4        (0.2

Discontinued products and other certain excess and obsolete inventory charges

     0.9        (1.0

Certain inventory and manufacturing related charges related to quality

     0.1        (0.3

Foreign currency hedges

     0.5        0.5   

Inventory step-up

     0.1        (0.1

U.S. medical device excise tax

     (0.5     (0.2

Other

     (0.2     0.3   

 

 

Current year gross margin

     73.3     72.2

 

 

The increase in gross margin percentage in 2014 compared to 2013 was primarily due to significant excess and obsolete inventory charges recorded in 2013 related to products we intend to discontinue. We also recognized higher hedge gains in 2014 from our foreign currency hedging program compared to 2013. Under the hedging 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 items affect earnings. Further, we experienced improved product category mix, resulting in lower average costs per unit sold. These favorable items were partially offset by lower average selling prices and the U.S. medical device excise tax. While we began paying the medical device excise tax in 2013, based upon the levels of inventory we were carrying before the excise tax was effective on January 1, 2013, we did not recognize any significant expenses from the excise tax until the fourth quarter of 2013. We are in discussions with the Internal Revenue Service (IRS) as to what an appropriate constructive sales price used to compute our excise tax obligations should be under IRS excise tax regulations and our specific business model. Our ultimate medical device excise tax and liability may differ from the amount we have estimated. Accordingly, the amount we have recognized as expense is an estimate and subject to change.

The decrease in gross margin in 2013 was primarily due to higher average costs per unit sold as a result of changes in product and geographic mix and increased excess and obsolescence charges related to products we intend to discontinue. Additionally, lower average selling prices and certain inventory and manufacturing related charges connected to quality enhancement and remediation efforts reduced gross margin. These negative effects were partially offset by hedge gains recorded in 2013 from our foreign currency hedging program versus hedge losses recorded in 2012.

Operating Expenses

R&D expenses and R&D as a percentage of sales have declined in the last three years. The lower spending reflected a natural decline from certain large projects that achieved commercialization, including Persona The Personalized Knee System, and a dedication of resources to our quality and operational excellence initiatives. We expect R&D spending in 2015 to increase and be between 4 and 4.5 percent of sales as we transition our resources towards new projects as our quality and operational excellence initiatives continue to progress.

SG&A expenses have remained relatively consistent while SG&A as a percentage of sales has decreased over the last three years. Improvement in SG&A expenditures as a percentage of sales reflects the effects of our operational excellence initiatives. Although variable expenses naturally increase with higher sales, our SG&A expenses as a percentage of sales has decreased due to our operational excellence initiatives which produced lower variable and fixed costs in SG&A as net sales increased. Additionally, selling and distribution expenses are lower in our Europe and Asia Pacific reporting segments compared to our Americas reporting segment. The mix of revenues with high sales growth in Europe and Asia Pacific compared to the Americas helped to lower SG&A as a percentage of sales in 2014 when compared to 2013.

 

 

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“Certain claims” expense is for estimated liabilities to Durom Cup patients undergoing revision surgeries. We recorded additional expense of $21.5 million in 2014, bringing the total recorded expense to $420.3 million for these claims, excluding a subset of Durom Cup claims that were recorded in SG&A. The additional expense recorded in 2014 was the result of new developments related to international claims activity. For more information regarding these claims, see Note 19 to the consolidated financial statements.

In connection with our annual goodwill impairment test performed in the fourth quarter of 2012, 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 a goodwill impairment charge of $96.0 million in 2012. We did not record a goodwill impairment charge in 2014 or 2013, as our annual goodwill impairment tests revealed that the carrying values of the net assets of our U.S. Spine reporting unit were less than their estimated fair value. For more information regarding goodwill impairment and the factors that led to the 2012 impairment, see Note 8 to the consolidated financial statements.

“Special items” have increased significantly in the past three years. The increase in 2014 was a result of higher professional fees related to the pending Biomet merger, increased other professional fees, contract labor and dedicated project personnel related to our quality and operational excellence initiatives, increased intangible asset impairments and a $70.0 million accrual for a certain litigation matter. We continue to implement our quality and operational excellence initiatives, which are intended to improve our future operating results by centralizing or outsourcing certain functions and improving quality, distribution, sourcing, manufacturing and our information technology systems. “Special items” expenses include consulting and professional fees, dedicated personnel costs, severance benefits as well as other costs for those programs. In addition to expenses for our quality and operational excellence programs, we recognize expenses related to integration of acquired businesses, impairment of assets, certain R&D agreements, certain litigation settlements, contract termination expenses and other items as “Special items.” See Note 2 to the consolidated financial statements for more information regarding “Special items” charges.

Other Expense, Interest Income, Interest Expense, and Income Taxes

Other expense represents debt issuance costs and unused commitment fees recognized for our senior credit facility and bridge credit agreement that we entered into in May 2014 in order to fund the pending Biomet merger.

Interest income and expense, net, was lower in 2014 compared to 2013 and 2012. In the second half of 2013, we entered into additional fixed-to-variable rate interest swaps designated as fair value hedges. In the 2014 periods, the variable rates we paid on the swaps were lower than the fixed rate on the hedged debt and, therefore, interest expense decreased.

Our effective tax rate (ETR) on earnings before income taxes for the years ended December 31, 2014, 2013 and 2012 was 23.8 percent, 22.6 percent and 24.0 percent, respectively. The variation of our ETR has largely been affected by “Special items”, “Certain claims”, goodwill impairment charges and a $34.3 million benefit in 2012 from the recognition of deferred tax assets related to a legal entity restructuring. Higher “Special items” and “Certain claims” expense favorably affect our ETR because most of these expenses have been incurred within jurisdictions with higher tax rates, resulting in lower taxable income in these higher tax jurisdictions. Goodwill impairment negatively affects our ETR because no tax benefit is recorded on the charge. In 2014, a portion of our “Special items” were for non-deductible expenses incurred related to the pending Biomet merger, which increased our ETR relative to 2013. In 2013, in addition to the effect of “Special items” and “Certain claims”, our ETR benefited from the retroactive reinstatement of the R&D tax credit and other tax benefits applicable to us that applied to 2012 and 2013. Due to the timing of the extension and the applicable rules of accounting principles generally accepted in the United States of America (GAAP), we recognized the 2012 benefit in 2013. Despite the $34.3 million benefit in 2012 from the recognition of deferred tax assets related to a legal entity restructuring, the 2012 ETR was higher than 2014 and 2013 due to the goodwill impairment charge and lower “Certain claims” and “Special items” expenses. The items discussed accounted for the majority of the variation in our ETRs in the past three years.

