Item 2.
Properties
The following are our principal properties:
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.
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.
Item 4.
Mine Safety Disclosures
Not Applicable.
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2015 FORM 10-K ANNUAL REPORT
PART II
Item 5.
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:
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:
(1) Includes repurchases made under a program authorizing $1.0 billion of repurchases with no expiration date.
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Item 6.
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):
(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.
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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2015 FORM 10-K ANNUAL REPORT
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):
“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):
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2015 FORM 10-K ANNUAL REPORT
Net Sales by Product Category
The following tables present net sales by product category and the components of the percentage changes (dollars in millions):
The following tables present our pro forma net sales by product category and the components of the percentage changes (dollars in millions):
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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):
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):
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):
* 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
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:
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).
* 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):
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):
$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.
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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2015 FORM 10-K ANNUAL REPORT
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):
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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2015 FORM 10-K ANNUAL REPORT
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.
ZIMMER BIOMET HOLDINGS, INC.
2015 FORM 10-K ANNUAL REPORT
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
Item 8.
Financial Statements and Supplementary Data
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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
ZIMMER BIOMET HOLDINGS, INC.
2015 FORM 10-K ANNUAL REPORT
CONSOLIDATED STATEMENTS OF EARNINGS
The accompanying notes are an integral part of these consolidated financial statements.
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2015 FORM 10-K ANNUAL REPORT
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
The accompanying notes are an integral part of these consolidated financial statements.
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2015 FORM 10-K ANNUAL REPORT
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these consolidated financial statements.
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2015 FORM 10-K ANNUAL REPORT
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
The accompanying notes are an integral part of these consolidated financial statements.
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2015 FORM 10-K ANNUAL REPORT
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these consolidated financial statements.
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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)
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2015 FORM 10-K ANNUAL REPORT
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Revisions to the Consolidated Balance Sheet
Revisions to the Consolidated Statements of Cash Flows
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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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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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
and other items as “Special items” in our consolidated statement of earnings. “Special items” included (in millions):
Pursuant to the Biomet merger agreement, all outstanding LVB stock options and LVB stock-based awards vested immediately prior to the effective time of the merger, and holders of these options and awards received a portion of the aggregate merger consideration. Some of these options and awards were already vested under the terms of LVB’s equity incentive plans. We accounted for the fair value of the consideration we paid in exchange for previously vested options and awards as consideration to complete the merger. As part of the merger agreement terms, all previously unvested options and awards vested immediately prior to the effective time of the merger. Under LVB’s equity incentive plans, unvested options and awards would have otherwise been forfeited. We have concluded that the discretionary accelerated vesting of these unvested options and awards was for the economic benefit of the combined company, and, therefore, we classified the fair value of the merger consideration we paid to holders of such unvested options and awards of $90.4 million as compensation expense.
Pursuant to the LVB merger agreement, retention plans were established for certain Biomet employees and third-party sales agents. Retention payments were earned by employees and third-party sales agents who remained with Biomet through the Closing Date. We recognized $73.0 million of expense resulting from these retention plans.
After the Closing Date, we started to implement our integration plans to drive operational synergies. Part of these integration plans included termination of employees and certain contracts. Expenses attributable to the initial phase of these integration plans that were recognized in 2015 as part of “Special items” related to employee termination benefits and contract termination expense associated with agreements with independent agents, distributors, suppliers and lessors. Our integration plans are expected to last through 2018 and we expect to incur a total of $170.0 million for employee termination benefits and $130.0 million for contract termination expense in that time period. The following table summarizes the liabilities related to these integration plans (in millions):
Consulting and professional fees relate to third-party consulting, professional fees and contract labor related to our quality and operational excellence initiatives, third-party consulting fees related to certain information system implementations, third-party integration consulting performed in a variety of areas such as tax, compliance, logistics and human resources for our business combinations and merger with Biomet, third-party fees related to severance and termination benefits matters and legal fees related to certain litigation matters. Our quality and operational excellence initiatives are company-wide and include improvements in quality, distribution, sourcing, manufacturing and information technology, among other areas.
Dedicated project personnel expenses include the salary, benefits, travel expenses and other costs directly associated with employees who are 100 percent dedicated to our quality and operational excellence initiatives or integration of acquired businesses.
Impairment/loss on disposal of assets relates to impairment of intangible assets that were acquired in business combinations or impairment of or a loss on the disposal of other assets. This caption also includes the effect of reducing
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2015 FORM 10-K ANNUAL REPORT
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
the estimated useful life of certain intangible assets to zero, which resulted in the remaining net book values of those assets being amortized immediately.
Certain R&D agreements relate to agreements with upfront payments to obtain intellectual property to be used in R&D projects that have no alternative future use in other projects.
Relocated facilities expenses are the moving costs and the lease expenses incurred during the relocation period in connection with relocating certain facilities.
Over the past few years we have acquired a number of U.S. and foreign-based distributors. We have incurred various costs related to the consummation and integration of those businesses.
Certain litigation matters relate to net expenses recognized during the year for the estimated or actual settlement of certain pending litigation and similar claims, including matters where we recognized income from a settlement on more favorable terms than our previous estimate, or we reduced our estimate of a previously recorded contingent liability. These litigation matters have included royalty disputes, patent litigation matters and commercial litigation matters.
Contract termination costs relate to terminated agreements in connection with the integration of acquired companies and changes to our distribution model as part of business restructuring and operational excellence initiatives. The terminated contracts primarily relate to sales agents and distribution agreements.
Information technology integration costs are non-capitalizable costs incurred related to integrating information technology platforms of acquired companies or other significant software implementations as part of our quality and operational excellence initiatives.
Contingent consideration adjustments represent the changes in the fair value of contingent consideration obligations to be paid to the prior owners of acquired businesses.
Accelerated software amortization is the incremental amortization resulting from a reduction in the estimated life of certain software. Due to an approved plan to replace certain software, the estimated economic useful life of the existing software was decreased to represent the period of time expected to implement replacement software. As a result, the amortization from the shortened life of this software is substantially higher than the previous amortization being recognized.
Cash and Cash Equivalents - We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. The carrying amounts reported in the balance sheet for cash and cash equivalents are valued at cost, which approximates their fair value.
Investments - We invest our excess cash and cash equivalents in debt securities. Our investments include corporate debt securities, U.S. government and agency debt
securities, foreign government debt securities, commercial paper and certificates of deposit, and are classified and accounted for as available-for-sale. Available-for-sale debt securities are recorded at fair value on our consolidated balance sheet. Investments with a contractual maturity of less than one year are classified as short-term investments on our consolidated balance sheet, or in other non-current assets if the contractual maturity is greater than one year. Changes in fair value for available-for-sale securities are recorded, net of taxes, as a component of accumulated other comprehensive loss on our consolidated balance sheet. We review our investments for other-than-temporary impairment at each reporting period. If an unrealized loss for any investment is considered to be other-than-temporary, the loss will be recognized in the consolidated statement of earnings in the period the determination is made. See Note 8 for more information regarding our investments.
