10-K 1 d112646d10k.htm FORM 10-K Form 10-K
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For year ended December 31, 2015

Commission file number 001-16407

ZIMMER BIOMET 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 $18,873,280,711 (based on the closing price of these shares on the New York Stock Exchange on June 30, 2015 and assuming solely for the purpose of this calculation that all directors and executive officers of the registrant are “affiliates”). As of February 24, 2016, 198,834,321 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 2016 Annual Meeting of Stockholders

     Part III   


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ZIMMER BIOMET HOLDINGS, INC.    2015 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      10   
Item 1B.    Unresolved Staff Comments      18   
Item 2.    Properties      19   
Item 3.    Legal Proceedings      19   
Item 4.    Mine Safety Disclosures      19   
PART II           20   
Item 5.    Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      20   
Item 6.    Selected Financial Data      21   
Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      22   
Item 7A.    Quantitative and Qualitative Disclosures About Market Risk      31   
Item 8.    Financial Statements and Supplementary Data      35   
Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      76   
Item 9A.    Controls and Procedures      76   
Item 9B.    Other Information      77   
PART III           78   
Item 10.    Directors, Executive Officers and Corporate Governance      78   
Item 11.    Executive Compensation      78   
Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      78   
Item 13.    Certain Relationships and Related Transactions and Director Independence      78   
Item 14.    Principal Accounting Fees and Services      78   
PART IV           79   
Item 15.    Exhibits, Financial Statement Schedules      79   

 

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PART I

 

Item 1.       Business

 

Overview

 

Zimmer Biomet is a global leader in musculoskeletal healthcare. We design, manufacture and market orthopaedic reconstructive products; sports medicine, biologics, extremities and trauma products; spine, bone healing, craniomaxillofacial and thoracic products; dental implants; and related surgical products. We collaborate with healthcare professionals around the globe to advance the pace of innovation. Our products and solutions help treat patients suffering from disorders of, or injuries to, bones, joints or supporting soft tissues. Together with healthcare professionals, we help millions of people live better lives. In this report, “Zimmer Biomet,” “we,” “us,” “our,” “the Company” and similar words refer collectively to Zimmer Biomet Holdings, Inc. and its subsidiaries. “Zimmer Biomet Holdings” refers to the parent company only.

Zimmer Biomet 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, we were spun off from our former parent and became an independent public company.

On June 24, 2015 (the “Closing Date”), we acquired LVB Acquisition, Inc. (“LVB”), the parent company of Biomet, Inc. (“Biomet”), and LVB and Biomet became our wholly-owned subsidiaries (sometimes hereinafter referred to as the “Biomet merger” or the “merger”). In connection with the merger, we changed our name from Zimmer Holdings, Inc. to Zimmer Biomet Holdings, Inc. The Biomet merger is expected to be a transformational event for us and have significant effects on all aspects of our business. Throughout 2015 and entering 2016, a key focus of ours has been, and will continue to be, the successful integration of Biomet.

“Zimmer” used alone refers to the business or information of us and our subsidiaries on a stand-alone basis without inclusion of the business or information of LVB or any of its subsidiaries.

Customers, Sales and Marketing

 

Our primary customers include orthopaedic surgeons, neurosurgeons, oral surgeons, and other specialists, 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 throughout the world. We manage our operations through three major geographic operating segments and four product category operating segments. Our three major geographic operating segments are the Americas, which is comprised principally of the U.S. and includes other North, Central and South American markets; EMEA, 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. Our four product category operating segments, which are individually not as significant as our geographic operating segments, are as follows: 1) Americas Spine; 2) Bone Healing; 3) Craniomaxillofacial and Thoracic (“CMF”); and 4) Dental.

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 80 percent of our net sales in 2015. 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 2015.

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, other specialists, dentists and oral surgeons and the medical procedures they perform.

Due to the Biomet merger, we changed our senior management organizational structure which has resulted in a change to our operating segments. We now allocate resources to achieve our operating profit goals through seven operating segments. Our operating segments are comprised of both geographic and product category business units. We are organized through a combination of geographic and product category operating segments for various reasons, including the distribution channels through which products are sold. Our product category operating segments generally have distribution channels focused specifically on those product

 

 

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categories, whereas our geographic operating segments have distribution channels that sell multiple product categories. The following is a summary of our seven operating segments. See Note 18 to the consolidated financial statements for more information regarding our segments.

Americas. The Americas geographic operating segment is our largest operating segment. The U.S. accounts for 94 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 Biomet. The sales force in the U.S. receives a commission on product sales and is responsible for many operating decisions and costs.

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

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

EMEA. The EMEA geographic operating segment is our second largest operating segment. France, Germany, Italy, Spain and the United Kingdom collectively account for 62 percent of net sales in the region. This segment also includes other key markets, including Switzerland, 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 operating segment includes key markets such as Japan, Australia, New Zealand, Korea, China, Taiwan, India, Thailand, Singapore, Hong Kong and Malaysia. Japan is the largest market within this segment, accounting for 40 percent of the region’s sales. 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 and neurosurgeons 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.

Americas Spine. The Americas Spine product category operating segment is comprised of our spine products division in the Americas, primarily in the U.S. market, but also in other North, Central and South American markets. The market dynamics of the Americas Spine business are similar to those described in the Americas geographic operating segment. However, the Americas Spine business maintains a separate sales force of employees and independent sales agents.

Bone Healing.    Our Bone Healing product category operating segment only sells to U.S. customers. In this product category, we market our products to doctors who prescribe them for use by patients. The products are mostly provided directly by Zimmer Biomet to patients and are paid for through patients’ insurance or by patients themselves. Products are also sold through wholesale channels on a limited basis.

CMF.    Our CMF product category operating segment competes across the world through a combination of direct and independent sales agents. The U.S. sales force consists of a combination of employees and independent sales agents. Internationally, our primary customers are independent stocking distributors who market our products to their customers.

Dental.    Our Dental product category operating segment competes across the world. Our sales force is primarily composed of employees who market our products to customers. We sell directly to dental practices or dental laboratories, or to independent stocking distributors depending on the market.

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 distribute our products both through large, centralized warehouses and through smaller, market specific facilities, depending on the needs of the market. We maintain large, centralized warehouses in the U.S. and Europe to be able to efficiently distribute our products to customers in those regions. In addition to these centralized warehouses, we maintain smaller distribution facilities within each of the countries where we have a direct sales presence. In many locations, our inventory is consigned to the healthcare institution.

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 products; sports medicine, biologics, extremities and trauma products; spine, bone healing and CMF products; dental implants; and related surgical products.

 

 

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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

 

Vanguard® Knee System

 

Oxford® Partial Knee

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

 

Taperloc® Hip System

 

Arcos® Modular Hip System

 

Continuum® Acetabular System

 

G7® Acetabular System

S.E.T.

Our S.E.T. product category includes surgical, sports medicine, biologics, foot and ankle, extremities and trauma products. Our surgical products are used to support various surgical procedures. Our sports medicine products are primarily for the repair of soft tissue injuries, most commonly used in the knee and shoulder. Our biologics products are used as early intervention for joint preservation or to support surgical procedures. Our foot and ankle and extremities products are designed to treat arthritic conditions and fractures in the foot, ankle, shoulder, elbow and wrist. Our trauma products are used to stabilize damaged or broken bones and their surrounding tissues to support the body’s natural healing process.

Our significant S.E.T. brands include the following:

 

Transposal® and Transposal Ultra® Fluid Waste Management Systems

 

A.T.S.® Automatic Tourniquet Systems

 

JuggerKnot® Soft Anchor System

 

Gel-One®1 Cross-linked Hyaluronate

 

Trabecular MetalTM Reverse Shoulder System

 

Comprehensive® Shoulder

 

Zimmer® Natural Nail® System

 

DVR® Plating System

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

 

3i T3® Implant

 

Puros® Allograft Products

SPINE and CMF

Our spine products division designs, manufactures and distributes medical devices and surgical instruments to deliver comprehensive solutions for individuals with back or neck pain caused by degenerative conditions, deformities or traumatic injury of the spine. Our CMF division includes face and skull reconstruction products as well as products that fixate and stabilize the bones of the chest in order to facilitate healing or reconstruction after open heart surgery, trauma or for deformities of the chest.

Our significant spine and CMF brands include the following:

 

Polaris™ Spinal System

 

Timberline® Lateral Fusion System

 

PathFinder NXT® Minimally Invasive Pedicle Screw System

 

TraumaOne™ Plating System

OTHER

Our other product category primarily includes our bone cement and bone healing products. Our significant brands include the following:

 

PALACOS®2 Bone Cement

 

SpinalPak® Spinal Fusion Stimulator

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.

 

1 Registered trademark of Seikagaku Corporation

2 Registered trademark of Heraeus Medical GmbH

 

 

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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, Canada, China, France, Switzerland and other U.S. locations. As of December 31, 2015, we employed approximately 1,700 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 U.S. Food and Drug Administration (“FDA”) has enacted regulations that control all aspects of the development, manufacture, advertising, promotion and postmarket surveillance of medical products, including medical devices. In addition, the FDA controls the access of products to market through processes designed to ensure that only products that are safe and effective are made available to the public.

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

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

 

 

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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.

Competition

 

The orthopaedics and broader musculoskeletal care industry is highly competitive. In the global markets for our knees, hips, and S.E.T. products, our major competitors include: the DePuy Synthes Companies of Johnson & Johnson; Stryker Corporation; and Smith & Nephew plc. There are smaller competitors in these product categories as well who have success by focusing on smaller subsegments of the industry.

In the spine and CMF categories, we compete globally primarily with the spinal and biologic business of Medtronic, Inc., the DePuy Synthes Companies, Stryker Corporation, NuVasive, Inc. and Globus Medical, Inc.

In the dental implant category, we compete primarily with Nobel Biocare Holding AG (part of the Danaher Corporation), Straumann Holding AG and Dentsply International.

Competition within the industry is primarily based on pricing, 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. 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 outsource 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 approximately 7,000 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, 2015, we employed approximately 17,500 employees worldwide, including approximately 1,700 employees dedicated to research and development. Approximately 8,400 employees are located within the U.S. and approximately 9,100 employees are located outside of the U.S., primarily throughout Europe and in Japan. We have approximately 7,700 employees dedicated to manufacturing our products worldwide. The Warsaw, Indiana production facilities employ approximately 2,800 employees in the aggregate.

 

 

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We have production employees represented by a labor union in Dover, Ohio and Bridgend, South Wales. We have other

employees in Europe who are represented by Works Councils. We believe that our relationship with our employees is satisfactory.     

 

 

EXECUTIVE OFFICERS

The following table sets forth certain information with respect to our executive officers as of February 19, 2016.

 

Name    Age        Position

David C. Dvorak

     52         President and Chief Executive Officer

Daniel P. Florin

     51         Senior Vice President and Chief Financial Officer

Tony W. Collins

     47         Vice President, Corporate Controller and Chief Accounting Officer

Adam R. Johnson

     38         Group President, Spine, Dental, CMF and Thoracic

Stuart G. Kleopfer

     53         President, Americas

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

     52         President, Europe, Middle East and Africa

David A. Nolan Jr.

     50         Group President, Biologics, Extremities, Sports Medicine, Surgical, Trauma, Foot and Ankle and Bone Healing
Chad F. Phipps      44         Senior Vice President, General Counsel and Secretary
Daniel E. Williamson      50         Group President, Joint Reconstruction
Sang Yi      54         President, Asia Pacific

 

Mr. Dvorak was appointed President, Chief Executive Officer and a member of the Board of Directors in May 2007. He championed Zimmer’s acquisition of Biomet, positioning the combined Zimmer Biomet as a global leader in musculoskeletal healthcare. Prior to his appointment as President and Chief Executive Officer, Mr. Dvorak served as Group President, Global Businesses and Chief Legal Officer from December 2005. From October 2003 to December 2005, he served as Executive Vice President, Corporate Services, Chief Counsel and Secretary, as well as Chief Compliance Officer. Mr. Dvorak joined the Company (then Zimmer) as Senior Vice President, Corporate Affairs and General Counsel in December 2001, shortly following the Company’s spin-off from Bristol-Myers Squibb.