Segment Operating Profit

For our reporting segments, operating profit increased in Europe and Asia Pacific in 2014 compared to 2013, while in the Americas it decreased. The decrease in the Americas was primarily from lower gross profit due to lower sales and the effect of the U.S. medical device excise tax. In Europe, the increase in operating profit was driven by increased sales coupled with controlled operating expenses. Operating expenses increased at a lower percentage compared to sales increases due to our operational excellence initiatives and the nature of fixed versus variable expenses resulting in operating margin expansion in Europe. The increase in operating profit in Asia Pacific was driven by increases in sales from volume and product mix. While changes in foreign currency exchange rates tempered sales growth in Asia Pacific, this decline was largely offset by increased hedge gains recorded in 2014 versus 2013.

Non-GAAP operating performance measures

We use financial measures that differ from financial measures determined in accordance with GAAP to evaluate our operating performance. These non-GAAP financial measures exclude the impact of inventory step-up, certain inventory and manufacturing related charges connected to quality enhancement and remediation efforts, “Certain claims,” goodwill impairment, “Special items,” other expenses related to financing obtained for the pending Biomet merger and any related effects on our income tax provision associated with

 

 

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these items. 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, 2014, 2013 and 2012 were $1,041.0 million, $988.4 million, and $932.5 million, respectively, and our non-GAAP adjusted diluted earnings per share were $6.06, $5.75, and $5.30, 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,  
      2014     2013     2012  

Net Earnings of Zimmer Holdings, Inc.

   $ 720.1      $ 761.0      $ 755.0   

Inventory step-up and other inventory and manufacturing related charges

     21.2        70.5        4.8   

Certain claims

     21.5        47.0        15.0   

Goodwill impairment

                   96.0   

Special items

     356.5        216.7        155.4   

Other expense on Biomet merger financing

     39.6                 

Taxes on above items and other certain tax adjustments*

     (117.9     (106.8     (93.7

 

   

 

 

   

 

 

 

Adjusted Net Earnings

   $ 1,041.0      $ 988.4      $ 932.5   

 

   

 

 

   

 

 

 

 

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

 

     Year ended December 31,  
      2014     2013     2012  

Diluted EPS

   $ 4.19      $ 4.43      $ 4.29   

Inventory step-up and other inventory and manufacturing related charges

     0.12        0.41        0.03   

Certain claims

     0.13        0.27        0.09   

Goodwill impairment

                   0.54   

Special items

     2.08        1.26        0.88   

Other expense on Biomet merger financing

     0.23                 

Taxes on above items and other certain tax adjustments*

     (0.69     (0.62     (0.53

 

   

 

 

   

 

 

 

Adjusted Diluted EPS

   $ 6.06      $ 5.75      $ 5.30   

 

   

 

 

   

 

 

 

 

* 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 $1,052.8 million in 2014, compared to $963.1 million in 2013. The principal source of cash from operating activities was net earnings. Non-cash items included in net earnings accounted for another $346.4 million of operating cash in 2014. All other

items of operating cash flows reflect a use of $12.6 million of cash in 2014, compared to a use of $84.9 million in 2013.

The increased cash flows provided by operating activities in 2014 were primarily due to improved cash flows generated from receivables collections, especially in Europe, lower funding necessary for our U.S. pension plans, and receipt of insurance proceeds related to Durom Cup product liability claims. These favorable items were partially offset by higher tax payments for certain unresolved matters in order to limit the potential impact of IRS interest charges and inventory investments.

At December 31, 2014, we had 64 days of sales outstanding in trade accounts receivable, which was 1 day less than at December 31, 2013. Our days of sales outstanding reflect the reimbursement patterns of the healthcare industry in the markets where we compete. Collection of trade accounts receivable is influenced by insurance reimbursements and government budgets, among other things. Days of sales outstanding are lowest in our Americas reporting segment, as the U.S. healthcare system has a higher percentage of private-pay insurers who generally pay more quickly than government-based healthcare systems. In our Europe and Asia Pacific reporting segments, days of sales outstanding are higher, as healthcare is typically sponsored by governments which tend to pay more slowly. Additionally, there are some seasonal trends in our days of sales outstanding as it usually trends higher in our third quarter due to lower sales volumes and is lower in our fourth quarter when sales volumes are at their highest. Our days of sales outstanding in the past three years have ranged between 64 and 73 days. We were at the low end of this range as of December 31, 2014 due to improved collections in Europe.

At December 31, 2014, we had 337 days of inventory on hand, an increase of 52 days compared to December 31, 2013. In order to maintain high service levels to our hospital customers in numerous geographic regions, we consign inventory to them, including all the various sizes of a particular product, so that our products are available when needed for a surgical procedure. As a result, we have a significant amount of inventory on hand. There are some seasonal trends in our days of inventory on hand, as it usually trends higher in our third quarter due to lower sales volumes and is lower in our fourth quarter when sales volumes are at their highest. Other factors that can affect our days of inventory on hand include when we build inventory for new product launches, or the level of excess and obsolete inventory charges and gains/losses related to foreign currency that is reported in cost of products sold in any particular period. Our days of inventory on hand in the past three years have ranged between 285 and 356 days. As of December 31, 2014, our days of inventory on hand were near the high end of this range. The higher inventory balance and days of inventory on hand were driven by the ongoing global commercialization of new product offerings, the effects of placing more inventory into distributor and hospital consignment and additional inventory in certain Eastern European markets where we now have a direct sales presence instead of selling to a distributor.

 

 

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Cash flows used in investing activities were $469.4 million in 2014, compared to $282.5 million in 2013. Additions to instruments were relatively consistent between 2014 and 2013 as we continued to invest in instruments for significant product launches, such as Persona The Personalized Knee System. Spending on other property, plant and equipment increased in 2014 compared to 2013, reflecting cash outlays necessary to complete new product-related investments and to replace 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 period to period depending on the maturity of the debt securities and other cash and cash equivalent needs. In the past three years, we have made a number of business acquisitions including ETEX Holdings, Inc., Knee Creations, LLC, NORMED Medizin-Technik GmbH, Dornoch Medical Systems, Inc., and Synvasive Technology, Inc.