Accounts Receivable - Accounts receivable consists of trade and other miscellaneous receivables. We grant credit to customers in the normal course of business and maintain an allowance for doubtful accounts for potential credit losses. We determine the allowance for doubtful accounts by geographic market and take into consideration historical credit experience, creditworthiness of the customer and other pertinent information. We make concerted efforts to collect all accounts receivable, but sometimes we have to write-off the account against the allowance when we determine the account is uncollectible. The allowance for doubtful accounts was $34.1 million and $22.3 million as of December 31, 2015 and 2014, respectively.
Inventories - Inventories are stated at the lower of cost or market, with cost determined on a first-in first-out basis.
Property, Plant and Equipment - Property, plant and equipment is carried at cost less accumulated depreciation. Depreciation is computed using the straight-line method based on estimated useful lives of ten to forty years for buildings and improvements and three to eight years for machinery and equipment. Maintenance and repairs are expensed as incurred. We review property, plant and equipment for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. An impairment loss would be recognized when estimated future undiscounted cash flows relating to the asset are less than its carrying amount. An impairment loss is measured as the amount by which the carrying amount of an asset exceeds its fair value.
Software Costs - We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use when both the preliminary project stage is completed and it is probable that the software will be used as intended. Capitalized software costs generally include external direct costs of materials and services utilized in developing or obtaining computer software and compensation and related
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benefits for employees who are directly associated with the software project. Capitalized software costs are included in property, plant and equipment on our balance sheet and amortized on a straight-line or weighted average estimated user basis when the software is ready for its intended use over the estimated useful lives of the software, which approximate three to fifteen years.
Instruments - Instruments are hand-held devices used by surgeons during total joint replacement and other surgical procedures. Instruments are recognized as long-lived assets and are included in property, plant and equipment. Undeployed instruments are carried at cost or realizable value. Instruments in the field are carried at cost less accumulated depreciation. Depreciation is computed using the straight-line method based on average estimated useful lives, determined principally in reference to associated product life cycles, primarily five years. We review instruments for impairment whenever events or changes in circumstances indicate that the carrying value of an instrument may not be recoverable. Depreciation of instruments is recognized as selling, general and administrative expense.
Goodwill - Goodwill is not amortized but is subject to annual impairment tests. Goodwill has been assigned to reporting units. We perform annual impairment tests by either comparing a reporting unit’s estimated fair value to its carrying amount or doing a qualitative assessment of a reporting unit’s fair value from the last quantitative assessment to determine if there is potential impairment. We may do a qualitative assessment when the results of the previous quantitative test indicated the reporting unit’s estimated fair value was significantly in excess of the carrying value of its net assets and we do not believe there have been significant changes in the reporting unit’s operations that would significantly decrease its estimated fair value or significantly increase its net assets. If a quantitative assessment is performed, the fair value of the reporting unit and the implied fair value of goodwill are determined based upon a discounted cash flow analysis and/or use of a market approach by looking at market values of comparable companies. Significant assumptions are incorporated into our discounted cash flow analyses such as estimated growth rates and risk-adjusted discount rates. We perform this test in the fourth quarter of the year or whenever events or changes in circumstances indicate that the carrying value of the reporting unit’s assets may not be recoverable. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the reporting unit goodwill is less than the carrying value of the reporting unit goodwill. See Note 10 for more information regarding goodwill.
Intangible Assets - Intangible assets are initially measured at their fair value. We have determined the fair value of our intangible assets either by the fair value of the consideration exchanged for the intangible asset or the estimated after-tax discounted cash flows expected to be
generated from the intangible asset. Intangible assets with an indefinite life, including certain trademarks and trade names, are not amortized. Indefinite life intangible assets are assessed annually to determine whether events and circumstances continue to support an indefinite life. Intangible assets with a finite life, including core and developed technology, certain trademarks and trade names, customer-related intangibles, intellectual property rights and patents and licenses are amortized on a straight-line basis over their estimated useful life, ranging from less than one year to 20 years. Intangible assets with a finite life are tested for impairment whenever events or circumstances indicate that the carrying amount may not be recoverable. Intangible assets with an indefinite life are tested for impairment annually or whenever events or circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognized if the carrying amount exceeds the estimated fair value of the asset. The amount of the impairment loss to be recorded would be determined based upon the excess of the asset’s carrying value over its fair value. The fair values of indefinite lived intangible assets are determined based upon a discounted cash flow analysis using the relief from royalty method or a qualitative assessment may be performed for any changes to the asset’s fair value from the last quantitative assessment. The relief from royalty method estimates the cost savings associated with owning, rather than licensing, assets. Significant assumptions are incorporated into these discounted cash flow analyses such as estimated growth rates, royalty rates and risk-adjusted discount rates. We may do a qualitative assessment when the results of the previous quantitative test indicated that the asset’s fair value was significantly in excess of its carrying value.
In determining the useful lives of intangible assets, we consider the expected use of the assets and the effects of obsolescence, demand, competition, anticipated technological advances, changes in surgical techniques, market influences and other economic factors. For technology-based intangible assets, we consider the expected life cycles of products, absent unforeseen technological advances, which incorporate the corresponding technology. Trademarks and trade names that do not have a wasting characteristic (i.e., there are no legal, regulatory, contractual, competitive, economic or other factors which limit the useful life) are assigned an indefinite life. Trademarks and trade names that are related to products expected to be phased out are assigned lives consistent with the period in which the products bearing each brand are expected to be sold. For customer relationship intangible assets, we assign useful lives based upon historical levels of customer attrition. Intellectual property rights are assigned useful lives that approximate the contractual life of any related patent or the period for which we maintain exclusivity over the intellectual property.
Income Taxes - We account for income taxes under the asset and liability method, which requires the recognition of
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deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.
We reduce our deferred tax assets by a valuation allowance if it is more likely than not that we will not realize some portion or all of the deferred tax assets. In making such determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations. In the event we were to determine that we would be able to realize our deferred income tax assets in the future in excess of their net recorded amount, we would make an adjustment to the valuation allowance which would reduce the provision for income taxes. Federal income taxes are provided on the portion of the income of foreign subsidiaries that is expected to be remitted to the U.S.
We operate on a global basis and are subject to numerous and complex tax laws and regulations. Our income tax filings are regularly under audit in multiple federal, state and foreign jurisdictions. Income tax audits may require an extended period of time to reach resolution and may result in significant income tax adjustments when interpretation of tax laws or allocation of company profits is disputed. Because income tax adjustments in certain jurisdictions can be significant, we record accruals representing management’s best estimate of the probable resolution of these matters. To the extent additional information becomes available, such accruals are adjusted to reflect the revised estimated probable outcome.
Derivative Financial Instruments - We measure all derivative instruments at fair value and report them on our consolidated balance sheet as assets or liabilities. We maintain written policies and procedures that permit, under appropriate circumstances and subject to proper authorization, the use of derivative financial instruments solely for risk management purposes. The use of derivative financial instruments for trading or speculative purposes is prohibited by our policy. See Note 14 for more information regarding our derivative and hedging activities.