Mr. Collins was appointed Vice President, Corporate Controller and Chief Accounting Officer effective June 2015. Prior to that, Mr. Collins served as Vice President, Finance for the Global Reconstructive Division and Global Operations organization. He joined the Company (then Zimmer) in 2010 as Vice President, Finance for the Global Reconstructive Division and U.S. Commercial organization. Before joining Zimmer, Mr. Collins held the position of Vice President, Finance and served as the chief financial officer of the Commercial segment of Oshkosh Corporation from 2007 to 2010. From 1997 to 2007, he was employed at Guidant Corporation and Boston Scientific Corporation, where he held a number of positions of increasing responsibility, including Finance Director and chief financial officer of the Guidant Japan organization, Global Director of Operations Finance and Director of Strategic Planning.

Mr. Florin was appointed Senior Vice President and Chief Financial Officer effective June 2015. He served as Senior Vice President and Chief Financial Officer of Biomet from June 2007 to June 2015. Prior to joining Biomet, Mr. Florin served as Vice President and Corporate Controller of Boston Scientific Corporation from 2001 until 2007. Before being appointed Corporate Controller in 2001, Mr. Florin served in financial leadership positions within Boston Scientific Corporation and its various business units. Prior to joining Boston Scientific Corporation, Mr. Florin worked for C.R. Bard from October 1990 through June 1995.

Mr. Johnson was appointed Group President with responsibility for the Company’s Spine, Dental, Craniomaxillofacial and Thoracic businesses effective June 2015. He served as Senior Vice President, Biomet, and President, Biomet Microfixation, Bone Healing and Spine from June 2012 to June 2015. Before that, he served as President, Biomet Microfixation from 2007 to 2012 and Vice President, Global Marketing, Biomet Microfixation from 2006 to 2007. Prior to that, Mr. Johnson served as Director of Global Marketing for Regeneration Technologies, Inc. (now known as RTI Surgical, Inc.). He also worked for Biomet for five years previously, starting his career with Biomet in 1999.

Mr. Kleopfer was appointed President, Americas effective June 2015. He is responsible for the Company’s sales and management of the direct and indirect sales channels in the Americas region, including the United States, Canada and Latin America. Mr. Kleopfer served as President, Biomet U.S. from May 2011 to June 2015. Before that, he served as President, Biomet Biologics from December 2005 to May 2011.

 

 

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Prior to those appointments, Mr. Kleopfer held numerous positions of increasing responsibility within Biomet, where he began his career in 1988.

Dr. Mazur-Hofsaess was appointed President, EMEA in April 2013. Dr. Mazur-Hofsaess joined the Company (then Zimmer) in February 2010 as Senior Vice President, EMEA Reconstructive. She has more than 20 years’ experience within the pharmaceutical, diagnostics and medical device sectors. Prior to joining Zimmer, Dr. Mazur-Hofsaess served in various management positions at Abbott Laboratories beginning in 2001, most recently as Vice President, Diagnostics – Europe.

Mr. Nolan was appointed Group President with responsibility for the Company’s Biologics, Extremities, Sports Medicine, Surgical, Trauma, Foot and Ankle and Bone Healing businesses effective June 2015. He joined the Company (then Zimmer) in November 2012 as Senior Vice President, Sales. From January 2014 to June 2015, he served as Senior Vice President, Sales and Advanced Solutions. Prior to joining Zimmer, Mr. Nolan served as President, Biomet Sports Medicine, Extremities and Trauma from 2011 to 2012 and as President, Biomet Sports Medicine from 2001 to 2011. He joined Biomet in 1996.

Mr. Phipps was appointed Senior Vice President, General Counsel and Secretary in May 2007. He has global responsibility for the Company’s Legal Affairs and he serves as Secretary to the Board of Directors. Mr. Phipps also oversees the Company’s Government Affairs, Corporate Communication and Public Relations activities. Previously, Mr. Phipps served as Associate General Counsel and Corporate Secretary from December 2005 to May 2007. He joined the Company (then Zimmer) in September 2003 as Associate Counsel and Assistant Secretary. Prior to joining Zimmer, he served as Vice President and General Counsel of L&N Sales and Marketing, Inc. in Pennsylvania and he practiced law with the firm of Morgan, Lewis & Bockius in Philadelphia, focusing on corporate and securities law, mergers and acquisitions and financial transactions.

Mr. Williamson was appointed Group President, Joint Reconstruction with responsibility for the Company’s Knee, Hip, Bone Cement, Patient-Matched Implants and Personalized Solutions businesses effective June 2015. He served as Senior Vice President, Biomet and President, Global Reconstructive Joints from February 2014 to June 2015. Prior to that, Mr. Williamson served as Biomet’s Vice President and General Manager, Global Bone Cement and Biomaterials Research from September 2011 to February 2014, and as Corporate Vice President, Global Biologics and Biomaterials from May 2006 to September 2011. Mr. Williamson previously served as Biomet’s Vice President, Business Development from December 2003 to May 2006. He began his career with Biomet in 1990 as a Product Development Engineer.

Mr. Yi was appointed President, Asia Pacific effective June 2015. He is responsible for the sales, marketing and distribution of products in the Asia Pacific region. Mr. Yi joined the Company (then Zimmer) in March 2013 as Senior Vice President, Asia Pacific. Before joining Zimmer, he served as

Vice President and General Manager of St. Jude Medical for Asia Pacific and Australia from 2005 to 2013. Prior to that, Mr. Yi held several leadership positions over a ten-year period with Boston Scientific Corporation, ultimately serving as Vice President for North Asia.

AVAILABLE INFORMATION

 

 

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

 

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

 

announcements of investor conferences and events at which our executives talk about our products and competitive strategies, as well as podcasts and archives of these events;

 

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 and Ethics, 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.

 

 

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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.

Successful integration of Biomet and anticipated benefits of the Biomet merger are not assured and integration matters could divert attention of management away from operations. Also, the merger could have an adverse effect on our business relationships.

Although Biomet has become an indirect wholly owned subsidiary of ours, it is initially continuing its operations on a basis that is separate from the legacy Zimmer operations. There can be no assurance that 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. 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.

Our ability to realize the anticipated benefits of the Biomet merger will depend, to a large extent, on our ability to integrate the legacy businesses. Integrating and coordinating certain aspects of the operations and personnel of Biomet with ours involves complex operational, technological and personnel-related challenges. This process is time-consuming and expensive, disrupts the businesses of both companies and may not result in the full benefits expected by us, 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 attention of our management may be directed towards integration considerations and may be diverted from our day-to-day business operations, and matters related to the integration may require commitments of time and resources that could otherwise have been devoted to other opportunities that might have been beneficial to us. The diversion of management’s attention, and any difficulties encountered in the transition and integration process, could harm our business, financial condition and operating results.

Even if our businesses are successfully integrated, we may not realize the full benefits of the merger, including anticipated synergies, cost savings or growth opportunities, within the expected timeframe or at all. In addition, we expect to incur significant integration and restructuring expenses to realize synergies. However, 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.

Any of these matters could adversely affect our businesses or harm our financial condition, results of operations or business prospects.

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

We incurred substantial additional indebtedness in connection with the Biomet merger. At December 31, 2015, our total indebtedness was $11.6 billion, as compared to $1.4 billion at December 31, 2014. We funded the cash portion of the merger consideration, the pay-off of certain indebtedness of Biomet and the payment of transaction-related expenses through a combination of available cash-on-hand and proceeds from debt financings, including proceeds from a $7.65 billion issuance of senior unsecured notes in March 2015, and borrowings of $3.0 billion under our $4.35 billion credit agreement. As of December 31, 2015, our debt service obligations, comprised of principal and interest (excluding capital leases and equipment notes), during the next 12 months are expected to be $339.8 million. As a result of the increase in our debt, demands on our cash resources have increased. The increased level of debt could, among other things:

 

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

 

 

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limit our ability to obtain additional financing to fund future working capital, capital expenditures, research and development expenditures and other general corporate requirements;

 

limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

 

restrict our ability to make strategic acquisitions or dispositions or to exploit business opportunities;

 

place us at a competitive disadvantage compared to our competitors that have less debt;

 

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

 

adversely affect the market price of our common stock; and

 

limit our ability to apply proceeds from a future offering or asset sale to purposes other than the servicing and repayment of debt.

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. In addition, we are subject to various federal and foreign laws concerning anti-corruption and anti-bribery matters, sales to countries or persons subject to economic sanctions and other matters affecting our international operations. 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 health programs. These laws are administered by, among others, the DOJ, the Office of Inspector General of the U.S. Department of Health and Human Services (“OIG-HHS”), the SEC, the Office of Foreign Assets Control of the U.S. Department of the Treasury (“OFAC”), the Bureau of Industry and Security of the U.S. Department of Commerce and state attorneys general. The interpretation and enforcement of these laws and regulations are uncertain and subject to change.

Biomet is involved in ongoing governmental investigations, the results of which may adversely impact our business and results of operations. Further, if Biomet fails to comply with the terms of the DPA that it entered into in March 2012, it may be subject to criminal prosecution and/or exclusion from federal healthcare programs.

On March 26, 2012, Biomet entered into a Deferred Prosecution Agreement (“DPA”) with the DOJ and a Consent to Final Judgment (“Consent”) with the SEC related to an investigation by the DOJ and the SEC into possible violations of the Foreign Corrupt Practices Act (“FCPA”) in the marketing and sale of medical devices in certain foreign countries. Pursuant to the DPA, the DOJ agreed to defer prosecution of Biomet in connection with those matters,

provided that Biomet satisfies its obligations under the DPA over the term of the DPA. The DPA had a three-year term and provided that it could be extended in the sole discretion of the DOJ for an additional year.

Pursuant to the Consent, Biomet consented to the entry of a Final Judgment which, among other things, permanently enjoined Biomet from violating the provisions of the FCPA. In addition, pursuant to the terms of the DPA, an independent external compliance monitor was appointed to review Biomet’s compliance with the DPA, particularly in relation to Biomet’s international sales practices. The Consent that Biomet entered into with the SEC mirrors the DPA’s provisions with respect to the compliance monitor.

In October 2013, Biomet became aware of certain alleged improprieties regarding its operations in Brazil and Mexico, including alleged improprieties that predated the entry of the DPA. Biomet retained counsel and other experts to investigate both matters. Based on the results of the ongoing investigations, Biomet has terminated, suspended or otherwise disciplined certain of the employees and executives involved in these matters, and has taken certain other remedial measures. Additionally, pursuant to the terms of the DPA, in April 2014 and thereafter, Biomet disclosed these matters to and discussed these matters with the independent compliance monitor and the DOJ and SEC. On July 2, 2014 and July 13, 2015, the SEC issued subpoenas to Biomet requiring that Biomet produce certain documents relating to such matters. These matters remain under investigation by the DOJ.

On March 13, 2015, the DOJ informed Biomet that the DPA and the independent compliance monitor’s appointment have been extended for an additional year. On April 2, 2015, at the request of the staff of the SEC, Biomet consented to an amendment to the Final Judgment to extend the term of the compliance monitor’s appointment for one year from the date of entry of the Amended Final Judgment.

Pursuant to the DPA, the DOJ has sole discretion to determine whether conduct by Biomet constitutes a violation or breach of the DPA. The DOJ has informed Biomet that it retains its rights under the DPA to bring further action against Biomet relating to the conduct in Brazil and Mexico referenced above or the violations set forth in the DPA. The DOJ could, among other things, revoke the DPA or prosecute Biomet and/or the involved employees and executives. Biomet continues to cooperate with the SEC and DOJ and expects that discussions with the SEC and the DOJ will continue.