Cash flows used in financing activities were $562.4 million in 2014, compared to $467.3 million in 2013. In 2014, we returned cash to our stockholders in the form of cash dividends of $145.5 million and share repurchases of $400.5 million. In association with the debt facilities we entered into for the pending Biomet merger, we incurred $64.1 million of debt issuance costs. In 2014, $250.0 million of our outstanding senior notes matured and were paid. Additionally, financing cash flows continued to benefit from our increased stock price, with many employees exercising stock options.

In 2014, our Board of Directors declared cash dividends of $0.22 per share in each quarter. 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 2014 dividend declarations equated to an annualized rate of $0.88 per share, which represented a 10 percent increase over the 2013 annualized rate.

As of December 31, 2014, $599.5 million remained authorized under our $1.0 billion share repurchase program, which has no expiration date. Due to the pending merger with Biomet, we suspended repurchases after the first quarter of 2014. Upon completion of the merger, in the near to medium term we intend to use our cash flows for debt repayment and dividends.

As discussed more completely in Note 15 to our consolidated financial statements, the IRS has issued proposed adjustments for years 2006 through 2009 reallocating profits between certain of our U.S. and foreign subsidiaries. We have disputed these proposed adjustments and continue to pursue resolution with the IRS. Although the ultimate timing for resolution of the disputed tax issues is uncertain, future payments may be significant to our operating cash flows.

Also as discussed in Note 19 to our consolidated financial statements, we have recorded a short-term liability of $50.0 million and long-term liability of $307.2 million related to Durom Cup product liability claims. We expect to continue paying these claims over the next few years. We expect to be reimbursed a portion of these payments for product liability

claims from insurance carriers. We have received an initial amount of the insurance proceeds we estimate to recover. We have a long-term receivable of $170.3 million remaining for future expected reimbursements from our insurance carriers.

We expect to fund the $10.35 billion cash portion of the pending Biomet merger with existing cash on hand, as well as proceeds to be obtained from a $3.0 billion 5-year unsecured term loan (Term Loan) and senior notes that we expect to issue. We have also entered into a $7.66 billion bridge credit agreement (Bridge Credit Agreement) that may be used to fund the pending merger if we are unable to issue senior notes. The lenders’ commitments under the Bridge Credit Agreement will be reduced dollar-for-dollar by the amount of net cash proceeds we receive from the issuance of the senior notes.

Currently, we have three tranches of senior notes outstanding: $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 (i) 100 percent of the principal amount of the notes being redeemed; or (ii) 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 20 basis points in the case of the 2019 and 2021 notes, and 25 basis points in the case of the 2039 notes. We will also pay the accrued and unpaid interest on the senior notes to the redemption date.

We have a senior credit facility (Senior Credit Facility) that contains: (i) the 5-year unsecured Term Loan in the principal amount of $3.0 billion, and (ii) a 5-year unsecured multicurrency revolving facility (Multicurrency Revolving Facility) in the principal amount of $1.35 billion. The Senior Credit Facility replaces a previous credit agreement that provided for a $1.35 billion revolving credit facility that would have matured in May 2017. The Multicurrency Revolving Facility will mature in May 2019, with two one-year extensions available at our option. Borrowings under the Multicurrency Revolving Facility may be used for general corporate purposes. There were no borrowings outstanding under the Multicurrency Revolving Facility as of December 31, 2014. The availability of the Term Loan is conditioned on, among other things, the consummation of the Biomet merger. The Term Loan will mature five years after the initial borrowing. Borrowings under the Term Loan may only be used by us to fund, in part, the Biomet merger, including the payment of any indebtedness of LVB and its subsidiaries, and to pay all or a portion of the costs incurred by us in connection with the Biomet merger. We must reduce unused commitments under the Term Loan and prepay the borrowings under the Term Loan with any net cash proceeds received from specified asset sales, issuances or sales of equity and incurrences of borrowed

 

 

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money indebtedness, subject to certain exceptions. The commitments under the Term Loan automatically terminate on the earliest to occur of (i) the funding and disbursement of Term Loan funds to us, (ii) April 24, 2015, as such date may be extended pursuant to the merger agreement or (iii) termination of the merger agreement.

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 floating rates based upon indices determined by the currency of the borrowings plus an applicable margin determined by reference to our senior unsecured long-term credit rating, or at an alternate base rate, or, in the case of borrowings under the Multicurrency Revolving Facility only, 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 of assets. Financial covenants include a consolidated indebtedness to consolidated EBITDA ratio of no greater than 3.0 to 1.0 in periods prior to any Term Loan funding and no greater than 5.0 to 1.0 in periods after the Term Loan is funded. If our credit rating falls below investment grade, additional restrictions would result, including restrictions on investments and payment of dividends. We were in compliance with all covenants under the Senior Credit Facility as of December 31, 2014.

Commitments under the Senior Credit Facility are subject to certain fees. On the Multicurrency Revolving Facility, we pay a facility fee at a rate determined by reference to our senior unsecured long-term credit rating. On the Term Loan, we pay a fee on the daily actual unused commitment for the period from and including July 23, 2014 through the day the commitments under the Term Loan terminate.

The Bridge Credit Agreement is a 364-day unsecured committed bridge facility in the principal amount of $7.66 billion. Funding of loans under the Bridge Credit Agreement is conditioned on, among other things, the consummation of the Biomet merger. Any loans under the Bridge Credit Agreement will mature 364 days after the funding date of the loans. The Bridge Credit Agreement requires us to reduce unused commitments and prepay the loans with any net cash proceeds received from specified asset sales, issuances or sales of equity and incurrences of borrowed money indebtedness, such as new senior notes we intend to issue, subject to certain exceptions. Commitments under the Bridge Credit Agreement automatically terminate on the earliest to occur of: (i) the funding and disbursement of the loans, (ii) April 24, 2015, as such date may be extended pursuant to the merger agreement, or (iii) termination of the merger agreement. Proceeds of loans under the Bridge Credit Agreement may only be used to fund, in part, the Biomet merger, including the payment of any indebtedness of LVB and its subsidiaries, and to pay all or a portion of the costs incurred by us in connection with the Biomet merger.

Zimmer Holdings is the borrower under the Bridge Credit Agreement. Borrowings under the Bridge Credit Agreement bear interest at floating rates based upon LIBOR plus an

applicable margin determined by reference to our senior unsecured long-term credit rating, or at an alternate base rate. The Bridge Credit Agreement 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 of assets. Financial covenants include a consolidated indebtedness to consolidated EBITDA ratio of no greater than 5.0 to 1.0. We were in compliance with all covenants under the Bridge Credit Agreement as of December 31, 2014. If our credit rating falls below investment grade, additional restrictions would result, including restrictions on investments and payment of dividends.