Other Comprehensive Income (Loss) - Other comprehensive income (loss) (“OCI”) refers to revenues, expenses, gains and losses that under generally accepted accounting principles are included in comprehensive income but are excluded from net earnings as these amounts are recorded directly as an adjustment to stockholders’ equity. Our OCI is comprised of foreign currency translation adjustments, unrealized gains and losses on cash flow hedges, unrealized gains and losses on available-for-sale securities and amortization of prior service costs and unrecognized gains and losses in actuarial assumptions.
Treasury Stock - We account for repurchases of common stock under the cost method and present treasury stock as a reduction of stockholders’ equity. We reissue common stock held in treasury only for limited purposes.
Noncontrolling Interest - In 2011, we made an investment in a company in which we acquired a controlling financial interest, but not 100 percent of the equity. In 2013, we purchased additional shares of the company from the minority shareholders. Further information related to the noncontrolling interests of that investment has not been provided as it is not significant to our consolidated financial statements.
Accounting Pronouncements - In May 2014, the FASB issued Accounting Standard Update (“ASU”) No. 2014-09 - Revenue from Contracts with Customers (Topic 606). This ASU provides a five-step model for revenue recognition that all industries will apply to recognize revenue when a customer obtains control of a good or service. The ASU will be effective for us beginning January 1, 2018. We are in the initial phases of our adoption plans and, accordingly, we are unable to estimate any effect this may have on our revenue recognition practices.
In April 2015, the FASB issued ASU 2015-03 - Simplifying the Presentation of Debt Issuance Costs. This ASU requires debt issuance costs to be presented in the balance sheet as a direct deduction from the carrying value of the associated debt liability, consistent with the presentation of a debt discount. This ASU does not affect the measurement and recognition of debt issuance costs in our statement of earnings. As of December 31, 2015, this change would result in a reclassification of $11.7 million of other current assets and $60.6 million of other assets to debt. The ASU will be effective for us beginning January 1, 2016.
In September 2015, the FASB issued ASU 2015-16 - Business Combinations: Simplifying the Accounting for Measurement-Period Adjustments. This ASU eliminates the requirement for an acquirer in a business combination to account for measurement-period adjustments retrospectively. Instead, acquirers must recognize measurement-period adjustments during the period in which they determine the amounts, including the effect on earnings of any amounts they would have recorded in previous periods if the accounting had been completed at the acquisition date. The ASU is effective for us beginning January 1, 2017, but early adoption is permitted. We early adopted this ASU in 2015.
On November 20, 2015, the FASB issued ASU 2015-17 - Balance Sheet Classification of Deferred Taxes. This ASU amends existing guidance on income taxes to require the classification of all deferred tax assets and liabilities as non-current on the balance sheet. The ASU will be effective for us beginning January 1, 2017, but early adoption is permitted. Additionally, the ASU allows for both retrospective and prospective methods of transition upon adoption. We early adopted this ASU effective December 31, 2015 on a prospective basis. No prior periods were retrospectively adjusted.
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There are no other recently issued accounting pronouncements that we have not yet adopted that are expected to have a material effect on our financial position, results of operations or cash flows.
4. Business Combinations
Biomet Merger
On the Closing Date, we completed our merger with LVB, the parent company of Biomet. We paid $12,030.3 million in cash and stock and assumed Biomet’s senior notes. The fair value of the principal amount of the senior notes was $2,740.0 million, which we repaid in full prior to June 30, 2015.
The merger enhances our position in the nearly $50.0 billion musculoskeletal industry. Our product portfolio now includes Biomet’s legacy product lines, including knee and hip reconstructive products; sports medicine, extremities and trauma products; spine, bone healing, craniomaxillofacial and thoracic products; dental reconstructive products; and cement, biologics and other products. Our larger scale provides for increased competitiveness in our core and emerging franchises and a stronger presence in our geographic markets. The merger positions us to increase cross-selling opportunities between our legacy product portfolios and sales force specialization. The combination of our R&D functions will allow us to allocate a greater portion of the combined R&D spending towards innovations designed to address unmet clinical needs and create new-market adjacencies. We also expect to realize operational synergies to enhance value for stockholders.
In order to consummate the merger under applicable antitrust laws and regulations in certain countries, we had to divest certain product line rights and assets. As a result, we recognized a net gain of $19.0 million in non-operating other expense, net in the year ended December 31, 2015.
We funded the cash portion of the merger consideration with available cash on hand, as well as proceeds from a $3.0 billion senior unsecured term loan and $7.65 billion in senior unsecured notes issued in March 2015. See Note 12 for further information regarding these debt instruments.
The aggregate merger consideration paid was $12,030.3 million, consisting of $8,307.6 million of cash and 32.7 million shares of our common stock valued at $3,722.7 million. The value of our common stock was based upon a stock price of $113.83 per share using the average of the high and low trading prices on the Closing Date. As discussed in Note 3, $90.4 million of the cash and common stock consideration was allocated to compensation expense due to the acceleration of the vesting of unvested LVB stock options and LVB stock-based awards in connection with the merger. Therefore, the amount of merger consideration utilized for the acquisition method of accounting was $11,939.9 million.
The merger was accounted for under the acquisition method of accounting. Accordingly, LVB’s results of operations have been included in our consolidated results of operations starting on the Closing Date, and LVB’s assets and liabilities were recorded at their estimated fair values in our consolidated statement of financial position as of the Closing Date, with the excess of the purchase price over the estimated fair values being allocated to goodwill. During the year ended December 31, 2015, Biomet contributed net sales of $1,602.0 million. During the year ended December 31, 2015, Biomet contributed net operating losses of $295.8 million to our consolidated results, driven by $90.4 million of merger compensation expense for unvested LVB stock options and LVB stock-based awards, $73.0 million of retention plan expense, severance expense, inventory step-up expense and intangible asset amortization.
The purchase price allocation as of December 31, 2015 is preliminary. The primary tasks to be completed related to our purchase price accounting are refinements to intangible assets for certain less significant products, finalizing tax accounts, including, but not limited to, the allocation of acquired intangible assets and goodwill on a jurisdictional basis, and finalizing the estimated fair values of contingent assets and liabilities. There may be differences between these preliminary estimates of fair value and the final acquisition accounting, which differences could be material. The final estimates of fair value are expected to be completed as soon as possible, but no later than one year from the Closing Date.
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The following table summarizes our estimate of the preliminary fair values of the assets acquired and liabilities assumed at the Closing Date, including measurement period adjustments recognized from our initial purchase price allocation through December 31, 2015 (in millions):
Adjustments to the initial preliminary fair values of the assets acquired and liabilities assumed related to a change in estimate to the fair value of merger compensation expense for unvested LVB stock options and LVB stock-based awards, refinement of the estimated fair values of inventory, property, plant and equipment and intangible assets, refinement of income and deferred tax balances and adjustments to contingent liabilities and contingent gains based upon additional evidence obtained, among other adjustments. There may be additional adjustments to these preliminary estimates of fair value which could be material.