In June 2013, Biomet received a subpoena from the U.S. Attorney’s Office for the District of New Jersey requesting various documents relating to the fitting of custom-fabricated or custom-fitted orthoses, or bracing, to patients in New Jersey, Texas and Washington. Biomet has produced responsive documents and is fully cooperating with the request of the U.S. Attorney’s Office. We may need to devote significant time and resources to this inquiry and can give no assurances as to its final outcome.

In July 2011, Biomet received an administrative subpoena from OFAC, requesting documents concerning the export of products to Iran. OFAC informed Biomet that the subpoena related to allegations that Biomet may have been involved in

 

 

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unauthorized sales of dental products to Iran. Biomet is fully cooperating in the investigation and submitted its response to the subpoena in October 2011. We may need to devote significant time and resources to this inquiry and can give no assurances as to its final outcome.

In February 2010, Biomet received a subpoena from the OIG-HHS requesting various documents relating to agreements or arrangements between physicians and Biomet’s Interpore Cross subsidiary for the period from 1999 through the date of the subpoena and the marketing and sales activities associated with Interpore Cross’ spinal products. Biomet is fully cooperating in the investigation. We may need to devote significant time and resources to this inquiry and can give no assurances as to its final outcome.

As a result of the merger, all obligations and liabilities of Biomet related to the above matters have been assumed by us as the combined company. From time to time, we are, and may continue to be, the subject of additional investigations. If, as a result of the investigations described above or any additional investigations, we are found to have violated one or more applicable laws, our business, financial condition, results of operations and cash flows could be materially adversely affected. If some of our existing business practices are challenged as unlawful, we may have to modify those practices, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

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 DOJ. 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 processes pertaining to products manufactured at our Ponce, Puerto Rico manufacturing facility. In June 2015, Biomet received a warning letter from the FDA that requested additional information to allow the FDA to evaluate the adequacy of Biomet’s responses to certain Form 483 observations issued following an inspection of Biomet’s Zhejiang, China manufacturing facility in January 2015. As of December 31, 2015, these warning letters remained 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 these and other FDA regulatory matters can be found in Note 20 to the consolidated financial statements.

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.

Interruption of our manufacturing operations could adversely affect our business, financial condition and results of operations.

We have manufacturing sites all over the world. In some instances, however, the manufacturing of certain of our product lines is concentrated in one or more of our plants. Damage to one or more of our facilities from weather or natural disaster-related events, or issues in our manufacturing arising from failure to follow specific internal protocols and procedures, compliance concerns relating to the Quality System regulation and Good Manufacturing Practice requirements, equipment breakdown or malfunction or other factors could adversely affect our ability to manufacture our products. In the event of an interruption in manufacturing, we may be unable to move quickly to alternate means of producing affected products or to meet customer demand. In the event of a significant interruption, for example, as a result of a failure to follow regulatory protocols and procedures, we may experience lengthy delays in resuming production of affected products due primarily to the need for regulatory approvals. As a result, we may experience loss of market share, which we may be unable to recapture, and harm to our reputation, which could adversely affect our business, financial condition and results of operations.

 

 

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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. Further, the legacy independent agents and distributors of us 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. A loss of a significant number of the combined company’s agents could have a material adverse effect on our business and results of operations.

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

 

 

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

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

We 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 over 40 percent of our net sales in 2015 from outside the U.S. We intend to continue to pursue growth opportunities in sales internationally, including in emerging markets, which could expose us to additional risks associated with international sales and operations. Our international operations are, and will continue to be, subject to a number of risks and potential costs, including:

 

changes in foreign medical reimbursement policies and programs;

 

unexpected changes in foreign regulatory requirements;

 

differing local product preferences and product requirements;

 

fluctuations in foreign currency exchange rates;

 

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

 

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

 

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

 

complex data privacy requirements and labor relations laws;

 

extraterritorial effects of U.S. laws such as the FCPA;

 

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.

Disruptions in the supply of the materials and components used in manufacturing our products could adversely affect our results of operations and financial condition.

We purchase many of the materials and components used in manufacturing our products from third-party vendors and we outsource some key manufacturing activities. Certain of these materials and components and outsourced activities can only be obtained from a single source or a limited number of sources due to quality considerations, expertise, costs or constraints resulting from regulatory requirements. In certain cases we may not be able to establish additional or replacement vendors for such materials or components or outsourced activities in a timely or cost effective manner, largely as a result of FDA regulations that require validation of materials and components prior to their use in our products and the complex nature of our and many of our vendors’ manufacturing processes. A reduction or interruption in the supply of materials or components used in manufacturing our products; an inability to timely develop and validate alternative sources if required; or a significant increase in the price of such materials or components could adversely affect our financial condition and results of operations.

Moreover, 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 reports on Form SD with the SEC regarding such matters in June 2014 and 2015 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.

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

 

 

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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 discussed further in Note 20 to the consolidated financial statements, we are defending product liability lawsuits relating to the Durom® Acetabular Component (“Durom Cup”), certain products within the NexGen Knee System, and the M2a-Magnum hip system. The majority of the Durom Cup cases are pending in a federal Multidistrict Litigation (“MDL”) in the District of New Jersey (In Re: Zimmer Durom Hip Cup Products Liability Litigation); the majority of the NexGen Knee System cases are pending in a federal MDL in the Northern District of Illinois (In Re: Zimmer NexGen Knee Implant Products Liability Litigation); and the majority of the M2a-Magnum hip system cases are pending in a federal MDL in the Northern District of

Indiana (In Re: Biomet M2a Magnum Hip 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 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

 

 

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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, including the Biomet merger, 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;

 

incur increased 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. At December 31, 2015, we had $9.9 billion in goodwill. The goodwill results from our acquisition activity, including the Biomet merger, 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.

Certain investors continue to have influence over us, including in connection with decisions that require the approval of stockholders, which could limit other stockholders’ ability to influence the outcome of key transactions, including a change of control.

In connection with our acquisition of Biomet, we entered into a stockholders agreement (the “stockholders agreement”) with LVB Acquisition Holding, LLC and its owners party thereto (collectively, the “Sponsors”). The Sponsors and certain of their affiliates currently hold approximately 9.4% of our common stock. In addition, representatives of the Sponsors currently have the right to designate two members of our board of directors. As a result, the Sponsors potentially have the ability to influence our decisions to enter into any corporate transaction (and the terms thereof).

Additionally, the Sponsors are in the business of making investments in companies and may acquire and hold interests in businesses that compete directly or indirectly with us. One

 

 

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or more of these entities may also pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us.

Future sales, or the perception of future sales, by us or our existing stockholders in the public market could cause the market price for our common stock to decline.

Pursuant to the stockholders’ agreement, we have filed a shelf registration statement with the SEC, registering shares of our common stock for resale by the Sponsors. Two of the Sponsors recently completed the sale of approximately 11.0 million shares of our common stock in an underwritten offering. The Sponsors own approximately 18.6 million additional shares that may be offered and sold under the resale registration statement. The sale of a substantial number of shares of our common stock in the public market by us or our existing stockholders, or the perception that such sales could occur, could harm the prevailing market price of shares of our common stock. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.

Anti-takeover provisions in our organizational documents could delay or prevent a change of control.

Certain provisions of our Restated Certificate of Incorporation, our Restated By-Laws and the Delaware General Corporation Law may have an anti-takeover effect and may delay, defer or prevent a merger, acquisition, tender offer, takeover attempt or other change of control transaction that a stockholder might consider in its best interest, including those attempts that might result in a premium over the market price for the shares held by our stockholders.

These provisions provide for, among other things:

 

the ability of our board of directors to issue one or more series of preferred stock without further stockholder action;

 

advance notice for nominations of directors by stockholders and for stockholders to include matters to be considered at our annual meetings;

 

certain limitations on convening special stockholder meetings; and

 

the prohibition on engaging in a “business combination” with an “interested stockholder” for three years after the time at which a person became an interested stockholder unless certain conditions are met, as set forth in Section 203 of the Delaware General Corporation Law.

These anti-takeover provisions could make it more difficult for a third party to acquire us, even if the third party’s offer may be considered beneficial by many of our stockholders. As a result, our stockholders may be limited in their ability to obtain a premium for their shares.

Our Restated By-Laws designate certain Delaware courts as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or other employees.

Our Restated By-Laws provide that, unless we consent in writing to the selection of an alternative forum, a state court located within the State of Delaware (or, if no state court located in the State of Delaware has jurisdiction, the federal district court for the District of Delaware) will be the sole and exclusive forum for any stockholder (including any beneficial owner) to bring (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of fiduciary duty owed by any of our directors, officers or other employees to us or our stockholders, (iii) any action asserting a claim against us or any of our directors, officers or other employees arising pursuant to any provision of the Delaware General Corporation Law or our Restated Certificate of Incorporation or our Restated By-Laws, as either may be amended from time to time, or (iv) any action asserting a claim against us or any of our directors, officers or other employees governed by the internal affairs doctrine. Any person or entity purchasing or otherwise acquiring any interest in shares of our common stock is deemed to have received notice of and consented to the foregoing provisions. This choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees, which may discourage such lawsuits against us and our directors, officers and employees. Alternatively, if a court were to find this choice of forum provision inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business, financial condition or results of operations.

We identified a material weakness in our internal control over financial reporting in 2015. While the particular material weakness has been remediated as of December 31, 2015, additional material weaknesses or relapses of this material weakness could result in a material misstatement in our financial statements.

We are responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Exchange Act. As discussed in Part II, Item 9A of this report, we identified a material weakness in our internal control over financial reporting during the three month period ended September 30, 2015 related to the control over accounting for non-routine, complex transactions. A material weakness is defined as a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. During the fourth quarter of 2015, we executed our remediation plans to address the material weakness. However, if the remedial measures are not adhered to or if additional material weaknesses or significant deficiencies in internal control over financial reporting are discovered or occur in the future, our

 

 

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consolidated financial statements may contain material misstatements and we could be required to restate our financial results.

 

Item 1B.   Unresolved Staff Comments

Not Applicable.

 

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Item 2.   Properties

The following are our principal properties:

 

Location    Use    Owned /Leased      Square Feet  

Warsaw, Indiana

   Business Unit Headquarters, Manufacturing, Warehousing, Marketing & Administration      Owned         1,900,000   
        

Warsaw, Indiana

   Corporate Headquarters      Owned         115,000   

Warsaw, Indiana

   Manufacturing & Warehousing      Leased         145,000   

Broomfield, Colorado

   Business Unit Headquarters      Leased         65,000   

Jacksonville, Florida

   Business Unit Headquarters & Manufacturing      Owned         85,000   

Palm Beach Gardens, Florida

   Business Unit Headquarters & Manufacturing      Owned         190,000   
        Leased         30,000   

Southaven, Mississippi

   Distribution Center      Leased         190,000   

Parsippany, New Jersey

   Business Unit Headquarters & Manufacturing      Leased         245,000   

Dover, Ohio

   Business Unit Headquarters & Manufacturing      Owned         140,000   
        Leased         65,000   

Beijing, China

   Manufacturing      Leased         95,000   

Changzhou, China

   Manufacturing      Owned         75,000   

Jinhua, China

   Manufacturing      Owned         135,000   

Valence, France

   Manufacturing      Owned         120,000   

Berlin, Germany

   Manufacturing      Owned         50,000   

Eschbach, Germany

   Distribution Center      Owned         95,000   

Galway, Ireland

   Manufacturing      Leased         115,000   

Shannon, Ireland

   Manufacturing      Owned         125,000   

Hazeldonk, The Netherlands

   Distribution Center      Leased         195,000   

Ponce, Puerto Rico

   Manufacturing      Owned         225,000   

Singapore

   Regional Headquarters      Leased         20,000   

Bridgend, South Wales

   Manufacturing      Owned         185,000   
        Leased         100,000   

Valencia, Spain

   Manufacturing      Owned         70,000   
        Leased         20,000   

Winterthur, Switzerland

   Regional Headquarters, Research & Development & Manufacturing      Leased         485,000   

In addition to the above, we maintain sales and administrative offices and warehouse and distribution facilities in more than 40 countries around the world. We believe that all of the facilities and equipment are in good condition, well maintained and able to operate at present levels. We believe the current facilities, including manufacturing, warehousing, research and development and office space, provide sufficient capacity to meet ongoing demands.