We will pay a funding fee if we borrow under the Bridge Credit Agreement as well as duration fees based on the outstanding principal amount of the loans in the amount and on the dates specified in the Bridge Credit Agreement. In addition, we pay a fee on the daily actual unused commitment for the period from and including July 23, 2014 through the day the commitments under the Bridge Credit Agreement terminate.

We have a term loan agreement with one of the lenders under the Senior Credit Facility for 11.7 billion Japanese Yen (Japan Term Loan) that will mature on May 31, 2018. Borrowings under the Japan Term Loan bear interest at a fixed rate of 0.61 percent per annum until maturity.

We also have other available uncommitted credit facilities totaling $31.9 million.

We currently have investment grade credit ratings from Standard and Poor’s Ratings Services (S&P) of A- and Moody’s Investor Services (Moody’s) of Baa1. After the announcement of the Biomet merger, S&P placed a CreditWatch with negative implications on our rating and has indicated that it expects to lower our rating to BBB if the merger is completed. Moody’s placed our rating on review for downgrade and expects to lower our rating to Baa3 if the merger is completed.

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.

As of December 31, 2014, we had short-term and long-term investments in debt securities with a fair value of $868.9 million. These investments are in debt securities of many different issuers and, therefore, we believe 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, 2014, $1,090.1 million of our cash and cash equivalents and short-term and long-term investments were 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. $844.0 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.

 

 

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Management believes that cash flows from operations and available borrowings under the Senior Credit Facility or from the public and private debt markets are sufficient to meet our working capital, capital expenditure and debt service needs and to fund our pending merger with Biomet, as well as return cash to stockholders in the form of dividends. Should additional 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      2015     

2016

and

2017

    

2018

and

2019

    

2020

and
Thereafter

 

Long-term debt

   $ 1,402.9       $       $       $ 602.9       $ 800.0   

Interest payments

     910.9         64.0         127.3         124.3         595.3   

Operating leases

     182.9         46.5         63.1         41.0         32.3   

Purchase obligations

     11.5         8.9         2.6                   

Other long-term liabilities

     405.1                 154.5         125.4         125.2   

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

   $ 2,913.3       $ 119.4       $ 347.5       $ 893.6       $ 1,552.8   

 

    

 

 

    

 

 

    

 

 

    

 

 

 

$63.3 million of the other long-term liabilities on our balance sheet as of December 31, 2014 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 2015. 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. Additionally, other long-term liabilities on our balance sheet include long-term deferred tax liabilities, primarily related to intangible assets acquired in business combinations and fixed assets. We have excluded these liabilities from this table as well, as they do not represent liabilities that will be settled in cash. See Note 15 to our consolidated financial statements for further information on these tax-related accounts.

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 $60 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 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

 

 

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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 $471.7 million related to the Durom Cup, including $21.5 million in 2014. 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 value 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 a 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. 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. In 2014 and 2013, we employed a similar combination of income and market approaches to estimate this reporting unit’s fair value and determined there were no

impairment charges necessary. For our annual impairment test in 2014, the goodwill balance of the U.S. Spine reporting unit was $41.0 million. Due to improved operating performance of our U.S. Spine reporting unit and improving macroenomic conditions, including higher valuation indicators used in our market approach, the U.S. Spine reporting unit’s estimated fair value was in excess of its carrying value of net assets by 24 percent for our 2014 impairment test. Our international Spine goodwill and related net assets are not tested separately for goodwill impairment as they are part of reporting units that contain other product categories.

We have four other reporting units with goodwill assigned to them. Our 2013 annual impairment test indicated the estimated fair value of the U.S. Dental reporting unit was in excess of its carrying value of net assets by 11 percent. For the annual impairment test in 2014, the goodwill balance of the U.S. Dental reporting unit was $169.1 million. In our 2014 annual impairment test, due to improved operating performance and improving macroenomic conditions, including higher valuation indicators used in our market approach, the U.S. Dental reporting unit’s estimated fair value was in excess of its carrying value of net assets by 24 percent.

In 2014, for our three other reporting units’ annual impairment test, we performed a qualitative assessment of changes in fair value from the 2013 income approach. A qualitative assessment was performed because the estimated fair value of each of the reporting units was significantly in excess of the carrying value of its net assets in the 2013 impairment test.

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.

 

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

 

 

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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, 2014, 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 2015 through June 2017. The notional amounts of outstanding forward contracts entered into with third parties to purchase U.S. Dollars at December 31, 2014 were $1,289.8 million. The notional amounts of outstanding forward contracts entered into with third parties to purchase Swiss Francs at December 31, 2014 were $306.3 million. The weighted average contract rates outstanding at December 31, 2014 were Euro:USD 1.34, USD:Swiss Franc: 0.91, USD:Japanese Yen 97.30, British Pound:USD 1.62, USD:Canadian Dollar 1.08, Australian Dollar:USD 0.89, USD:Korean Won 1,115, USD:Swedish Krona 6.74, USD:Czech Koruna 19.98, USD:Thai Baht 33.01, USD:Taiwan Dollar 29.48, USD:South African Rand 11.11, USD:Russian Ruble 37.37 and USD:Indian Ruppee 67.14.

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, 2014 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 2017, depending on the direction of the change, by the following average approximate amounts (in millions):

 

Currency    Average
Amount
 

Euro

   $ 53.7   

Swiss Franc

     31.3   

Japanese Yen

     27.2   

British Pound

     15.0   

Canadian Dollar

     9.6   

Australian Dollar

     12.8   

Korean Won

     3.4   

Swedish Krona

     2.2   

Czech Koruna

     0.4   

Thai Baht

     1.0   

Taiwan Dollars

     2.0   

South African Rand

     0.5   

Russian Rubles

     0.6   

Indian Rupees

     0.6   

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.

We had net assets in legal entities with non-U.S. Dollar functional currencies of $2,113.5 million at December 31, 2014, primarily in Euros, Japanese Yen and Australian Dollars. $1,221.0 million of the net asset exposure at December 31, 2014 related 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.

 

 

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COMMODITY PRICE RISK

 

We purchase raw material commodities such as cobalt chrome, titanium, tantalum, polymer and sterile packaging. We enter into supply contracts generally with terms of 12 to 24 months, where available, on these commodities to alleviate the effect of market 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.