The weighted-average amortization period selected for trademarks and trade names, technology and customer relationship intangible assets was 15 years, 15 years and 18 years, respectively.
IPR&D intangible assets represent acquired R&D projects which have not received regulatory approval. IPR&D intangible assets are capitalized and accounted for as indefinite lived intangible assets and will be subject to periodic impairment testing until the successful completion or abandonment of the associated R&D project. Upon successful completion of each R&D project, the associated indefinite lived intangible asset is then accounted for as a finite lived intangible asset and amortized on a straight-line basis over its estimated useful life. If an R&D project is abandoned, the associated indefinite lived asset is charged to expense.
The IPR&D intangible assets recognized in the Biomet merger relates to a variety of R&D projects. The fair values of the IPR&D intangible assets were determined using the income approach. Most of these projects are expected to be completed within a year or two after the Closing Date. Remaining costs to complete these projects are expected to be an insignificant amount of our total annual R&D spending.
The goodwill is generated from the operational synergies we expect to achieve from our combined operations. None of the goodwill is expected to be deductible for tax purposes.
The following sets forth unaudited pro forma financial information derived from (i) the audited financial statements of Zimmer for the years ended December 31, 2015 and 2014; and (ii) the unaudited financial statements of LVB for the period January 1, 2015 to June 23, 2015 and for the year ended December 31, 2014. The pro forma financial information has been adjusted to give effect to the merger as if it had occurred on January 1, 2014.
Pro Forma Financial Information
(Unaudited)
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These unaudited pro forma results have been prepared for comparative purposes only and include adjustments such as inventory step-up, amortization of acquired intangible assets and interest expense on debt incurred to finance the merger. Material, nonrecurring pro forma adjustments directly attributable to the Biomet merger include:
•
The $90.4 million of merger compensation expense for unvested LVB stock options and LVB stock-based awards was removed from net earnings for the year ended December 31, 2015 and recognized as an expense in the year ended December 31, 2014.
•
The $73.0 million of retention plan expense was removed from net earnings for the year ended December 31, 2015 and recognized as an expense in the year ended December 31, 2014.
•
Transaction costs of $17.7 million was removed from net earnings for the year ended December 31, 2015 and recognized as an expense in the year ended December 31, 2014.
Other Acquisitions
We made a number of business acquisitions during the years 2014 and 2013. In October 2014, we acquired ETEX Holdings, Inc. (“Etex”). The Etex acquisition enhanced our biologics portfolio through the addition of Etex’s bone void filler products. In May 2013, we acquired the business assets of Knee Creations, LLC (“Knee Creations”). The Knee Creations acquisition enhanced our product portfolio of joint preservation solutions. In June 2013, we acquired NORMED Medizin-Technik GmbH (“Normed”). The Normed acquisition strengthened our Extremities and Trauma product portfolios and brought new product development capabilities in the foot and ankle and hand and wrist markets.
The results of operations of these acquired companies have been included in our consolidated results of operations subsequent to the transaction dates, and the respective assets and liabilities of the acquired companies have been recorded at their estimated fair values in our consolidated statement of financial position as of the transaction dates, with any excess purchase price being recorded as goodwill. Pro forma financial information and other information required by GAAP have not been included for these acquisitions as they, individually and in the aggregate, did not have a material impact upon our financial position or results of operations.
5. Share-Based Compensation
Our share-based payments primarily consist of stock options and restricted stock units (“RSUs”). Share-based compensation expense was as follows (in millions):
Stock Options
We had two equity compensation plans in effect at December 31, 2015: the 2009 Stock Incentive Plan (“2009 Plan”) and the Stock Plan for Non-Employee Directors. The 2009 Plan succeeded the 2006 Stock Incentive Plan (“2006 Plan”) and the TeamShare Stock Option Plan (“TeamShare Plan”). No further awards have been granted under the 2006 Plan or under the TeamShare Plan since May 2009, and shares remaining available for grant under those plans have been merged into the 2009 Plan. Vested stock options previously granted under the 2006 Plan, the TeamShare Plan and another prior plan, the 2001 Stock Incentive Plan, remained outstanding as of December 31, 2015. We have reserved the maximum number of shares of common stock available for award under the terms of each of these plans. We have registered 57.9 million shares of common stock under these plans. The 2009 Plan provides for the grant of nonqualified stock options and incentive stock options, long-term performance awards in the form of performance shares or units, restricted stock, RSUs and stock appreciation rights. The Compensation and Management Development Committee of the Board of Directors determines the grant date for annual grants under our equity compensation plans. The date for annual grants under the 2009 Plan to our executive officers is expected to occur in the first quarter of each year following the earnings announcements for the previous quarter and full year. In 2015, the Compensation and Management Development Committee set the Closing Date as the grant date for awards to our executive officers. The Stock Plan for Non-Employee Directors provides for awards of stock options, restricted stock and RSUs to non-employee directors. It has been our practice to issue shares of common stock upon exercise of stock options from previously unissued shares, except in limited circumstances where they are issued from treasury stock. The total number of awards which may be granted in a given year and/or over the life of the plan under each of our equity compensation plans is limited. At December 31, 2015, an aggregate of 5.6 million shares were available for future grants and awards under these plans.
Stock options granted to date under our plans vest over four years and have a maximum contractual life of 10 years. As established under our equity compensation plans, vesting may accelerate upon retirement after the first anniversary date of the award if certain criteria are met. We recognize expense related to stock options on a straight-line basis over the requisite service period, less awards expected to be forfeited using estimated forfeiture rates. Due to the accelerated retirement provisions, the requisite service period of our stock options range from one to four years. Stock options are granted with an exercise price equal to the market price of our common stock on the date of grant, except in limited circumstances where local law may dictate otherwise.
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A summary of stock option activity for the year ended December 31, 2015 is as follows (options in thousands):
We use a Black-Scholes option-pricing model to determine the fair value of our stock options. Expected volatility was derived from a combination of historical volatility and implied volatility because the traded options that were actively traded around the grant date of our stock options did not have maturities of over one year. The expected term of the stock options has been derived from historical employee exercise behavior. The risk-free interest rate was determined using the implied yield currently available for zero-coupon U.S. government issues with a remaining term approximating the expected life of the options. The dividend yield was determined by using an estimated annual dividend and dividing it by the market price of our stock on the grant date.
The following table presents information regarding the weighted average fair value for stock options granted, the assumptions used to determine fair value, and the intrinsic value of options exercised in the indicated year:
As of December 31, 2015, there was $40.3 million of unrecognized share-based payment expense related to nonvested stock options granted under our plans. That expense is expected to be recognized over a weighted average period of 3.0 years.
RSUs
We have awarded RSUs to certain of our employees. The terms of the awards have been two to four years. Some of the awards have only service conditions while some have performance and market conditions in addition to service
conditions. The service condition-only awards vest ratably on the anniversary date of the award. The awards that have performance and market conditions vest all at once on the third anniversary date. Future service conditions may be waived if an employee retires after the first anniversary date of the award, but performance and market conditions continue to apply. Accordingly, the requisite service period used for share-based payment expense on our RSUs range from one to four years.