 

Item 3.   Legal Proceedings

Information pertaining to legal proceedings in which we are involved can be found in Note 20 to our consolidated financial statements included in Part II, Item 8 of this report and is incorporated herein by reference.

 

Item 4.   Mine Safety Disclosures

Not Applicable.

 

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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 “ZBH.” 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 2015 and 2014 are as follows:

 

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

Year Ended December 31, 2015:

        

First Quarter

   $ 121.84       $ 111.06       $ 0.22   

Second Quarter

   $ 119.10       $ 97.48       $ 0.22   

Third Quarter

   $ 111.35       $ 90.92       $ 0.22   

Fourth Quarter

   $ 108.99       $ 88.77       $ 0.22   

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   

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 record of our common stock on February 24, 2016 was approximately 26,600. On February 25, 2016, the closing price of our common stock, as reported on the New York Stock Exchange, was $96.89 per share.

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

The following table summarizes repurchases of common stock settled during the three months ended December 31, 2015:

 

      Total Number
of Shares
Purchased
     Average Price
Paid per Share
    

Total Number of
Shares Purchased

as Part of

Publicly
Announced Plans
or Programs(1)

    

Approximate

Dollar Value of

Shares that May

Yet Be Purchased

Under Plans

or Programs(1)

 

October 2015

           $  –               $ 599,534,755   

November 2015

     1,414,960         106.01         1,414,960         449,534,731   

December 2015

                            449,534,731   

 

    

 

 

    

 

 

    

 

 

 

Total

     1,414,960       $ 106.01         1,414,960       $ 449,534,731   

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes repurchases made under a program authorizing $1.0 billion of repurchases with no expiration date.

 

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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):

 

            As Revised(2)  
      2015(1)      2014      2013      2012      2011  

STATEMENT OF EARNINGS DATA

              

Net sales

   $ 5,997.8       $ 4,673.3       $ 4,623.4       $ 4,471.7       $ 4,451.8   

Net earnings of Zimmer Biomet Holdings, Inc.

     147.0         720.3         780.4         734.0         784.0   

Earnings per common share

              

Basic

   $ 0.78       $ 4.26       $ 4.60       $ 4.20       $ 4.18   

Diluted

     0.77         4.20         4.54         4.17         4.15   

Dividends declared per share of common stock

   $ 0.88       $ 0.88       $ 0.80       $ 0.54       $ 0.18   

Average common shares outstanding

              

Basic

     187.4         169.0         169.6         174.9         187.6   

Diluted

     189.8         171.7         171.8         176.0         188.7   

BALANCE SHEET DATA

              

Total assets

   $ 27,219.5       $ 9,658.0       $ 9,595.0       $ 8,995.6       $ 8,514.4   

Long-term debt

     11,556.3         1,425.5         1,672.3         1,720.8         1,576.0   

Other long-term obligations

     4,155.9         656.8         583.6         568.2         558.2   

Stockholders’ equity

     9,889.4         6,551.7         6,310.6         5,848.0         5,513.0   

 

 

(1) Includes the results of Biomet starting on June 24, 2015 and Biomet balance sheet data as of December 31, 2015. See Note 4 to the audited financial statements for additional information on the Biomet merger.

(2) See Note 2 to the audited financial statements for additional information on revisions.

 

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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 Annual Report on 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 2014 and 2013 consolidated financial statements have been reclassified to conform to the 2015 presentation. Additionally, as more fully described in Note 2 of the consolidated financial statements included in Part II, Item 8 of this report, due to accounting errors in prior periods, certain amounts in the 2014 and 2013 consolidated financial statements have been revised.

On June 24, 2015, we completed our merger with Biomet and its results of operations have been included in our results starting on that date. The Biomet merger is a transformational event for us and has had significant effects on all aspects of our business. Accordingly, our revenues and expenses increased significantly in the year ended December 31, 2015.

In portions of this discussion and analysis, we also present sales information on an unaudited, pro forma basis for the years ended December 31, 2015 and 2014. This pro forma information includes Zimmer and Biomet sales in those periods as if the merger occurred on January 1, 2014. Accordingly, the pro forma net sales information for periods prior to the Closing Date includes the net sales of Biomet, but does not include the impact of the divestiture of certain product line rights and assets. We believe this pro forma analysis is beneficial for investors because it represents how the merged companies may have performed on a combined basis in 2015 and 2014. Such pro forma net sales information may not be indicative, however, of future operating performance.

EXECUTIVE LEVEL OVERVIEW

 

2015 Results

The last half of 2015 was significantly affected by our Biomet integration activities. We made significant progress by accomplishing important commercial integration milestones across all geographies. We largely completed the appointment of our global sales leaders. We also began to execute our integration roadmaps designed to capture the net operating synergy opportunities presented by this merger.

Our results have been significantly impacted by the Biomet merger. Our sales for 2015 increased by 28.3 percent primarily due to the Biomet merger. Volume/mix growth from the merger was partially offset by the negative effects of changes in foreign currency exchange rates and continued, but stable, pricing pressure in all of our geographic regions.

Our net earnings decreased in 2015 compared to 2014. The primary driver of the lower net earnings was expense incurred in connection with the Biomet merger. As a result of the merger, we recognized significant expenses due to stepping up the acquired inventory to fair value, intangible asset amortization, the acceleration of the vesting of unvested LVB stock options and LVB stock-based awards, retention bonuses paid to Biomet employees and third-party sales agents who remained with Biomet through the Closing Date, severance expense, contract termination expense related to agreements with independent agents, distributors, suppliers and lessors, a loss related to a call premium on Biomet debt we redeemed, third party fees, and other acquisition and integration charges. Interest expense also increased due to financing-related costs for the merger.

2016 Outlook

We expect our sales in the first half of 2016 to be higher than in the first half of 2015, on a reported basis, since the Biomet merger was completed midway through 2015. On a pro forma basis, we expect revenues to be approximately flat in 2016 compared to 2015. This estimate assumes foreign currency exchange rates will decrease revenues by approximately 2 percent, continued pricing pressure will decrease revenues by approximately 2 percent, and our volume/mix growth will be approximately 4 percent. We expect pro forma sales growth will improve in the last half of the year compared to the first half as our sales force stabilizes, we take advantage of cross-selling opportunities and we anniversary out of many sales force dissynergies caused by the merger.

We expect cost of products sold to continue to realize significant expense related to stepping up acquired Biomet inventory to fair value. Similarly, our intangible asset amortization expense will increase significantly as we recognize a full year of intangible asset amortization from the Biomet merger. We expect research and development (“R&D”) expense for the year to be in a range of 4.5 to 5.0 percent of sales. Selling, general and administrative (“SG&A”) expense is expected to approximate 37 percent of sales, which is an improvement from 2015 as we realize synergies from the merger. We estimate special items expense will continue to be significant as we continue our integration activities. However, we expect special items expense will be less in 2016 compared to 2015 due to the significant, initial expenses incurred in 2015 for the integration. Interest expense will increase in 2016 compared to 2015 due to the debt borrowed in 2015 to fund the Biomet merger.

RESULTS OF OPERATIONS

 

We analyze sales by three geographies, the Americas, EMEA and Asia Pacific, and by the following product

 

 

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categories: Knees, Hips, S.E.T., Dental, Spine & CMF and Other. This sales analysis differs from our reportable operating segments, which are based upon our senior management organizational structure and how we allocate resources towards achieving operating profit goals. We analyze sales by

geography because the underlying market trends in any particular geography tend to be similar across product categories and because we primarily sell the same products in all geographies.

 

 

Net Sales by Geography

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

 

     Year Ended December 31,            Volume/
Mix
          Foreign
Exchange
 
      2015      2014      % Inc       Price    

Americas

   $ 3,662.4       $ 2,594.2         41.2     44.3     (2.3 )%      (0.8 )% 

EMEA

     1,417.8         1,269.5         11.7        27.9        (1.1     (15.1

Asia Pacific

     917.6         809.6         13.3        26.0        (2.2     (10.5

 

    

 

 

          

Total

   $ 5,997.8       $ 4,673.3         28.3        36.7        (2.0     (6.4

 

    

 

 

          

 

     Year Ended December 31,            Volume/
Mix
          Foreign
Exchange
 
      2014      2013      % Inc/(Dec)       Price    

Americas

   $ 2,594.2       $ 2,619.8         (1.0 )%      2.4     (3.0 )%      (0.4 )% 

EMEA

     1,269.5         1,212.6         4.7        7.3        (1.8     (0.8

Asia Pacific

     809.6         791.0         2.4        9.0        (1.3     (5.3

 

    

 

 

          

Total

   $ 4,673.3       $ 4,623.4         1.1        4.8        (2.4     (1.3

 

    

 

 

          

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

The following table presents our pro forma net sales by geography and the components of the percentage changes (dollars in millions):

 

     Year Ended December 31,            Volume/
Mix
          Divestiture
Impact
    Foreign
Exchange
 
      Pro Forma
2015
     Pro Forma
2014
     % (Dec)       Price      

Americas

   $ 4,685.2       $ 4,748.6         (1.3 )%      1.6     (1.5 )%      (0.9 )%      (0.5 )% 

EMEA

     1,767.9         2,072.6         (14.7     1.6        (1.0     (0.5     (14.8

Asia Pacific

     1,064.7         1,144.1         (6.9     5.6        (1.9            (10.6

 

    

 

 

            

Total

   $ 7,517.8       $ 7,965.3         (5.6     2.3        (1.5     (0.7     (5.7

 

    

 

 

            

 

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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
 
      2015      2014      % Inc       Price    

Knees

   $ 2,276.8       $ 1,895.2         20.1     28.8     (2.4 )%      (6.3 )% 

Hips

     1,537.2         1,326.4         15.9        26.1        (2.4     (7.8

S.E.T.

     1,214.9         863.2         40.7        46.8        (0.7     (5.4

Dental

     335.7         242.8         38.2        45.0        (1.1     (5.7

Spine & CMF

     404.4         207.2         95.2        101.2        (1.6     (4.4

Other

     228.8         138.5         65.3        70.4        (1.8     (3.3

 

    

 

 

          

Total

   $ 5,997.8       $ 4,673.3         28.3        36.7        (2.0     (6.4

 

    

 

 

          

 

     Year Ended December 31,            Volume/
Mix
          Foreign
Exchange
 
      2014      2013      % Inc/(Dec)       Price    

Knees

   $ 1,895.2       $ 1,862.2         1.8     6.3     (3.2 )%      (1.3 )% 

Hips

     1,326.4         1,330.5         (0.3     3.9        (2.6     (1.6

S.E.T.

     863.2         847.2         1.9        4.5        (1.2     (1.4

Dental

     242.8         239.3         1.5        2.5        (0.4     (0.6

Spine & CMF

     207.2         202.3         2.4        5.0        (2.0     (0.6

Other

     138.5         141.9         (2.4     (0.3     (1.4     (0.7

 

    

 

 

          

Total

   $ 4,673.3       $ 4,623.4         1.1        4.8        (2.4     (1.3

 

    

 

 

          

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

 

     Year Ended December 31,                                 
     Pro Forma      Pro Forma              Volume/           Divestiture     Foreign  
      2015      2014      % (Dec)     Mix         Price     Impact     Exchange  

Knees

   $ 2,735.9       $ 2,888.9         (5.3 )%      3.7     (1.9 )%      (1.1 )%      (6.0 )% 

Hips

     1,842.6         1,984.3         (7.1     2.2        (2.1            (7.2

S.E.T.