We have multiple fixed-to-variable interest rate swap agreements that we have designated as fair value hedges of the fixed interest rate obligations on our senior notes due 2019 and 2021. The total notional amounts are $250 million and $300 million for the senior notes due 2019 and 2021, respectively. On the interest rate swap agreements for the senior notes due 2019, we receive a fixed interest rate of 4.625 percent and pay variable interest equal to the three-month LIBOR plus an average of 133 basis points. On the interest rate swap agreements for the senior notes due 2021, we receive a fixed interest rate of 3.375 percent and pay variable interest equal to the three-month LIBOR plus an average of 99 basis points.

The interest rate swap agreements are intended 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 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.

In 2014, we entered into forward starting interest rate swaps that we have designated as cash flow hedges of our anticipated issuance of senior notes related to the pending Biomet merger that we anticipate will mature in March 2045.

The forward starting interest rate swaps mitigate the risk of changes in interest rates prior to completion of the senior notes offering. The total notional amounts of the forward starting interest rate swaps are $1 billion and will settle in March 2015. On the forward starting interest rate swaps, we receive variable interest equal to three-month LIBOR and pay a fixed interest weighted average rate of 3.01 percent. We will defer the effective portion of the forward starting interest rate swaps over the maturity period of the hedged senior notes, which is thirty years, and recognize any ineffective portion immediately in earnings.

Based upon our overall interest rate exposure as of December 31, 2014, a change of 10 percent in interest rates, assuming the principal 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,

 

 

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we are indirectly exposed to government budget constraints. The ongoing financial uncertainties in the Euro zone impact the indirect credit exposure we have to those governments through their public hospitals. As of December 31, 2014, 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 $183.1 million. With allowances for doubtful accounts of $9.4 million recorded in those countries, the net balance was $173.7 million, representing 20 percent of our total consolidated short-term and long-term trade accounts receivable balance, net. Italy and Spain accounted for $164.4 million of that net amount. We are actively monitoring the situations in these countries. We maintain contact with

customers in these countries 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. To the extent the respective governments’ ability to fund their public hospital programs deteriorates, we may have to record significant bad debt expenses in the future.

While we are exposed to risks from the broader healthcare industry in Europe and around the world, there is no significant net exposure due to any individual customer. Exposure to credit risk is controlled through credit approvals, credit limits and monitoring procedures and we believe that reserves for losses are adequate.

 

 

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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, 2014. 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 (2013).

Based on that assessment, management has concluded that, as of December 31, 2014, 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, 2014, 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.    2014 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

     36   

Consolidated Statements of Earnings for the Years Ended December 31, 2014, 2013 and 2012

     37   

Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2014, 2013 and 2012

     38   

Consolidated Balance Sheets as of December 31, 2014 and 2013

     39   

Consolidated Statements of Stockholders’ Equity for the Years Ended December  31, 2014, 2013 and 2012

     40   

Consolidated Statements of Cash Flows for the Years Ended December 31, 2014, 2013 and 2012

     41   

Notes to Consolidated Financial Statements

     42   

 

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ZIMMER HOLDINGS, INC.    2014 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, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014 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 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, 2014, based on criteria established in Internal Control - Integrated Framework 2013 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 Management’s Report on Internal Control over Financial Reporting appearing under Part II, Item 7A. 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 23, 2015

 

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ZIMMER HOLDINGS, INC.    2014 FORM 10-K ANNUAL REPORT

CONSOLIDATED STATEMENTS OF EARNINGS

 

 

      (in millions, except per share amounts)  
For the Years Ended December 31,    2014     2013     2012  

Net Sales

     $4,673.3      $ 4,623.4      $ 4,471.7   

Cost of products sold

     1,249.8        1,286.1        1,125.2   

 

   

 

 

   

 

 

 

Gross Profit

     3,423.5        3,337.3        3,346.5   

 

   

 

 

   

 

 

 

Research and development

     188.3        204.2        225.6   

Selling, general and administrative

     1,822.5        1,833.8        1,807.1   

Certain claims (Note 19)

     21.5        47.0        15.0   

Goodwill impairment (Note 8)

                   96.0   

Special items (Note 2)

     356.5        216.7        155.4   

 

   

 

 

   

 

 

 

Operating expenses

     2,388.8        2,301.7        2,299.1   

 

   

 

 

   

 

 

 

Operating Profit

     1,034.7        1,035.6        1,047.4   

Other expense

     (39.6              

Interest income

     11.9        15.6        15.6   

Interest expense

     (63.1     (70.1     (72.9

 

   

 

 

   

 

 

 

Earnings before income taxes

     943.9        981.1        990.1   

Provision for income taxes

     224.9        221.9        237.2   

 

   

 

 

   

 

 

 

Net earnings

     719.0        759.2        752.9   

Less: Net loss attributable to noncontrolling interest

     (1.1     (1.8     (2.1

 

   

 

 

   

 

 

 

Net Earnings of Zimmer Holdings, Inc.

   $ 720.1      $ 761.0      $ 755.0   

 

   

 

 

   

 

 

 

Earnings Per Common Share – Basic

   $ 4.26      $ 4.49      $ 4.32   

Earnings Per Common Share – Diluted

   $ 4.19      $ 4.43      $ 4.29   

Weighted Average Common Shares Outstanding

      

Basic

     169.0        169.6        174.9   

Diluted

     171.7        171.8        176.0   

Cash Dividends Declared Per Common Share

   $ 0.88      $ 0.80      $ 0.54   

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

 

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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

 

      (in millions)  
For the Years Ended December 31,    2014     2013     2012  

Net Earnings

   $ 719.0      $ 759.2      $ 752.9   

Other Comprehensive Income (Loss):

      

Foreign currency cumulative translation adjustments

     (241.5     (44.4     46.1   

Unrealized cash flow hedge gains, net of tax

     55.9        33.4        10.9   

Reclassification adjustments on cash flow hedges, net of tax

     (18.9     (4.4     3.3   

Reclassification adjustments on securities, net of tax

     (0.4              

Unrealized gains/(losses) on securities, net of tax

     (0.5     0.1        0.4   

Adjustments to prior service cost and unrecognized actuarial assumptions, net of tax

     (75.8     38.5        11.8   

 

   

 

 

   

 

 

 

Total Other Comprehensive Income (Loss)

     (281.2     23.2        72.5   

 

   

 

 

   

 

 

 

Comprehensive Income

     437.8        782.4        825.4   

Comprehensive Loss Attributable to Noncontrolling Interest

     (1.0     (2.0     (2.2

 

   

 

 

   

 

 

 

Comprehensive Income Attributable to Zimmer Holdings, Inc.