A summary of nonvested RSU activity for the year ended December 31, 2015 is as follows (RSUs in thousands):
For the RSUs with service conditions only, the fair value of the awards was determined based upon the fair market value of our common stock on the date of grant. For the RSUs with market conditions, a Monte Carlo valuation technique was used to simulate the market conditions of the awards. The outcome of the simulation was used to determine the fair value of the awards.
We are required to estimate the number of RSUs that will vest and recognize share-based payment expense on a straight-line basis over the requisite service period. As of December 31, 2015, we estimate that approximately 795,000 outstanding RSUs will vest. If our estimate were to change in the future, the cumulative effect of the change in estimate will be recorded in that period. Based upon the number of RSUs that we expect to vest, the unrecognized share-based payment expense as of December 31, 2015 was $39.6 million and is
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expected to be recognized over a weighted-average period of 2.4 years. The fair value of RSUs vesting during the years ended December 31, 2015, 2014 and 2013 based upon our stock price on the date of vesting was $40.6 million, $29.3 million and $32.5 million, respectively.
6. Inventories
Inventories consisted of the following (in millions):
Finished goods inventory as of December 31, 2015 includes $284.4 million to step-up the acquired Biomet inventory to fair value.
Amounts charged to the consolidated statement of earnings for excess and obsolete inventory in the years ended
December 31, 2015, 2014 and 2013 were $118.4 million, $51.8 million and $112.0 million, respectively.
7. Property, Plant and Equipment
Property, plant and equipment consisted of the following (in millions):
Depreciation expense was $375.0 million, $268.6 million and $262.6 million for the years ended December 31, 2015, 2014 and 2013, respectively.
8. Investments
We invest in short and long-term investments classified as available-for-sale securities. Information regarding our investments is as follows (in millions):
The unrealized losses on our investments in corporate debt securities were caused by increases in interest yields in the global credit markets. We believe the unrealized losses associated with these securities as of December 31, 2015 are temporary because we do not intend to sell these investments, and we do not believe we will be required to sell them before recovery of their amortized cost basis.
The amortized cost and fair value of our available-for-sale fixed-maturity securities by contractual maturity are as follows (in millions):
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9. Fair Value Measurements of Assets and Liabilities
The following financial assets and liabilities are recorded at fair value on a recurring basis (in millions):
We value our available-for-sale securities using a market approach based on broker prices for identical assets in over-the-counter markets and we perform ongoing assessments of counterparty credit risk.
We value our foreign currency forward contracts and foreign currency options using a market approach based on foreign currency exchange rates obtained from active markets and we perform ongoing assessments of counterparty credit risk.
We value our interest rate swaps using a market approach based on publicly available market yield curves and the terms of our swaps and we perform ongoing assessments of counterparty credit risk.
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10. Goodwill and Other Intangible Assets
The following table summarizes the changes in the carrying amount of goodwill (in millions):
The components of identifiable intangible assets were as follows (in millions):
During 2015, we reclassified $129.0 million of indefinite lived trademarks and trade names to finite lived trademarks and trade names as they were determined to have a finite useful life.
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Estimated annual amortization expense based upon intangible assets recognized as of December 31, 2015 for the years ending December 31, 2016 through 2020 is (in millions):
11. Other Current and Long-term Liabilities
Other current and long-term liabilities consisted of the following (in millions):
12. Debt
Our debt consisted of the following (in millions):
At December 31, 2015, our total debt consisted of $8.95 billion aggregate principal amount of our senior notes, a $2.5 billion U.S. term loan (“U.S. Term Loan”), an 11.7 billion Japanese Yen term loan agreement (“Japan Term Loan”) that will mature on May 31, 2018, and other debt, debt discount and fair value adjustments totaling $9.5 million.
The U.S. Term Loan is part of our $4.35 billion credit agreement (“Credit Agreement”) that contains: (i) a 5-year unsecured term loan facility in the principal amount of $3.0 billion (the “U.S. Term Loan Facility”), and (ii) a 5-year unsecured multicurrency revolving facility in the principal amount of $1.35 billion (the “Multicurrency Revolving Facility”). 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.
On June 24, 2015, we borrowed $3.0 billion under the U.S. Term Loan Facility to fund a portion of the Biomet merger. Under the terms of the U.S. Term Loan Facility, starting September 30, 2015, principal payments are due 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. Due to the $500.0 million of advanced payments in 2015 on the U.S. Term Loan Facility, we have no quarterly principal obligations in 2016.
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.
Of the total $8.95 billion aggregate principal amount of senior notes outstanding at December 31, 2015, we issued $7.65 billion of this amount 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. The Merger Notes consist of the following seven tranches: the 1.450% Senior Notes due 2017, the 2.000% Senior Notes due 2018, the 2.700% Senior Notes due 2020, the 3.150% Senior Notes due 2022, the 3.550% Senior Notes due 2025, the 4.250% Senior Notes due 2035 and the 4.450% Senior Notes due 2045.
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
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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.
Between the Closing Date and June 30, 2015, we repaid the Biomet senior notes we assumed in the merger. The fair value of the principal amount plus interest was $2,798.6 million. These senior notes required us to pay a call premium in excess of the fair value of the notes when they were repaid. As a result, we recognized $22.0 million in non-operating other expense related to this call premium.
The estimated fair value of our senior notes as of December 31, 2015, based on quoted prices for the specific securities from transactions in over-the-counter markets (Level 2), was $8,837.5 million. The estimated fair value of the Japan Term Loan as of December 31, 2015, based upon publicly available market yield curves and the terms of the debt (Level 2), was $96.4 million. The carrying value of the U.S. Term Loan approximates fair value as it bears interest at short-term variable market rates.
We have entered into interest rate swap agreements which we designated as fair value hedges of underlying fixed-rate obligations on our senior notes due 2019 and 2021. See Note 14 for additional information regarding the interest rate swap agreements.
We also have available uncommitted credit facilities totaling $35.8 million.
At December 31, 2015 and 2014, the weighted average interest rate for our long-term borrowings was 2.9 percent and 3.5 percent, respectively. We paid $207.1 million, $67.5 million and $68.1 million in interest during 2015, 2014 and 2013, respectively.
13. Accumulated Other Comprehensive (Loss) Income
OCI refers to certain gains and losses that under GAAP are included in comprehensive income but are excluded from net earnings as these amounts are initially recorded as an adjustment to stockholders’ equity. Amounts in OCI may be reclassified to net earnings upon the occurrence of certain events.
Our OCI is comprised of foreign currency translation adjustments, unrealized gains and losses on cash flow hedges, unrealized gains and losses on available-for-sale securities, and amortization of prior service costs and unrecognized gains and losses in actuarial assumptions on our defined benefit plans. Foreign currency translation adjustments are reclassified to net earnings upon sale or upon a complete or substantially complete liquidation of an investment in a foreign entity. Unrealized gains and losses on cash flow hedges are reclassified to net earnings when the hedged item affects net earnings. Unrealized gains and losses on available-for-sale securities are reclassified to net earnings if we sell the security before maturity or if the unrealized loss is considered to be other-than-temporary. Amounts related to defined benefit plans that are in OCI are reclassified over the service periods of employees in the plan. The reclassification amounts are allocated to all employees in the plans and, therefore, the reclassified amounts may become part of inventory to the extent they are considered direct labor costs. See Note 15 for more information on our defined benefit plans.