     1,571.8         1,619.1         (2.9     3.0        (0.7     (0.3     (4.9

Dental

     454.8         500.4         (9.1     (3.5     0.1               (5.7

Spine & CMF

     583.5         604.1         (3.4     0.1        (0.7            (2.8

Other

     329.2         368.5         (10.6     (1.4     (1.2     (4.8     (3.2

 

    

 

 

            

Total

   $ 7,517.8       $ 7,965.3         (5.6     2.3        (1.5     (0.7     (5.7

 

    

 

 

            

 

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The following table presents net sales by product category by geography for our Knees and Hips product categories, which represent our most significant product categories (dollars in millions):

 

     Year Ended December 31,  
      2015      2014      2013     

2015 vs. 2014

% Inc

   

2014 vs. 2013

% Inc/(Dec)

 

Knees

             

Americas

   $ 1,391.5       $ 1,086.8       $ 1,087.5         28.0     (0.1 )% 

EMEA

     535.2         498.6         468.4         7.3        6.5   

Asia Pacific

     350.1         309.8         306.3         13.0        1.1   

 

    

 

 

    

 

 

      

Total

     2,276.8         1,895.2         1,862.2         20.1        1.8   

 

    

 

 

    

 

 

      
             

Hips

             

Americas

     789.8         607.8         621.0         29.9        (2.1

EMEA

     459.2         448.9         445.0         2.3        0.9   

Asia Pacific

     288.2         269.7         264.5         6.9        2.0   

 

    

 

 

    

 

 

      

Total

     1,537.2         1,326.4         1,330.5         15.9        (0.3

 

    

 

 

    

 

 

      

The following table presents our pro forma net sales by product category by geography for our Knees and Hips product categories, which represent our most significant product categories (dollars in millions):

 

     Year Ended December 31,  
      Pro Forma
2015
     Pro Forma
2014
    

2015 vs. 2014

% Inc/(Dec)

 

Knees

        

Americas

   $ 1,684.6       $ 1,708.4         (1.4 )% 

EMEA

     649.5         752.3         (13.7

Asia Pacific

     401.8         428.2         (6.1

 

    

 

 

    

Total

     2,735.9         2,888.9         (5.3

 

    

 

 

    

Hips

        

Americas

     980.3         998.4         (1.8

EMEA

     537.2         625.9         (14.2

Asia Pacific

     325.1         360.0         (9.7

 

    

 

 

    

Total

     1,842.6         1,984.3         (7.1

 

    

 

 

    

 

Demand (Volume and Mix) Trends

Increased volume and changes in the mix of product sales contributed 36.7 percentage points of year-over-year sales growth during 2015. Volume/mix growth was driven by the Biomet merger, new product introductions and sales in key emerging markets.

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 2.0 percentage points on year-over-year sales during 2015. The negative 2.0 percent effect on year-over-year sales is consistent with what we have experienced over the past three years. The majority of countries in which we operate continued to

experience pricing pressure from governmental healthcare cost containment efforts and from local hospitals and health systems.

Foreign Currency Exchange Rates

In 2015, changes in foreign currency exchange rates had a negative effect of 6.4 percentage points on year-over-year sales. We address currency risk through regular operating and financing activities and through the use of forward contracts and foreign currency options solely to manage foreign currency volatility and risk. Changes in foreign currency exchange rates affect sales growth, but due to offsetting 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 reduced.

Sales by Product Category

Knees

Knee sales increased in 2015 when compared to 2014 due to the Biomet merger. On a pro forma basis, Knee sales declined in 2015 due to changes in foreign currency exchange

 

 

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rates, the divestiture of certain product line rights and assets and continued pricing pressure. The volume/mix growth on a pro forma basis was driven by recent product introductions, such as Persona The Personalized Knee System. In particular, our EMEA and Asia Pacific operating segments experienced strong volume/mix growth in this product category.

Hips

Hip sales increased in 2015 when compared to 2014 due to the Biomet merger. On a pro forma basis, positive volume and mix trends were more than offset by pricing pressure and the negative effects of changes in foreign currency exchange rates.

S.E.T.

Our S.E.T. product category sales increased in 2015 compared to 2014 due to the Biomet merger. On a pro forma basis, positive volume and mix trends were more than offset by pricing pressure, the divestiture of certain product line rights and assets and the negative effects of changes in foreign currency exchange rates. On a pro forma basis within this category, our Extremities business achieved solid sales growth from sales of our shoulder and elbow products.

Dental

Dental sales increased in 2015 compared to 2014 due to the Biomet merger. On a pro forma basis, sales in 2015 declined partly due to a supply disruption related to a voluntary field action in response to a packaging issue and the negative effects of changes in foreign currency exchange rates. We are in the process of remediating the supply disruption and we expect to do so fully by the close of the first quarter of 2016.

Spine & CMF

Spine and CMF sales increased in 2015 compared to 2014 due to the Biomet merger. On a pro forma basis, strong sales of our CMF products were offset by a decline in Spine product sales.

The following table presents estimated* 2015 global market size and market share information (dollars in billions):

 

      Global
Market
Size
    

Global Market

% Growth**

    Zimmer
Biomet
Market
Share
    Zimmer
Biomet
Market
Position
 

Knees

   $ 7.5         3     37     1   

Hips

     6.1         1        30        1   

S.E.T.

     14.8         5        11        5   

Dental

     4.1         4        11        4   

Spine & CMF

     10.6         1        6        5   

 

* 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    

Expenses as a Percent of Net Sales

 

     Year Ended December 31,  
      2015     2014     2013     2015 vs. 2014
Inc/(Dec)
    2014 vs. 2013
Inc/(Dec)
 

Cost of products sold, excluding intangible asset amortization

     30.0     26.6     27.4     3.4        (0.8

Intangible asset amortization

     5.6        2.0        1.7        3.6        0.3   

Research and development            

     4.5        4.0        4.4        0.5        (0.4

Selling, general and administrative

     38.1        37.5        37.8        0.6        (0.3

Certain claims

     0.1        0.5        1.0        (0.4     (0.5

Special items

     13.9        7.3        4.5        6.6        2.8   

Operating Profit

     7.8        22.2        23.1        (14.4     (0.9

Cost of Products Sold and Intangible Asset Amortization

The following table sets forth the factors that contributed to the gross margin changes in each of 2015 and 2014 compared to the prior year:

 

     Year Ended December 31,  
               2015              2014  

Prior year gross margin

     71.4     70.6

Lower average selling prices

     (0.6     (0.6

Average cost per unit

     1.3        0.4   

Excess and obsolete inventory

     (0.8     0.4   

Discontinued products and other certain excess and obsolete inventory charges

            0.9   

Certain inventory and manufacturing related charges related to quality

     0.2        0.1   

Foreign currency hedges

     1.3        0.5   

Inventory step-up

     (5.1     0.1   

U.S. medical device excise tax

            (0.5

Intangible asset amortization

     (3.5     (0.2

Other

     0.2        (0.3

 

 

Current year gross margin

     64.4     71.4

 

 

The decrease in gross margin percentage in 2015 compared to 2014 was primarily due to increased inventory step-up costs as well as increased intangible asset amortization from the Biomet merger. The decline was also a result of lower average selling prices and higher excess and obsolete inventory charges. These unfavorable items were partially offset by higher hedge gains in 2015 from our foreign currency hedging program compared to 2014. 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 and geographic mix, resulting in lower average costs per unit sold as a percentage of sales.

In 2014, we experienced an increase in gross margin percentage compared to 2013, primarily due to significant excess and obsolete inventory charges related to products we

 

 

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intend to discontinue. We also recognized higher hedge gains in 2014 from our foreign currency hedging program compared to 2013.

Operating Expenses

R&D expenses and R&D as a percentage of sales increased in 2015 compared to 2014. The primary driver of the increased expense was the Biomet merger. The combination of our R&D functions subsequent to the merger will allow us to allocate a greater portion of the combined R&D spending towards innovation efforts to address unmet clinical needs and create new-market adjacencies. Additionally, most of our R&D activities occur in the U.S., so expenses do not decrease proportionally to changes in net sales when there are significant changes in foreign currency exchange rates, which contributes to an increase in R&D as a percentage of sales. The increase in 2015 reverses a trend of declines in R&D expense and R&D as a percentage of sales. In prior 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 2016 to increase and be between 4.5 and 5.0 percent of sales.

SG&A as a percentage of sales increased in 2015 compared to 2014 after realizing improvements in 2014 and 2013 due to our operational excellence initiatives. The Biomet merger was the primary cause of the increase. We expect that SG&A as a percentage of sales will continue to be higher than prior to the Biomet merger until we can realize synergy benefits of the merger. Additionally, a significant portion of our SG&A expenses occur in the U.S., so expenses do not decrease proportionally to changes in net sales when there are significant changes in foreign currency exchange rates.

“Certain claims” expense is for estimated liabilities to Durom Cup patients undergoing revision surgeries. We recorded additional expense of $7.7 million in 2015 for Durom Cup-related claims. Since 2008, we have recognized $479.4 million for these claims. For more information regarding these claims, see Note 20 to the consolidated financial statements.

“Special items” have increased significantly in the past three years. The increases in 2015 were due to Biomet merger-related expenses such as the acceleration of unvested LVB stock options and LVB stock-based awards, retention bonuses paid to Biomet employees and third-party sales agents who remained with Biomet through the Closing Date, severance expense and contract terminations. “Special items” expense also includes 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. See Note 3 to the consolidated financial statements for more information regarding “Special items” charges.

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

Other expense, net, represents debt issuance costs that we recognized for the bridge credit agreement that we entered

into in May 2014 in connection with the Biomet merger, the net expense related to remeasuring monetary assets and liabilities denominated in a foreign currency other than an entity’s functional currency offset by foreign currency forward exchange contracts we enter into to mitigate any gain or loss, and the call premium expense we recognized when we repaid Biomet’s senior notes, partially offset by a gain related to selling certain product line rights and assets. The decrease in Other expense, net in 2015 compared to 2014, was driven by fewer months of debt issuance costs from the bridge credit agreement and the gains recognized on the sale of the product line rights and assets.

Net interest expense increased in 2015 due to the issuance of the debt in connection with the Biomet merger.

Our effective tax rate (“ETR”) on earnings before income taxes for the years ended December 31, 2015, 2014 and 2013 was 4.6 percent, 23.4 percent and 22.8 percent, respectively. “Special items” expense has significantly affected our ETR as such expenses have generally been incurred within jurisdictions with higher tax rates, resulting in lower taxable income in these higher tax jurisdictions. The low 2015 tax rate results from operating losses in the U.S. caused by significant expenses incurred in connection with the merger. The U.S. has a higher tax rate compared to the majority of foreign operations where we realized operating income. We expect “Special items,” the outcome of various federal, state and foreign audits, as well as expiration of certain statutes of limitations, to impact our ETR in future years. Currently, we cannot reasonably estimate the impact of these items on our financial results.

Segment Operating Profit    

Similar to our consolidated results, our segment operating profit has been significantly impacted by the addition of Biomet sales and expenses to these segments. In the Americas, operating profit as a percentage of sales increased in 2015 compared to 2014, as we started to realize synergies of the merger. In EMEA, operating profit as a percentage of sales declined in 2015 compared to 2014 due to the increased Biomet expenses. This decline is expected to continue until we can realize the synergy benefits of the merger in this region. In the Asia Pacific segment, operating profit as a percentage of sales increased in 2015 compared to 2014 due to changes in foreign currency exchange rates and our hedging program.

Non-GAAP operating performance measures

We use financial measures that differ from financial measures determined in accordance with generally accepted accounting principles (“GAAP”) to evaluate our operating performance. These non-GAAP financial measures exclude the impact of inventory step-up, certain other inventory and manufacturing related charges connected to quality enhancement and remediation efforts, “Certain claims,” intangible asset amortization, “Special items,” other expenses related to financing obtained for the Biomet merger, other expenses related to the call premium expense recognized to redeem the assumed Biomet senior notes, the interest expense incurred on issued debt during the period prior to the consummation of the Biomet merger and any related effects on

 

 

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our income tax provision associated with these items and other certain tax adjustments. We use this information internally and believe it is helpful to investors because it provides useful 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 additional 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, 2015, 2014 and 2013 were $1,310.5 million, $1,098.0 million, and $1,069.0 million, respectively, and our non-GAAP adjusted diluted earnings per share were $6.90, $6.40, and $6.22, 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,  
      2015     2014     2013  

Net Earnings of Zimmer Biomet Holdings, Inc.