   $ 438.8      $ 784.4      $ 827.6   

 

   

 

 

   

 

 

 

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

 

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ZIMMER HOLDINGS, INC.    2014 FORM 10-K ANNUAL REPORT

CONSOLIDATED BALANCE SHEETS

 

 

      (in millions)  
As of December 31,    2014     2013  

ASSETS

    

Current Assets:

    

Cash and cash equivalents

   $ 1,083.3      $ 1,080.6   

Short-term investments

     612.5        727.0   

Accounts receivable, less allowance for doubtful accounts

     912.1        936.6   

Inventories

     1,169.0        1,074.5   

Prepaid expenses and other current assets

     193.7        107.1   

Deferred income taxes

     318.4        271.9   

 

   

 

 

 

Total Current Assets

     4,289.0        4,197.7   

Property, plant and equipment, net

     1,288.8        1,224.7   

Goodwill

     2,514.2        2,611.2   

Intangible assets, net

     603.5        707.7   

Other assets

     939.2        839.3   

 

   

 

 

 

Total Assets

   $ 9,634.7      $ 9,580.6   

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current Liabilities:

    

Accounts payable

   $ 167.1      $ 146.3   

Income taxes

     72.4        221.2   

Other current liabilities

     798.5        664.1   

 

   

 

 

 

Total Current Liabilities

     1,038.0        1,031.6   

Other long-term liabilities

     648.6        576.6   

Long-term debt

     1,425.5        1,672.3   

 

   

 

 

 

Total Liabilities

     3,112.1        3,280.5   

 

   

 

 

 

Commitments and Contingencies (Note 19)

    

Stockholders’ Equity:

    

Common stock, $0.01 par value, one billion shares authorized,
268.4 million (264.3 million in 2013) issued

     2.7        2.6   

Paid-in capital

     4,330.7        4,000.6   

Retained earnings

     8,285.2        7,712.7   

Accumulated other comprehensive income

     85.9        367.1   

Treasury stock, 98.7 million shares (94.5 million shares in 2013)

     (6,183.7     (5,785.7

 

   

 

 

 

Total Zimmer Holdings, Inc. stockholders’ equity

     6,520.8        6,297.3   

Noncontrolling interest

     1.8        2.8   

 

   

 

 

 

Total Stockholders’ Equity

     6,522.6        6,300.1   

 

   

 

 

 

Total Liabilities and Stockholders’ Equity

   $ 9,634.7      $ 9,580.6   

 

   

 

 

 

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

 

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ZIMMER HOLDINGS, INC.    2014 FORM 10-K ANNUAL REPORT

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

 

 

      (in millions)  
      Zimmer Holdings, Inc. Stockholders     Noncontrolling
Interest
    Total
Stockholders’

Equity
 
  

 

Common Shares

     Paid-in
Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive

Income
   

 

Treasury Shares

     
   Number      Amount            Number     Amount      

Balance January 1, 2012

     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 dividends declared

                            (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   

Net earnings

                            761.0                             (1.8     759.2   

Other comprehensive income

                                   23.2                      (0.2     23.0   

Purchase of additional shares from noncontrolling interest

                     (1.1                                 (0.6     (1.7

Cash dividends declared

                            (135.4                                 (135.4

Stock compensation plans, including tax benefits

     7.2                 501.1        1.2               0.1        5.4               507.7   

Share repurchases

                                          (9.1     (719.0            (719.0

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance December 31, 2013

     264.3         2.6         4,000.6        7,712.7        367.1        (94.5     (5,785.7     2.8        6,300.1   

Net earnings

                            720.1                             (1.1     719.0   

Other comprehensive loss

                                   (281.2                   0.1        (281.1

Cash dividends declared

                            (148.6                                 (148.6

Stock compensation plans, including tax benefits

     4.1         0.1         330.1        1.0                      2.5               333.7   

Share repurchases

                                          (4.2     (400.5            (400.5

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance December 31, 2014

     268.4       $ 2.7       $ 4,330.7      $ 8,285.2      $ 85.9        (98.7   $ (6,183.7   $ 1.8      $ 6,522.6   

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

 

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ZIMMER HOLDINGS, INC.    2014 FORM 10-K ANNUAL REPORT

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

      (in millions)  
For the Years Ended December 31,    2014     2013     2012  

Cash flows provided by (used in) operating activities:

      

Net earnings

   $ 719.0      $ 759.2      $ 752.9   

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

      

Depreciation and amortization

     375.8        358.5        363.1   

Goodwill impairment

                   96.0   

Share-based compensation

     49.4        48.5        55.0   

Income tax benefit from stock option exercises

     37.2        38.4        11.0   

Excess income tax benefit from stock option exercises

     (11.1     (8.6     (2.7

Inventory step-up

     5.4        8.0        4.8   

Deferred income tax provision

     (84.2     (126.2     (64.8

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

      

Income taxes payable

     (51.9     96.8        59.2   

Receivables

     (40.4     (74.3     (45.5

Inventories

     (154.1     (128.4     (67.5

Accounts payable and accrued liabilities

     120.1        38.3        47.8   

Other assets and liabilities

     87.6        (47.1     (57.4

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     1,052.8        963.1        1,151.9   

 

   

 

 

   

 

 

 

Cash flows provided by (used in) investing activities:

      

Additions to instruments

     (197.4     (192.9     (148.9

Additions to other property, plant and equipment

     (144.9     (100.0     (114.7

Purchases of investments

     (1,350.9     (732.7     (1,130.1

Sales of investments

     1,282.2        830.8        878.5   

Business combination investments

     (54.3     (74.2     (59.0

Investments in other assets

     (4.1     (13.5     (17.9

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (469.4     (282.5     (592.1

 

   

 

 

   

 

 

 

Cash flows provided by (used in) financing activities:

      

Payment of senior notes

     (250.0              

Net proceeds (payments) under revolving credit facilities

     2.3        (97.5     (50.1

Proceeds from term loans

                   147.3   

Dividends paid to stockholders

     (145.5     (132.4     (94.4

Debt issuance costs

     (64.1            (3.3

Equity issuance costs

     (0.4              

Proceeds from employee stock compensation plans

     284.7        474.8        46.9   

Excess income tax benefit from stock option exercises

     11.1        8.6        2.7   

Purchase of additional shares from noncontrolling interest

            (1.8       

Repurchase of common stock

     (400.5     (719.0     (485.6

 

   

 

 

   

 

 

 

Net cash used in financing activities

     (562.4     (467.3     (436.5

 

   

 

 

   

 

 

 

Effect of exchange rates on cash and cash equivalents

     (18.3     (17.0     (7.3

 

   

 

 

   

 

 

 

Increase in cash and cash equivalents

     2.7        196.3        116.0   

Cash and cash equivalents, beginning of year

     1,080.6        884.3        768.3   

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of year

   $ 1,083.3      $ 1,080.6      $ 884.3   

 

   

 

 

   

 

 

 

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

 

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ZIMMER HOLDINGS, INC.    2014 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.