The following table shows the changes in the components of OCI, net of tax (in millions):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table shows the reclassification adjustments from OCI (in millions):
* These OCI components are included in the computation of net periodic pension expense (see Note 15).
The following table shows the tax effects on each component of OCI recognized in our consolidated statements of comprehensive income (in millions):
14. Derivative Instruments and Hedging Activities
We are exposed to certain market risks relating to our ongoing business operations, including foreign currency exchange rate risk, commodity price risk, interest rate risk and credit risk. We manage our exposure to these and other market risks through regular operating and financing activities. Currently, the only risks that we manage through the use of derivative instruments are interest rate risk and foreign currency exchange rate risk.
Interest Rate Risk
Derivatives Designated as Fair Value Hedges
We use interest rate derivative instruments to manage our exposure to interest rate movements by converting fixed-rate
debt into variable-rate debt. Under these agreements, we agree to exchange, at specified intervals, the difference between fixed and variable interest amounts calculated by reference to an agreed-upon notional principal amount. 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 current earnings and are offset by gains or losses on the underlying debt instrument.
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 4.625% Senior Notes due 2019 and 3.375% Senior Notes due 2021. The total notional amounts are $250.0 million and $300.0 million for the 4.625% Senior Notes due 2019 and 3.375% Senior Notes due
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2021, respectively. On the interest rate swap agreements for the 4.625% 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 3.375% 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.
Derivatives Designated as Cash Flow Hedges
In 2014, we entered into forward starting interest rate swaps that were designated as cash flow hedges of the thirty year tranche of senior notes we expected to issue in 2015. The forward starting interest rate swaps mitigated the risk of changes in interest rates prior to the completion of the Merger Notes offering. The total notional amounts of the forward starting interest rate swaps were $1 billion and settled in March 2015 at a loss of $97.6 million. The loss will be recognized using the effective interest rate method over the maturity period of the 4.450% Senior Notes due 2045.
Foreign Currency Exchange Rate 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. To reduce the potential effects of foreign currency exchange rate movements on net earnings, we enter into derivative financial instruments in the form of foreign currency exchange forward contracts and options with major financial institutions. We are primarily exposed to foreign currency exchange rate risk with respect to transactions and net assets denominated in Euros, Swiss Francs, Japanese Yen, British Pounds, Canadian Dollars, Australian Dollars, Korean Won, Swedish Krona, Czech Koruna, Thai Baht, Taiwan Dollars, South African Rand, Russian Rubles and Indian Rupees. We do not use derivative financial instruments for trading or speculative purposes.
Derivatives Designated as Cash Flow Hedges
Our revenues are generated in various currencies throughout the world. However, a significant amount of our inventory is produced in U.S. Dollars. Therefore, movements in foreign currency exchange rates may have different proportional effects on our revenues compared to our cost of products sold. To minimize the effects of foreign currency exchange rate movements on cash flows, we hedge intercompany sales of inventory expected to occur within the next 30 months with foreign currency exchange forward contracts and options. We designate these derivative instruments as cash flow hedges.
We perform quarterly assessments of hedge effectiveness by verifying and documenting the critical terms of the hedge instrument and that forecasted transactions have not changed significantly. We also assess on a quarterly basis whether there have been adverse developments regarding the risk of a counterparty default. For derivatives which qualify as hedges of future cash flows, the effective portion of changes in fair value is temporarily recorded in other comprehensive income and then recognized in cost of products sold when the hedged item affects net earnings. The ineffective portion of a derivative’s change in fair value, if any, is immediately reported in cost of products sold. On our consolidated statement of cash flows, the settlements of these cash flow hedges are recognized in operating cash flows.
For foreign currency exchange forward contracts and options 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 obligations to purchase Swiss Francs and sell U.S. Dollars. These derivatives mature at dates ranging from January 2016 through June 2018. As of December 31, 2015, the notional amounts of outstanding forward contracts and options entered into with third parties to purchase U.S. Dollars were $1,427.5 million. As of December 31, 2015, the notional amounts of outstanding forward contracts and options entered into with third parties to purchase Swiss Francs were $307.2 million.
Derivatives Not Designated as Hedging Instruments
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, any foreign currency re-measurement gains/losses recognized in earnings are generally offset with gains/losses on the foreign currency forward exchange contracts in the same reporting period. Starting in 2015, the net amount of these offsetting gains/losses is recorded in other expense. In prior periods, the net amount was recorded in cost of products sold and was not material. Prior periods have been reclassified to conform to the 2015 presentation. These contracts are settled on the last day of each reporting period. Therefore, there is no outstanding balance related to these contracts recorded on the balance sheet as of the end of the reporting period. The notional amounts of these contracts are typically in a range of $1.5 billion to $2.0 billion per quarter.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Income Statement Presentation
Derivatives Designated as Fair Value Hedges
Derivative instruments designated as fair value hedges had the following effects on our consolidated statements of earnings (in millions):
We had no ineffective fair value hedging instruments nor any amounts excluded from the assessment of hedge effectiveness during the years ended December 31, 2015, 2014 and 2013.
Derivatives Designated as Cash Flow Hedges
Derivative instruments designated as cash flow hedges had the following effects, before taxes, on OCI and net earnings on our consolidated statements of earnings, consolidated statements of comprehensive income and consolidated balance sheets (in millions):
The net amount recognized in earnings during the years ended December 31, 2015, 2014 and 2013 due to ineffectiveness and amounts excluded from the assessment of hedge effectiveness were not significant.
The fair value of outstanding derivative instruments designated as cash flow hedges and recorded on the balance sheet at December 31, 2015, together with settled derivatives where the hedged item has not yet affected earnings, was a net unrealized gain of $26.1 million, or $29.8 million after taxes, which is deferred in accumulated other comprehensive income. Of the net unrealized gain, $101.4 million, or $76.7 million after taxes, is expected to be reclassified to earnings in cost of products sold and a loss of $1.7 million, or $1.1 million after taxes, is expected to be reclassified to earnings in interest expense over the next twelve months.
Derivatives Not Designated as Hedging Instruments
The following gains from these derivative instruments were recognized on our consolidated statements of earnings (in millions):
This impact does not include any offsetting gains/losses recognized in earnings as a result of foreign currency remeasurement of monetary assets and liabilities denominated in a currency other than an entity’s functional currency.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Balance Sheet Presentation
As of December 31, 2015 and December 31, 2014, all derivative instruments designated as fair value hedges and cash flow hedges are recorded at fair value on the balance sheet. On our consolidated balance sheets, we recognize individual forward contracts and options with the same counterparty on a net asset/liability basis if we have a master netting agreement with the counterparty. Under these master netting agreements, we are able to settle derivative instrument assets and liabilities with the same counterparty in a single transaction, instead of settling each derivative instrument separately. We have master netting agreements with all of our counterparties.