   $ 147.0      $ 720.3      $ 780.4   

Inventory step-up and other inventory and manufacturing related charges

     348.8        36.3        88.7   

Certain claims

     7.7        21.5        47.0   

Intangible asset amortization

     337.4        92.5        78.5   

Special items

      

Biomet merger-related

     619.1        61.9          

Other special items

     212.7        279.2        210.3   

Other expense, net

     23.0        39.6          

Interest expense on Biomet merger financing

     70.0                 

Taxes on above items and other certain tax adjustments*

     (455.2     (153.3     (135.9

 

   

 

 

   

 

 

 

Adjusted Net Earnings

   $ 1,310.5      $ 1,098.0      $ 1,069.0   

 

   

 

 

   

 

 

 

 

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

 

     Year ended December 31,  
      2015     2014     2013  

Diluted EPS

   $ 0.77      $ 4.20      $ 4.54   

Inventory step-up and other inventory and manufacturing related charges

     1.84        0.21        0.52   

Certain claims

     0.04        0.13        0.27   

Intangible asset amortization

     1.78        0.54        0.46   

Special items

      

Biomet merger-related

     3.26        0.36          

Other special items

     1.12        1.63        1.22   

Other expense, net

     0.12        0.23          

Interest expense on Biomet merger financing

     0.37                 

Taxes on above items and other certain tax adjustments*

     (2.40     (0.90     (0.79

 

   

 

 

   

 

 

 

Adjusted Diluted EPS

   $ 6.90      $ 6.40      $ 6.22   

 

   

 

 

   

 

 

 

 

* 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 declined to $816.7 million in 2015, compared to $1,052.8 million in 2014. The decreased cash flows provided by operating activities in 2015 were primarily due to higher expenses related to the Biomet merger, a $97.6 million loss on our forward starting interest rate swaps we settled in March 2015 when we issued senior notes for the Biomet merger and inventory investments. These unfavorable items were partially offset by lower tax payments and the receipt of insurance proceeds related to Durom Cup product liability claims in the 2015 period. In 2014, we made significant tax payments for certain unresolved matters in order to limit the potential impact of IRS interest charges. In 2016, we estimate operating cash flows to be in a range of $1,650.0 million to $1,750.0 million, inclusive of approximately $290.0 million of outflows related to integration expenses to drive synergies.

Cash flows used in investing activities were $7,557.9 million in 2015 compared to $469.4 million in 2014. The primary investing activity in 2015 was the Biomet merger. We continued to invest in instruments for significant product launches, such as Persona The Personalized Knee System, as we deploy that system around the world. In 2016, we expect instrument investments to be in a range of $300.0 million to $325.0 million in support of our cross-sell initiatives as well as new product introductions. In 2015, we continued to invest in other property, plant and equipment at levels necessary to complete new product-related investments and to replace older machinery and equipment. In 2016, we expect to spend approximately $250.0 million on property, plant and equipment, including $105.0 million necessary to rationalize facilities and IT systems as well as to optimize our manufacturing and logistics network.

Cash flows provided by financing activities were $7,139.8 million in 2015, compared to a use of cash of $562.4 million in 2014. We issued debt in 2015 for the Biomet merger, which resulted in proceeds and related debt issuance costs. We also repaid Biomet’s senior notes that we assumed in the merger. Additionally, with an increase in our stock price throughout 2014, many employees exercised stock options in the prior year. Accordingly, there were fewer stock options outstanding at the end of 2014, leading to fewer option exercises in 2015 compared to 2014.

In February, May, July and December 2015, our Board of Directors declared cash dividends of $0.22 per share. We expect to continue paying cash dividends on a quarterly basis; however, future dividends are subject to approval of the Board of Directors and may be adjusted as business needs or market conditions change. As further discussed below, our debt facilities restrict the payment of dividends in certain circumstances.

As of December 31, 2015, $449.5 million remained authorized under our $1.0 billion share repurchase program, which has no expiration date. In anticipation of the merger with Biomet, we suspended repurchases after the first quarter of 2014. We commenced share repurchases in the fourth quarter of 2015 and continued repurchases in the first two months of 2016.

 

 

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Through February 25, 2016, we repurchased approximately $415.0 million of shares of our common stock, which includes the $250.0 million of shares that we repurchased from certain selling stockholders on February 10, 2016.

In order to achieve operational synergies, we expect cash outlays related to our integration plans to be approximately $290.0 million in 2016. These cash outlays are necessary to achieve our integration goals of net annual pre-tax operating profit synergies of $350.0 million by the end of the third year post-Closing Date.

Also as discussed in Note 20 to our consolidated financial statements, as of December 31, 2015, a short-term liability of $50.0 million and long-term liability of $264.6 million related to Durom Cup product liability claims was recorded on our consolidated balance sheet. 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. As of December 31, 2015, we have received a portion of the insurance proceeds we estimate we will recover. We have a long-term receivable of $95.3 million remaining for future expected reimbursements from our insurance carriers. We also had a short-term liability of $33.4 million related to Biomet metal-on-metal hip implant claims.

At December 31, 2015, we had ten tranches of senior notes outstanding as follows (dollars in millions):

 

Principal      Interest
Rate
    Maturity Date
$ 500.0         1.450   April 1, 2017
  1,150.0         2.000      April 1, 2018
  500.0         4.625      November 30, 2019
  1,500.0         2.700      April 1, 2020
  300.0         3.375      November 30, 2021
  750.0         3.150      April 1, 2022
  2,000.0         3.550      April 1, 2025
  500.0         4.250      August 15, 2035
  500.0         5.750      November 30, 2039
  1,250.0         4.450      August 15, 2045

We issued $7.65 billion of senior notes in March 2015 (the “Merger Notes”), the proceeds of which were used to finance a portion of the cash consideration payable in the Biomet merger, pay merger related fees and expenses and pay a portion of Biomet’s funded debt. On June 24, 2015, we also borrowed $3.0 billion on a U.S. term loan (“U.S. Term Loan”) to fund the Biomet merger.

We may, at our option, redeem our senior notes, in whole or in part, at any time upon payment of the principal, any applicable make-whole premium, and accrued and unpaid interest to the date of redemption. In addition, the Merger Notes and the 3.375% Senior Notes due 2021 may be redeemed at our option without any make-whole premium at specified dates ranging from one month to six months in advance of the scheduled maturity date.

We have a $4.35 billion credit agreement (“Credit Agreement”) that contains: (i) a 5-year unsecured U.S. term loan facility (“U.S. Term Loan Facility”) 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 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, 2015. The U.S. Term Loan Facility will mature in June 2020, with principal payments due beginning September 30, 2015, as follows: $75.0 million on a quarterly basis during the first three years, $112.5 million on a quarterly basis during the fourth year, and $412.5 million on a quarterly basis during the fifth year. In 2015, we paid $500.0 million in principal under the U.S. Term Loan Facility, resulting in $2.5 billion in outstanding borrowings as of December 31, 2015.

We and certain of our wholly owned foreign subsidiaries are the borrowers under the Credit Agreement. Borrowings under the Credit Agreement 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 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 through June 24, 2016 and no greater than 4.5 to 1.0 thereafter. 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 Credit Agreement as of December 31, 2015.

Commitments under the Credit Agreement 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.

We have a Japan Term Loan agreement with one of the lenders under the Credit Agreement for 11.7 billion Japanese Yen 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 $35.8 million.

We place our cash and cash equivalents in highly-rated financial institutions and limit the amount of credit exposure to any one entity. We invest only in high-quality financial instruments in accordance with our internal investment policy.

As of December 31, 2015, we had short-term and long-term investments in debt securities with a fair value of $273.1 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.

 

 

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As of December 31, 2015, $921.9 million of our cash and cash equivalents and short-term and long-term investments were held in jurisdictions outside of the U.S. Of this amount, $564.7 million 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.

In light of our commitments under various credit facilities, as well as our expectation for continued business development, we have plans to repatriate a significant portion of our offshore earnings to the U.S. In particular, as a result of the Biomet merger we have unremitted foreign earnings of $4,387.9 million which we plan to repatriate to the U.S. in future periods. We have recorded a long-term liability of $1,494.9 million for the estimated tax impact of this repatriation.

Management believes that cash flows from operations and available borrowings under the Multicurrency Revolving Facility are sufficient to meet our working capital, capital expenditure and debt service needs, as well as return cash to stockholders in the form of dividends and share repurchases. Should 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      2016     

2017

and

2018

    

2019

and

2020

    

2021

and
Thereafter

 

Long-term debt

   $ 11,551.4       $  –       $ 2,263.9       $ 3,987.5       $ 5,300.0   

Interest payments

     4,142.6         339.8         651.0         531.1         2,620.7   

Operating leases

     231.8         59.1         78.6         48.2         45.9   

Purchase obligations

     91.0         61.9         22.5         3.7         2.9   

Other long-term liabilities

     406.7                 136.9         107.6         162.2   

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

   $ 16,423.5       $ 460.8       $ 3,152.9       $ 4,678.1       $ 8,131.7   

 

    

 

 

    

 

 

    

 

 

    

 

 

 

$93.5 million of the other long-term liabilities on our balance sheet as of December 31, 2015 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 2016. Therefore, this table does not include any amounts related to future contributions to our plans. See Note 15 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. We have also excluded long-term deferred tax liabilities from this table, as they do not represent liabilities that will be settled in cash. See Note 16 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 $45 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.

 

 

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

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

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

In addition to our general product liability, we have recorded provisions totaling $479.4 million related to the Durom Cup, including $7.7 million in 2015. See Note 20 to our consolidated financial statements for further discussion of the Durom Cup litigation.

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.

We have seven reporting units with goodwill assigned to them. Two of these reporting units, CMF and Bone Healing, consist entirely of assets and liabilities acquired in the Biomet merger. Since these assets and liabilities were valued at their estimated fair value on the Closing Date, in our 2015 impairment test, the carrying value approximated the fair value. Therefore, if these reporting units perform below what we expected at the time that we estimated their fair value, we may be required to record impairment charges.

Our other five reporting units consist of combined Zimmer and Biomet assets and liabilities. In our 2015 impairment test, our EMEA reporting unit’s estimated fair value only exceeded the carrying value of its net assets by 8 percent, or approximately $240 million. This reporting unit’s estimated fair value has significantly decreased from prior year impairment tests due to the weakening of the Euro against the U.S. Dollar. For our other four reporting units, their estimated fair value exceeded their carrying value by more than 20 percent.

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 3 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 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,

 

 

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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, 2015, 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 2016 through June 2018. The notional amounts of outstanding forward contracts entered into with third parties to purchase U.S. Dollars at December 31, 2015 were $1,427.5 million. The notional amounts of outstanding forward contracts entered into with third parties to purchase Swiss Francs at December 31, 2015 were $307.2 million. The weighted average contract rates outstanding at December 31, 2015 were Euro:USD 1.21, USD:Swiss Franc: 0.91, USD:Japanese Yen 112.44, British Pound:USD 1.59, USD:Canadian Dollar 1.22, Australian Dollar:USD 0.77, USD:Korean Won 1,125, USD:Swedish Krona 7.68, USD:Czech Koruna 22.88, USD:Thai Baht 35.03, USD:Taiwan Dollar 31.48, USD:South African Rand 13.60, USD:Russian Ruble 65.50 and USD:Indian Ruppee 68.80.