On April 24, 2014, we entered into a definitive agreement to merge with LVB, the parent company of Biomet, in a cash and stock transaction valued at approximately $13.35 billion. We will pay $10.35 billion in cash, subject to certain adjustments, and issue 32.7 million shares of our common stock which had a value of approximately $3.0 billion, based on a stock price of $91.73 per share using the five day volume weighted average price immediately preceding the signing of the agreement. In connection with the merger, we will pay off all of LVB’s outstanding funded debt, and the aggregate cash merger consideration will be reduced by such amount. The merger, which is subject to customary closing conditions and regulatory approvals, is expected to close in the first quarter of 2015. The merger will position the combined company as a leader in the $45 billion musculoskeletal industry.

Biomet’s product portfolio includes knee and hip reconstructive products; sports medicine, extremities and trauma products; spine, bone healing and microfixation products; dental reconstructive products; and cement, biologics and other products. The combination will enhance enterprise diversification with broader franchises in the Knee, Hip, Surgical, Spine and Dental categories, as well as in the faster-growing Sports Medicine, Extremities and Trauma categories.

We expect to fund the cash portion of the purchase price with existing cash on hand, as well as proceeds obtained from a committed $3.0 billion senior unsecured term loan and up to $7.66 billion in senior unsecured notes we intend to issue. In May 2014, we entered into a $7.66 billion 364-day bridge credit facility. To the extent the senior unsecured notes are not

issued and sold on or prior to the closing date of the merger, we intend to draw on the bridge credit facility to finance, in part, the cash consideration for the merger and to pay fees and expenses incurred in connection with the merger. The commitments of the bridge lenders to provide the bridge loan will be permanently reduced dollar-for-dollar by the amount of net cash proceeds we receive from the issuance of senior unsecured notes. See Note 11 and Item 7 in this Form 10-K for further information regarding these debt instruments.

 

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. All significant intercompany accounts and transactions are eliminated. Certain amounts in the 2013 and 2012 consolidated financial statements have been reclassified to conform to the 2014 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, 2014, 2013 and 2012 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 represented approximately 75 percent of our net sales in 2014. 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.

 

 

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ZIMMER HOLDINGS, INC.    2014 FORM 10-K ANNUAL REPORT

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

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 accounted for approximately 25 percent of our net sales in 2014. 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, 2014, 2013 and 2012.

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 $181.9 million, $163.6 million and $139.5 million for the years ended December 31, 2014, 2013 and 2012, 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 that 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 R&D agreements, certain contract terminations, consulting and professional fees and asset impairment or loss on disposal charges connected with global restructuring, operational and quality 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,    2014      2013      2012  

Impairment/loss on disposal of assets

   $ 32.4       $ 10.9       $ 14.6   

Consulting and professional fees

     176.7         99.1         90.1   

Employee severance and retention, including share-based compensation acceleration

     0.9         14.2         8.2   

Dedicated project personnel

     50.8         34.0         15.1   

Certain R&D agreements

     4.5         0.8           

Relocated facilities

     0.7         3.6         1.8   

Distributor acquisitions

     0.6         0.4         0.8   

Certain litigation matters

     70.0         26.9         13.7   

Contract terminations

     6.2         3.9         6.6   

Contingent consideration adjustments

     0.6         9.0         (2.8

Accelerated software amortization

     6.0         6.0         4.5   

Other

     7.1         7.9         2.8   

 

    

 

 

    

 

 

 

Special items

   $ 356.5       $ 216.7       $ 155.4   

 

    

 

 

    

 

 

 

Impairment/loss on disposal of assets relates to impairment of intangible assets that were acquired in business combinations or impairment of or a loss on the disposal of other assets. This caption also includes the effect of reducing the estimated useful life of certain intangible assets to zero, which resulted in the remaining net book values of those assets being amortized immediately.

Consulting and professional fees relate to third-party consulting, professional fees and contract labor related to our quality and 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 and pending merger with Biomet, third-party fees related to severance and termination benefits matters and legal fees related to certain litigation matters. Our quality and operational excellence initiatives are company-wide and include improvements in quality, distribution, sourcing, manufacturing and information technology, among other areas.

In 2014, 2013 and 2012, we eliminated positions 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. As a result of these changes in our work force and headcount reductions in connection with 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

 

 

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ZIMMER HOLDINGS, INC.    2014 FORM 10-K ANNUAL REPORT

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

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

Certain R&D agreements relate to agreements with upfront payments to obtain intellectual property to be used in R&D projects that have no alternative future use in other projects.

Relocated facilities expenses are the moving costs and the lease expenses incurred during the relocation period in connection with relocating certain 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 net expenses recognized during the year for the estimated or actual settlement of certain pending litigation and similar claims, including matters where we recognized income from a settlement on more favorable terms than our previous estimate, or we reduced our estimate of a previously recorded contingent liability. These litigation matters have included 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 represent 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 resulting from a reduction in the estimated life of certain software. Due to an approved plan to replace certain software, 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.

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, 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 $22.3 million and $22.7 million as of December 31, 2014 and 2013, 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

 

 

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ZIMMER HOLDINGS, INC.    2014 FORM 10-K ANNUAL REPORT

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

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 fifteen 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 year ended December 31, 2012, we recorded a goodwill impairment charge of $96.0 million related to our U.S. Spine reporting unit. We did not record a goodwill impairment charge during the years ended December 31, 2014 or 2013. See Notes 8 and 9 for more information regarding goodwill and goodwill impairment.

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 that 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.

 

 

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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 (OCI) 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. Our OCI is 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. In 2013, we purchased additional shares of the company from the minority shareholders. 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 May 2014, the Financial Accounting Standards Board issued Accounting Standard Update (ASU) No. 2014-09 – Revenue from Contracts with Customers (Topic 606). The ASU provides a five-step model for revenue recognition that all industries will apply to recognize revenue when a customer obtains control of a good or service. The ASU will be effective for us beginning January 1, 2017. We are in the initial phases of our adoption plans and, accordingly, we are unable to estimate any effect this may have on our revenue recognition practices.