The fair value of derivative instruments on a gross basis is as follows (in millions):
The table below presents the effects of our master netting agreements on our consolidated balance sheets (in millions):
15. Retirement Benefit Plans
We have defined benefit pension plans covering certain U.S. and Puerto Rico employees. The employees who are not participating in the defined benefit plans receive additional benefits under our defined contribution plans. Plan benefits are primarily based on years of credited service and the participant’s average eligible compensation. In addition to the U.S. and Puerto Rico defined benefit pension plans, we sponsor various foreign pension arrangements, including retirement and termination benefit plans required by local law or coordinated with government sponsored plans.
We use a December 31 measurement date for our benefit plans.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Defined Benefit Plans
The components of net pension expense for our defined benefit retirement plans were as follows (in millions):
The weighted average actuarial assumptions used to determine net pension expense for our defined benefit retirement plans were as follows:
The expected long-term rate of return on plan assets is based on the historical and estimated future rates of return on the different asset classes held in the plans. The expected long-term rate of return is the weighted average of the target asset allocation of each individual asset class. We believe that historical asset results approximate expected market returns applicable to the funding of a long-term benefit obligation.
Discount rates were determined for each of our defined benefit retirement plans at their measurement date to reflect the yield of a portfolio of high quality bonds matched against the timing and amounts of projected future benefit payments. Beginning in 2016, we will change the method used to estimate the service and interest costs for pension and postretirement benefits. The new method utilizes a full yield curve approach to estimate service and interest costs by applying specific spot rates along the yield curve used to determine the benefit obligation of relevant projected cash outflows. Historically, we utilized a single weighted-average discount rate applied to projected cash outflows. We made the change to provide a more precise measurement of service and interest costs by aligning the timing of the plan’s liability cash flows to the corresponding spot rate on the yield curve. The change does not impact the measurement of the plan’s obligations. We will account for this change as a change in accounting estimate.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Changes in projected benefit obligations and plan assets were (in millions):
We estimate the following amounts recorded as part of accumulated other comprehensive income will be recognized as part of our net pension expense during 2016 (in millions):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The weighted average actuarial assumptions used to determine the projected benefit obligation for our defined benefit retirement plans were as follows:
Plans with projected benefit obligations in excess of plan assets were as follows (in millions):
Total accumulated benefit obligations and plans with accumulated benefit obligations in excess of plan assets were as follows (in millions):
The benefits expected to be paid out in each of the next five years and for the five years combined thereafter are as follows (in millions):
The U.S. and Puerto Rico defined benefit retirement plans’ overall investment strategy is to maximize total returns by emphasizing long-term growth of capital while mitigating risk. We have established target ranges of assets held by the plans of 40 to 45 percent for equity securities, 30 to 35 percent for debt securities and 20 to 25 percent in non-traditional investments. The plans strive to have sufficiently diversified assets so that adverse or unexpected results from one asset class will not have an unduly detrimental impact on the entire portfolio. We regularly review the investments in the plans and we may rebalance them from time-to-time based upon the target asset allocation of the plans.
For the U.S. and Puerto Rico plans, we maintain an investment policy statement that guides the investment allocation in the plans. The investment policy statement describes the target asset allocation positions described above. Our benefits committee, along with our investment advisor, monitor compliance with and administer the investment policy statement and the plans’ assets and oversee the general
investment strategy and objectives of the plans. Our benefits committee generally meets quarterly to review performance and to ensure that the current investment allocation is within the parameters of the investment policy statement.
The investment strategies of foreign based plans vary according to the plan provisions and local laws. The majority of the assets in foreign based plans are located in Switzerland-based plans. These assets are held in trusts and are commingled with the assets of other Swiss companies with representatives of all the companies making the investment decisions. The overall strategy is to maximize total returns while avoiding risk. The trustees of the assets have established target ranges of assets held by the plans of 30 to 50 percent in debt securities, 20 to 37 percent in equity securities, 15 to 24 percent in real estate, 3 to 15 percent in cash funds and 0 to 12 percent in other funds.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The fair value of our U.S. and Puerto Rico pension plan assets by asset category was as follows (in millions):
The fair value of our foreign pension plan assets was as follows (in millions):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
As of December 31, 2015 and 2014, our defined benefit pension plans’ assets did not hold any direct investment in Zimmer Biomet Holdings common stock.
Equity securities are valued using a market approach, based on quoted prices for the specific security from transactions in active exchange markets (Level 1), or in some cases where we are invested in mutual or collective funds, based upon the net asset value per unit of the fund which is determined from quoted market prices of the underlying securities in the fund’s portfolio (Level 2). Fixed income securities are valued using a market approach, based upon quoted prices for the specific security or from institutional bid evaluations. Some fixed income securities are in funds with a net asset value per unit which is determined using similar techniques for the underlying securities in the fund’s portfolio. Real estate is valued by discounting to present value the cash flows expected to be generated by the specific properties.
The following table provides a reconciliation of the beginning and ending balances of our foreign pension plan assets measured at fair value that used significant unobservable inputs (Level 3) (in millions):
We expect that we will have no legally required minimum funding requirements in 2016 for the qualified U.S. and Puerto Rico defined benefit retirement plans, nor do we expect to voluntarily contribute to these plans during 2016. Contributions to foreign defined benefit plans are estimated to be $15.1 million in 2016. We do not expect the assets in any of our plans to be returned to us in the next year.
Defined Contribution Plans
We also sponsor defined contribution plans for substantially all of the U.S. and Puerto Rico employees and certain employees in other countries. The benefits offered under these plans are reflective of local customs and practices in the countries concerned. We expensed $40.2 million, $32.8 million and $29.6 million related to these plans for the years ended December 31, 2015, 2014 and 2013, respectively.
16. Income Taxes
The components of earnings before income taxes consisted of the following (in millions):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
A reconciliation of the U.S. statutory income tax rate to our effective tax rate is as follows:
Our operations in Puerto Rico and Switzerland benefit from various tax incentive grants. These grants expire between fiscal years 2019 and 2029.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Valuation allowances are recorded to reduce deferred income tax assets when it is more likely than not that an income tax benefit will not be realized.
The components of deferred taxes consisted of the following (in millions):
Net operating loss carryovers are available to reduce future federal, state and foreign taxable earnings. At December 31, 2015, $103.9 million of these net operating loss carryovers generally expire within a period of 1 to 20 years and $13.5 million of these net operating loss carryovers have an indefinite life. Valuation allowances for net operating loss carryovers have been established in the amount of $47.0 million and $99.0 million at December 31, 2015 and 2014, respectively.