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, 2015 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 2018,

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

 

Currency    Average
Amount
 

Euro

   $ 55.5   

Swiss Franc

     31.7   

Japanese Yen

     34.6   

British Pound

     9.2   

Canadian Dollar

     11.0   

Australian Dollar

     15.7   

Korean Won

     3.4   

Swedish Krona

     2.5   

Czech Koruna

     0.6   

Thai Baht

     0.8   

Taiwan Dollars

     3.4   

South African Rand

     0.6   

Russian Rubles

     0.8   

Indian Rupees

     1.7   

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, excluding goodwill and intangible assets, in legal entities with non-U.S. Dollar functional currencies of $2,042.4 million at December 31, 2015, primarily in Euros, Japanese Yen and Australian Dollars.

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

COMMODITY PRICE RISK

 

We purchase raw material commodities such as cobalt chrome, titanium, tantalum, polymer and sterile packaging. We enter into supply contracts generally with terms of 12 to 24 months, where available, on these commodities to alleviate the effect of market fluctuation in prices. As part of our risk management program, we perform sensitivity analyses related to potential commodity price changes. A 10 percent price change across all these commodities would not have a material effect on our consolidated financial position, results of operations or cash flows.

 

 

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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 $250.0 million and $300.0 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.

Based upon our overall interest rate exposure as of December 31, 2015, 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, 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, 2015, 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 $238.6 million. With allowances for doubtful accounts of $17.3 million recorded in those countries, the net balance was $221.3 million, representing 16 percent of our total consolidated short-term and long-term trade accounts receivable balance, net. Italy and Spain accounted for $194.2 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 Biomet 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 acquired Biomet during the second quarter of 2015 in a purchase business combination. Management excluded Biomet from its evaluation of internal control over financial reporting as of December 31, 2015. The Company will incorporate Biomet into its annual report on internal control over financial reporting as of December 31, 2016. Biomet’s assets as of December 31, 2015 excluded from management’s assessment were $2,631.0 million, or 10 percent of our total assets. Biomet’s net sales for the year ended December 31, 2015 excluded from management’s assessment were $1,602.0 million, or 27 percent of our total net sales.

The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2015. 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, 2015, 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, 2015, as stated in its report which appears in Item 8 of this Annual Report on Form 10-K.

 

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Item 8.   Financial Statements and Supplementary Data

 

Zimmer Biomet 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, 2015, 2014 and 2013

     37   

Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2015, 2014 and 2013

     38   

Consolidated Balance Sheets as of December 31, 2015 and 2014

     39   

Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2015, 2014 and 2013

     40   

Consolidated Statements of Cash Flows for the Years Ended December 31, 2015, 2014 and 2013

     41   

Notes to Consolidated Financial Statements

     42   

 

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ZIMMER BIOMET HOLDINGS, INC.    2015 FORM 10-K ANNUAL REPORT

 

Report of Independent Registered Public Accounting Firm

 

To the Stockholders and Board of Directors of Zimmer Biomet 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 Biomet Holdings, Inc. and its subsidiaries at December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2015 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, 2015, 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 Item 7. 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.

As discussed in Note 3 to the consolidated financial statements, the Company changed the manner in which it classifies deferred income taxes in 2015.

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.

As described in Management’s Report on Internal Control Over Financial Reporting, management has excluded Biomet, Inc. from its assessment of internal control over financial reporting as of December 31, 2015 because it was acquired by the Company in a purchase business combination during 2015. We have also excluded Biomet, Inc. from our audit of internal control over financial reporting. Biomet, Inc. is a wholly-owned subsidiary whose total assets and total revenues represent $2,631.0 million or 10% of total assets and $1,602.0 million or 27% of total net sales, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2015.

/s/ PricewaterhouseCoopers LLP

Chicago, Illinois    

February 29, 2016

 

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CONSOLIDATED STATEMENTS OF EARNINGS

 

 

      (in millions, except per share amounts)  
For the Years Ended December 31,    2015     2014     2013  

Net Sales

     $5,997.8      $ 4,673.3      $ 4,623.4   

Cost of products sold, excluding intangible asset amortization

     1,800.6        1,242.8        1,266.7   

Intangible asset amortization

     337.4        92.5        78.5   

Research and development

     268.8        187.4        203.0   

Selling, general and administrative

     2,284.2        1,750.7        1,749.3   

Certain claims (Note 20)

     7.7        21.5        47.0   

Special items (Note 3)

     831.8        341.1        210.3   

 

   

 

 

   

 

 

 

Operating expenses

     5,530.5        3,636.0        3,554.8   

 

   

 

 

   

 

 

 

Operating Profit

     467.3        1,037.3        1,068.6   

Other expense, net

     (36.9     (46.7     (6.0

Interest income

     9.4        11.9        15.6   

Interest expense

     (286.6     (63.1     (70.1

 

   

 

 

   

 

 

 

Earnings before income taxes

     153.2        939.4        1,008.1   

Provision for income taxes

     7.0        220.2        229.5   

 

   

 

 

   

 

 

 

Net earnings

     146.2        719.2        778.6   

Less: Net loss attributable to noncontrolling interest

     (0.8     (1.1     (1.8

 

   

 

 

   

 

 

 

Net Earnings of Zimmer Biomet Holdings, Inc.

   $ 147.0      $ 720.3      $ 780.4   

 

   

 

 

   

 

 

 

Earnings Per Common Share – Basic

   $ 0.78      $ 4.26      $ 4.60   

Earnings Per Common Share – Diluted

   $ 0.77      $ 4.20      $ 4.54   

Weighted Average Common Shares Outstanding

      

Basic

     187.4        169.0        169.6   

Diluted

     189.8        171.7        171.8   

Cash Dividends Declared Per Common Share

   $ 0.88      $ 0.88      $ 0.80   

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

 

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ZIMMER BIOMET HOLDINGS, INC.    2015 FORM 10-K ANNUAL REPORT

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

 

 

      (in millions)  
For the Years Ended December 31,    2015     2014     2013  

Net Earnings

   $ 146.2      $ 719.2      $ 778.6   

Other Comprehensive Income (Loss):

      

Foreign currency cumulative translation adjustments

     (305.2     (223.1     (35.0

Unrealized cash flow hedge gains, net of tax

     52.7        55.9        33.4   

Reclassification adjustments on cash flow hedges, net of tax

     (93.0     (18.9     (4.4

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

     (0.2     (0.5     0.1   

Reclassification adjustments on securities, net of tax

            (0.4       

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

     (21.4     (75.8     38.5   

 

   

 

 

   

 

 

 

Total Other Comprehensive (Loss) Income

     (367.1     (262.8     32.6   

 

   

 

 

   

 

 

 

Comprehensive (Loss) Income

     (220.9     456.4        811.2   

 

   

 

 

   

 

 

 

Comprehensive Loss Attributable to Noncontrolling Interest

     (0.3     (1.0     (2.0

 

   

 

 

   

 

 

 

Comprehensive (Loss) Income Attributable to Zimmer Biomet Holdings, Inc.

   $ (220.6   $ 457.4      $ 813.2   

 

   

 

 

   

 

 

 

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

 

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ZIMMER BIOMET HOLDINGS, INC.    2015 FORM 10-K ANNUAL REPORT

 

CONSOLIDATED BALANCE SHEETS

 

 

      (in millions)  
As of December 31,    2015     2014  

ASSETS

    

Current Assets:

    

Cash and cash equivalents

   $ 1,459.3      $ 1,083.3   

Short-term investments

     164.6        612.5   

Accounts receivable, less allowance for doubtful accounts

     1,446.5        912.1   

Inventories

     2,254.1        1,193.3   

Prepaid expenses and other current assets

     538.4        317.2   

Deferred income taxes

            194.9   

 

   

 

 

 

Total Current Assets

     5,862.9        4,313.3   

Property, plant and equipment, net

     2,062.6        1,285.3   

Goodwill

     9,934.2        2,514.2   

Intangible assets, net

     8,746.3        603.5   

Other assets

     613.5        941.7   

 

   

 

 

 

Total Assets

   $ 27,219.5      $ 9,658.0   

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current Liabilities:

    

Accounts payable

   $ 284.8      $ 145.2   

Income taxes

     147.2        80.3   

Other current liabilities

     1,185.9        798.5   

 

   

 

 

 

Total Current Liabilities

     1,617.9        1,024.0   

Deferred income taxes

     3,150.2        45.9   

Other long-term liabilities

     1,005.7        610.9   

Long-term debt

     11,556.3        1,425.5   

 

   

 

 

 

Total Liabilities

     17,330.1        3,106.3   

 

   

 

 

 

Commitments and Contingencies (Note 20)

    

Stockholders’ Equity:

    

Common stock, $0.01 par value, one billion shares authorized,
302.7 million (268.4 million in 2014) issued

     3.0        2.7   

Paid-in capital

     8,195.3        4,330.7   

Retained earnings

     8,347.7        8,362.1   

Accumulated other comprehensive (loss) income

     (329.0     38.1   

Treasury stock, 100.0 million shares (98.7 million shares in 2014)

     (6,329.1     (6,183.7

 

   

 

 

 

Total Zimmer Biomet Holdings, Inc. stockholders’ equity

     9,887.9        6,549.9   

Noncontrolling interest

     1.5        1.8   

 

   

 

 

 

Total Stockholders’ Equity

     9,889.4        6,551.7   

 

   

 

 

 

Total Liabilities and Stockholders’ Equity

   $ 27,219.5      $ 9,658.0   

 

   

 

 

 

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

 

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ZIMMER BIOMET HOLDINGS, INC.    2015 FORM 10-K ANNUAL REPORT

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

 

 

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

 

Common Shares

     Paid-in
Capital
    Retained
Earnings
    Accumulated
Other

Comprehensive
(Loss) Income
   

 

Treasury Shares

     
   Number      Amount            Number     Amount      

Balance January 1, 2013

     257.1       $ 2.6       $ 3,500.6      $ 7,143.2      $ 268.3        (85.5   $ (5,072.1   $ 5.4      $ 5,848.0   

Net earnings

                            780.4                             (1.8     778.6   

Other comprehensive income

                                   32.6                      (0.2     32.4   

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        7,789.4        300.9        (94.5     (5,785.7     2.8        6,310.6   

Net earnings

                            720.3                             (1.1     719.2   

Other comprehensive loss

                                   (262.8                   0.1        (262.7

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        8,362.1        38.1        (98.7     (6,183.7     1.8        6,551.7   

Net earnings

                            147.0                             (0.8     146.2   

Other comprehensive loss

                                   (367.1                   0.5        (366.6

Cash dividends declared

                            (164.4                                 (164.4

Stock compensation plans, including tax benefits

     1.6                 142.2        3.0               0.1        4.6               149.8   

Share repurchases

                                          (1.4     (150.0            (150.0

Biomet merger consideration

     32.7         0.3         3,722.4                                           3,722.7   

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance December 31, 2015

     302.7       $ 3.0       $ 8,195.3      $ 8,347.7      $ (329.0     (100.0   $ (6,329.1   $ 1.5      $ 9,889.4   

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

 

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ZIMMER BIOMET HOLDINGS, INC.    2015 FORM 10-K ANNUAL REPORT

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

      (in millions)  
For the Years Ended December 31,    2015     2014     2013  

Cash flows provided by (used in) operating activities:

      

Net earnings

   $ 146.2      $ 719.2      $ 778.6   

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

      

Depreciation and amortization

     712.4        375.8        358.5   

Biomet merger consideration compensation expense

     90.4                 

Share-based compensation

     46.4        49.4        48.5   

Income tax benefit from stock option exercises

     81.4        37.2        38.4   

Excess income tax benefit from stock option exercises

     (11.8     (11.1     (8.6

Inventory step-up

     317.8        5.4        8.0   

Gain on divestiture of assets

     (19.0              

Deferred income tax provision

     (164.0     (90.5     (126.2

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

      

Income taxes

     163.3        (50.4     104.4   

Receivables

     (56.1     (40.4     (74.3

Inventories

     (205.4     (164.6     (148.1

Accounts payable and accrued liabilities

     (263.1     108.4        33.6   

Other assets and liabilities

     (21.8     114.4        (49.7

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     816.7        1,052.8        963.1   