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 and restricted stock units (RSUs). Share-based compensation expense was as follows (in millions):

 

For the Years Ended December 31,        2014         2013         2012  

Stock options

   $ 24.2      $ 24.7      $ 32.4   

RSUs

     25.2        23.8        22.6   

 

   

 

 

   

 

 

 

Total expense, pre-tax

     49.4        48.5        55.0   

Tax benefit related to awards

     (15.5     (15.6     (16.6

 

   

 

 

   

 

 

 

Total expense, net of tax

   $ 33.9      $ 32.9      $ 38.4   

 

   

 

 

   

 

 

 

Stock Options

We had two equity compensation plans in effect at December 31, 2014: the 2009 Stock Incentive Plan (2009 Plan) and the Stock Plan for Non-Employee Directors. The 2009 Plan succeeded 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

 

 

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the 2009 Plan. Vested stock options previously granted under the 2006 Plan, the TeamShare Plan and another prior plan, the 2001 Stock Incentive Plan, remained outstanding as of December 31, 2014. 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 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, 2014, 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 vest over four years and 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, 2014 is as follows (options in thousands):

 

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

Outstanding at January 1, 2014

     10,741      $ 70.06         

Options granted

     1,193        94.58         

Options exercised

     (3,811     73.55         

Options forfeited

     (235     75.84         

Options expired

     (42     71.25         

 

         

Outstanding at December 31, 2014

     7,846      $ 71.94         5.5       $ 325.5   

 

   

 

 

    

 

 

    

 

 

 

Vested or expected to vest as of December 31, 2014

     7,485      $ 71.47         5.4       $ 314.0   

 

   

 

 

    

 

 

    

 

 

 

Exercisable at December 31, 2014

     4,927      $ 67.91         3.9       $ 224.2   

 

   

 

 

    

 

 

    

 

 

 

 

We use a Black-Scholes option-pricing model to determine the fair value of our stock options. For stock options granted in 2012, 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. In 2013 and 2014, we used a combination of historical volatility and implied volatility because the traded options that were actively traded around the grant date of our stock options did not have 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. 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.

 

 

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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,    2014     2013     2012  

Dividend yield

     0.9     1.1     1.1

Volatility

     25.2     24.5     25.6

Risk-free interest rate

     1.8     1.1     1.5

Expected life (years)

     5.5        6.1        6.1   

Weighted average fair value of options granted

   $ 22.59      $ 16.33      $ 15.40   

Intrinsic value of options exercised (in millions)

   $ 99.6      $ 97.9      $ 17.1   

As of December 31, 2014, there was $33.8 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 2.6 years.

RSUs

We have awarded RSUs to our employees. The terms of the awards have been three to four years. Some of the awards have only service conditions while some have performance and market conditions in addition to service conditions. The service condition-only 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 on our RSUs range from one to four years.

A summary of nonvested RSU activity for the year ended December 31, 2014 is as follows (RSUs in thousands):

 

      RSUs    

Weighted Average
Grant Date

Fair Value

 

Outstanding at January 1, 2014

     1,454      $ 67.42   

Granted

     455        94.48   

Vested

     (306     61.46   

Forfeited

     (128     72.54   

 

   

Outstanding at December 31, 2014

     1,475        76.60   

 

   

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, 2014, we estimate that approximately 866,000 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, 2014 was $31.7 million and is expected to be recognized over a weighted-average period of 2.2 years. The fair value of RSUs vesting during the years ended December 31, 2014, 2013 and 2012 based upon our stock price on the date of vesting was $29.3 million, $32.5 million and $18.9 million, respectively.

 

4. Inventories

 

Inventories consisted of the following (in millions):

 

As of December 31,    2014      2013  

Finished goods

   $ 899.9       $ 817.0   

Work in progress

     87.8         77.4   

Raw materials

     181.3         180.1   

 

    

 

 

 

Inventories

   $ 1,169.0       $ 1,074.5   

 

    

 

 

 

Amounts charged to the consolidated statement of earnings for excess and obsolete inventory in the years ended December 31, 2014, 2013 and 2012 were $51.8 million, $112.0 million and $55.1 million, respectively. The 2013 period was higher due to our decision to discontinue certain products.

 

5. Property, Plant and Equipment

 

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

 

As of December 31,    2014     2013  

Land

   $ 20.4      $ 21.7   

Building and equipment

     1,283.4        1,353.1   

Capitalized software costs

     294.7        272.6   

Instruments

     1,696.3        1,610.6   

Construction in progress

     115.8        58.2   

 

   

 

 

 
     3,410.6        3,316.2   

Accumulated depreciation

     (2,121.8     (2,091.5

 

   

 

 

 

Property, plant and equipment, net

   $ 1,288.8      $ 1,224.7   

 

   

 

 

 

Depreciation expense was $268.6 million, $262.6 million and $266.0 million for the years ended December 31, 2014, 2013 and 2012, respectively.

 

 

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6. Acquisitions

 

We made a number of business acquisitions during the years 2014, 2013 and 2012. In October 2014, we acquired ETEX Holdings, Inc. (Etex). The Etex acquisition enhanced our biologics portfolio through the addition of Etex’s bone void filler products. In May 2013, we acquired the business assets of Knee Creations, LLC (Knee Creations). The Knee Creations acquisition enhanced our product portfolio of joint preservation solutions. In June 2013, we acquired NORMED Medizin-Technik GmbH (Normed). The Normed acquisition strengthened our Extremities and Trauma product portfolios and brought new product development capabilities in the foot and ankle and hand and wrist markets. 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 enhanced our product portfolio through the addition of a medical waste fluid management and disposal technology.

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 information and other information required by GAAP 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):

 

            Gross Unrealized     Fair
value
 
     

Amortized

Cost

     Gains      Losses    

As of December 31, 2014

          

Corporate debt securities

   $ 516.9       $ 0.1       $ (0.5   $ 516.5   

U.S. government and agency debt securities

     194.3                        194.3   

Commercial paper

     57.8                        57.8   

Certificates of deposit

     100.3                        100.3   

 

    

 

 

    

 

 

   

 

 

 

Total short and long-term investments

   $ 869.3       $ 0.1       $ (0.5   $ 868.9   

 

    

 

 

    

 

 

   

 

 

 

As of December 31, 2013

          

Corporate debt securities

   $ 457.6       $ 0.4       $ (0.1