 

   

 

 

   

 

 

 

Cash flows provided by (used in) investing activities:

      

Additions to instruments

     (266.4     (197.4     (192.9

Additions to other property, plant and equipment

     (167.7     (144.9     (100.0

Purchases of investments

     (214.8     (1,350.9     (732.7

Sales of investments

     802.9        1,282.2        830.8   

Proceeds from divestiture of assets

     69.9                 

Biomet acquistion, net of acquired cash

     (7,760.1              

Business combination investments

            (54.3     (74.2

Investments in other assets

     (21.7     (4.1     (13.5

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (7,557.9     (469.4     (282.5

 

   

 

 

   

 

 

 

Cash flows provided by (used in) financing activities:

      

Proceeds from (payments on) senior notes

     7,628.2        (250.0       

Proceeds from term loan

     3,000.0                 

Redemption of senior notes

     (2,740.0              

Payments on term loan

     (500.0              

Net proceeds (payments) under revolving credit facilities

     0.1        2.3        (97.5

Dividends paid to stockholders

     (157.1     (145.5     (132.4

Proceeds from employee stock compensation plans

     105.2        284.7        474.8   

Excess income tax benefit from stock option exercises

     11.8        11.1        8.6   

Debt issuance costs

     (58.4     (64.1       

Repurchase of common stock

     (150.0     (400.9     (720.8

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     7,139.8        (562.4     (467.3

 

   

 

 

   

 

 

 

Effect of exchange rates on cash and cash equivalents

     (22.6     (18.3     (17.0

 

   

 

 

   

 

 

 

Increase in cash and cash equivalents

     376.0        2.7        196.3   

Cash and cash equivalents, beginning of year

     1,083.3        1,080.6        884.3   

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 1,459.3      $ 1,083.3      $ 1,080.6   

 

   

 

 

   

 

 

 

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

 

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ZIMMER BIOMET HOLDINGS, INC.    2015 FORM 10-K ANNUAL REPORT

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

1. Business

 

We design, manufacture and market orthopaedic reconstructive products; sports medicine, biologics, extremities and trauma products; spine, bone healing, craniomaxillofacial and thoracic products; dental implants; and related surgical products. We collaborate with healthcare professionals around the globe to advance the pace of innovation. Our products and solutions help treat patients suffering from disorders of, or injuries to, bones, joints or supporting soft tissues.

On June 24, 2015 (the “Closing Date”), pursuant to an agreement and plan of merger dated April 24, 2014, we acquired LVB Acquisition, Inc. (“LVB”), the parent company of Biomet, Inc. (“Biomet”), and LVB and Biomet became our wholly-owned subsidiaries (sometimes hereinafter referred to as the “Biomet merger” or the “merger”). For more information on the merger, see Note 4. In connection with the merger, we changed our name from Zimmer Holdings, Inc. to Zimmer Biomet Holdings, Inc.

The words “Zimmer Biomet,” “we,” “us,” “our,” “the Company” and similar words refer to Zimmer Biomet Holdings, Inc. and its subsidiaries. “Zimmer Biomet Holdings” refers to the parent company only. “Zimmer” used alone refers to the business or information of us and our subsidiaries on a stand-alone basis without inclusion of the business or information of LVB or any of its subsidiaries.

2. Revision of Prior Period Financial Statements

 

In the three month period ended September 30, 2015, we discovered two errors related to our financial statements for prior periods. One error related to accounts payable accruals. For certain received goods and services, we did not completely relieve the related accrual in a timely manner. As a result, our accounts payable balance was overstated. This error had been accumulating since 2012. The second error related to the accounting for the divestiture of certain Biomet product lines and rights in the three month period ended June 30, 2015. We calculated a gain on the divestiture based upon the pre-merger net book value of the assets. However, the gain should have been calculated based upon the fair value of such assets post-merger. We evaluated the impact of these errors on our prior period quarterly and annual financial statements, assessing materiality both quantitatively and qualitatively, and concluded the errors were not material to any of our previously issued financial statements. However, we concluded the cumulative corrections of these errors would be material to our financial statements for the three month period ended September 30, 2015 and, therefore, it was not appropriate to recognize the cumulative corrections in that period. Consequently, we revised previous periods’ financial statements to correct these errors as well as other unrelated, immaterial out of period adjustments that had been previously recorded. Following is a summary of the financial statement line items impacted by these revisions for the periods presented in this Form 10-K (in millions, except per share amounts).

 

 

 

Revisions to the Consolidated Statements of Earnings and Comprehensive Income (Loss)

 

     Year Ended December 31, 2014     Year Ended December 31, 2013  
      As Reported     Adjustments     As Revised     As Reported     Adjustments     As Revised  

Cost of products sold, excluding intangible asset amortization

   $ 1,242.7      $ 0.1      $ 1,242.8      $ 1,280.1      $ (13.4   $ 1,266.7   

Research and development

     187.9        (0.5     187.4        203.4        (0.4     203.0   

Selling, general and administrative

     1,744.4        6.3        1,750.7        1,758.8        (9.5     1,749.3   

Special items

     342.5        (1.4     341.1        214.0        (3.7     210.3   

Operating expenses

     3,631.5        4.5        3,636.0        3,581.8        (27.0     3,554.8   

Earnings before income taxes

     943.9        (4.5     939.4        981.1        27.0        1,008.1   

Provision for income taxes

     224.9        (4.7     220.2        221.9        7.6        229.5   

Net earnings

     719.0        0.2        719.2        759.2        19.4        778.6   

Net Earnings of Zimmer Holdings, Inc.

   $ 720.1      $ 0.2      $ 720.3      $ 761.0      $ 19.4      $ 780.4   

Earnings Per Common Share - Basic

   $ 4.26      $      $ 4.26      $ 4.49      $ 0.11      $ 4.60   

Earnings Per Common Share - Diluted

   $ 4.19      $ 0.01      $ 4.20      $ 4.43      $ 0.11      $ 4.54   

Foreign currency cumulative translation adjustments

   $ (241.5   $ 18.4      $ (223.1   $ (44.4   $ 9.4      $ (35.0

Total Other Comprehensive Income (Loss)

     (281.2     18.4        (262.8     23.2        9.4        32.6   

Comprehensive Income

     437.8        18.6        456.4        782.4        28.8        811.2   

Comprehensive Income Attributable to Zimmer Holdings, Inc.

     438.8        18.6        457.4        784.4        28.8        813.2   

 

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ZIMMER BIOMET HOLDINGS, INC.    2015 FORM 10-K ANNUAL REPORT

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

 

Revisions to the Consolidated Balance Sheet

 

     December 31, 2014  
      As Reported      Adjustments     As Revised  

Inventories

   $ 1,169.0       $ 24.3      $ 1,193.3   

Total Current Assets

     4,289.0         24.3        4,313.3   

Property, plant and equipment, net

     1,288.8         (3.5     1,285.3   

Other assets

     939.2         2.5        941.7   

Total Assets

     9,634.7         23.3        9,658.0   

Accounts payable

     167.1         (21.9     145.2   

Income taxes payable

     72.4         7.9        80.3   

Other current liabilities

     798.5                798.5   

Total Current Liabilities

     1,038.0         (14.0     1,024.0   

Long-term income tax payable

     181.7         8.2        189.9   

Total Liabilities

     3,112.1         (5.8     3,106.3   

Retained earnings

     8,285.2         76.9        8,362.1   

Accumulated other comprehensive income

     85.9         (47.8     38.1   

Total Zimmer Holdings, Inc. stockholders’ equity

     6,520.8         29.1        6,549.9   

Total Stockholders’ Equity

     6,522.6         29.1        6,551.7   

Total Liabilities and Stockholders’ Equity

     9,634.7         23.3        9,658.0   

Revisions to the Consolidated Statements of Cash Flows

 

     Year ended December 31, 2014     Year ended December 31, 2013  
      As Reported     Adjustments     As Revised     As Reported     Adjustments     As Revised  

Net earnings

   $ 719.0      $ 0.2      $ 719.2      $ 759.2      $ 19.4      $ 778.6   

Deferred income tax provision

     (84.2     (6.3     (90.5     (126.2            (126.2

Changes in operating assets and liabilities, net of effect of acquisitions:

            

Income taxes payable

     (51.9     1.5        (50.4     96.8        7.6        104.4   

Inventories

     (154.1     (10.5     (164.6     (128.4     (19.7     (148.1

Accounts payable and accrued expenses

     120.1        (11.7     108.4        38.3        (4.7     33.6   

Other assets and liabilities

     87.6        26.8        114.4        (47.1     (2.6     (49.7

 

We have not presented revisions to our consolidated statements of stockholders’ equity. The only revisions to these statements are related to retained earnings caused by revisions to net earnings and accumulated other comprehensive income caused by revisions to other comprehensive income (loss). These revisions have already been presented in the tables for the consolidated statements of earnings and comprehensive income and the consolidated balance sheets.

In the fourth quarter of 2015 we discovered an error that was immaterial to previous quarters’ condensed consolidated statements of cash flows. As further discussed in Note 4, we recognized $90.4 million of compensation expense related to

previously unvested LVB stock options and LVB stock-based awards that vested immediately prior to the merger under the terms of the merger agreement. $52.8 million of the $90.4 million represented cash payments to holders of these options and stock-based awards. In the six month period ended June 30, 2015 and nine month period ended September 30, 2015, we presented the $52.8 million as a cash outflow from investing activities. However, since the payment represented compensation expense, the $52.8 million should have been presented as an operating cash outflow. We have corrected this error in the consolidated statement of cash flows for the year ended December 31, 2015. We will also revise future interim filings to correct for this error.

 

 

3. Significant Accounting Policies

 

Basis of Presentation – The consolidated financial statements include the accounts of Zimmer Biomet Holdings and its subsidiaries in which it holds a controlling financial interest. All significant intercompany accounts and transactions are eliminated. Certain amounts in the 2014 and

2013 consolidated financial statements have been reclassified to conform to the 2015 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

 

 

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ZIMMER BIOMET HOLDINGS, INC.    2015 FORM 10-K ANNUAL REPORT

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

 

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, 2015, 2014 and 2013 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 80 percent of our net sales in 2015. Through this channel, inventory is generally consigned to sales agents or customers so that products are available when needed for surgical procedures. No revenue is recognized upon the placement of inventory into consignment as we retain title and maintain the inventory on our balance sheet. Upon implantation, we issue an invoice and revenue is recognized. Pricing for products is generally predetermined by contracts with customers, agents acting on behalf of customer groups or by government regulatory bodies, depending on the market. Price discounts under group purchasing contracts are generally linked to volume of implant purchases by customer healthcare institutions within a specified group. At negotiated thresholds within a contract buying period, price discounts may increase.

Sales to stocking distributors, healthcare dealers, dental practices and dental laboratories accounted for approximately 20 percent of our net sales in 2015. 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, 2015, 2014 and 2013.

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 $214.2 million, $181.9 million and $163.6 million for the years ended December 31, 2015, 2014 and 2013, respectively.

Research and Development –  We expense all research and development (“R&D”) costs as incurred except when there is alternative future use for the R&D. 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, quality and operational excellence initiatives,

 

 

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Table of Contents
ZIMMER BIOMET HOLDINGS, INC.    2015 FORM 10-K ANNUAL REPORT

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

 

and other items as “Special items” in our consolidated statement of earnings. “Special items” included (in millions):

 

     For the Years Ended December 31,  
      2015      2014      2013  

Biomet-related

        

Merger compensation expense

   $ 90.4       $       $   

Retention plans

     73.0                   

Employee termination benefits

     101.0                   

Consulting and professional fees

     167.4         61.5           

Dedicated project personnel

     62.3         0.4           

Relocated facilities

     5.6                   

Contract terminations

     95.0                   

Information technology integration

     5.2                   

Other

     19.2                   

Other

        

Employee termination benefits

     1.9