Deferred tax assets related to tax credit carryovers are available to offset future federal, state and foreign tax liabilities. At December 31, 2015, the Company’s total tax credit carryovers of $207.8 million generally expire within a period of 1 to 10 years. Valuation allowances for certain tax credit carryovers have been established in the amount of $14.4 million and $11.5 million at December 31, 2015 and 2014, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Deferred tax assets related to capital loss carryovers are also available to reduce future federal capital gains. At December 31, 2015, the Company’s capital loss carryovers of $4.2 million generally expire within a period of 2 to 4 years. Valuation allowances for certain capital loss carryovers have been established in the amount of $4.2 million and $7.4 million at December 31, 2015 and 2014, respectively. The remaining valuation allowances booked against deferred tax assets of $7.1 million and $4.9 million at December 31, 2015 and 2014, respectively, relate primarily to intangible assets and potential capital losses that management believes, more likely than not, will not be realized.
At December 31, 2015, we had an aggregate of approximately $3,853 million of unremitted earnings of foreign subsidiaries that have been, or are intended to be, indefinitely reinvested for continued use in foreign operations. If the total undistributed earnings of foreign subsidiaries were remitted, a significant amount of the additional tax would be offset by the allowable foreign tax credits. It is not practical for us to determine the additional tax related to remitting these earnings.
The following is a tabular reconciliation of the total amounts of unrecognized tax benefits (in millions):
* Subject to change during measurement period of the merger.
We recognize accrued interest and penalties related to unrecognized tax benefits as income tax expense. During 2015, we accrued interest and penalties of $4.8 million, and as of December 31, 2015, had a recognized liability for interest and penalties of $82.9 million, which included a $29.8 million increase from December 31, 2014 related to the Biomet merger.
During 2014, we accrued interest and penalties of $5.9 million, and as of December 31, 2014, had recognized a liability for interest and penalties of $48.3 million. During 2013, we accrued interest and penalties of $8.1 million, and as of December 31, 2013, had recognized a liability for interest and penalties of $42.4 million.
We operate on a global basis and are subject to examinations by taxing authorities throughout the world, including major jurisdictions such as: Australia, Canada, China,
France, Germany, Ireland, Italy, Japan, Luxembourg, the Netherlands, Puerto Rico, Spain, Switzerland, the United Kingdom and the United States.
Our U.S. Federal income tax returns have been audited through 2009 and are currently under audit for years 2010-2014. The IRS has proposed adjustments for years 2005-2009, reallocating profits between certain of our U.S. and foreign subsidiaries. We have disputed these adjustments and intend to continue to vigorously defend our positions. For years 2005-2007, we have filed a petition with the U.S. Tax Court. For years 2008-2009, we are pursuing resolution through the IRS Administrative Appeals Process. The acquired Biomet consolidation group has been audited through financial year 2008.
State income tax returns are generally subject to examination for a period of 3 to 5 years after filing of the respective return. The state impact of any federal changes generally remains subject to examination by various states for a period of up to one year after formal notification to the states. We have various state income tax return positions in the process of examination, administrative appeals or litigation.
In other major jurisdictions, open years are generally 2008 or later.
The net amount of tax liability for unrecognized tax benefits may change within the next twelve months due to changes in audit status, expiration of statutes of limitations, settlements of tax assessments and other events which could impact our determination of unrecognized tax benefits. Currently, we cannot reasonably estimate the amount by which our unrecognized tax benefits will change.
17. Capital Stock and Earnings per Share
We are authorized to issue 250.0 million shares of preferred stock, none of which were issued or outstanding as of December 31, 2015.
The numerator for both basic and diluted earnings per share is net earnings available to common stockholders. The denominator for basic earnings per share is the weighted average number of common shares outstanding during the period. The denominator for diluted earnings per share is weighted average shares outstanding adjusted for the effect of dilutive stock options and other equity awards. The following is a reconciliation of weighted average shares for the basic and diluted share computations (in millions):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended December 31, 2015 and 2013, an average of 0.5 million and 3.1 million options, respectively, to purchase shares of common stock were not included in the computation of diluted earnings per share as the exercise prices of these options were greater than the average market price of the common stock. In the year ended December 31, 2014, all outstanding options to purchase shares of common stock were included in the computation of diluted earnings per share as the exercise prices of all options were less than the average market price of the common stock.
During 2015, we repurchased 1.4 million shares of our common stock at an average price of $106.01 per share for a total cash outlay of $150.0 million, including commissions.
18. Segment Data
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. 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. The 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. The product category operating segments are Americas Spine, Bone Healing, CMF and Dental. The geographic operating segments include results from all of our product categories except those in the product category operating segments. The Bone Healing, CMF and Dental
product category operating segments reflect those respective product category results from all regions, whereas the Americas Spine operating segment only includes spine product results from the Americas.
As it relates to the geographic operating segments, management evaluates performance based upon segment operating profit exclusive of operating expenses pertaining to inventory step-up and certain other inventory and manufacturing related charges, “Certain claims,” goodwill impairment, intangible asset amortization, “Special items,” and global operations and corporate functions. Global operations and corporate functions include research, development engineering, medical education, brand management, corporate legal, finance and human resource functions, manufacturing operations and logistics and share-based payment expense. As it relates to each product category operating segment, research, development engineering, medical education, brand management and other various costs that are specific to the product category operating segment’s operations are reflected in its operating profit results. Due to these additional costs included in the product category operating segments, profitability metrics between the geographic operating segments and product category operating segments are not comparable. Intercompany transactions have been eliminated from segment operating profit.
Management reviews accounts receivable, inventory, and property, plant and equipment assets by reportable segment exclusive of manufacturing operations and logistics and corporate assets.
These seven operating segments are the basis for our reportable segment information provided below. The four product category operating segments are individually insignificant to our consolidated results and therefore do not constitute a reporting segment either individually or combined. For presentation purposes, these product category operating segments have been aggregated. Prior period reportable segment financial information has been restated to conform to the current period.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Net sales and other information by segment is as follows (in millions):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For segment reporting purposes, deployed instruments are included in the measurement of reportable segment assets while undeployed instruments at manufacturing operations and logistics are included in global operations and corporate functions. The majority of instruments are purchased by manufacturing operations and logistics and are deployed to the reportable segments as needed for the business. Therefore, the reportable segment assets include deployed instruments even though that reportable segment may not report the instrument addition.
We conduct business in the following countries that hold 10 percent or more of our total consolidated Property, plant and equipment, net:
U.S. sales were $3,447.2 million, $2,397.9 million and $2,418.2 million for the years ended December 31, 2015, 2014 and 2013, respectively. Sales within any other individual country were less than 10 percent of our consolidated sales in each of those years. Sales are attributable to a country based upon the customer’s country of domicile.
Net sales by product category are as follows (in millions):
19. Leases
Total rent expense for the years ended December 31, 2015, 2014 and 2013 aggregated $60.1 million, $48.4 million and $49.2 million, respectively.
Future minimum rental commitments under non-cancelable operating leases in effect as of December 31, 2015 were (in millions):
20. Commitments and Contingencies
On a quarterly and annual basis, we review relevant information with respect to loss contingencies and update our accruals, disclosures and estimates of reasonably possible losses or ranges of loss based on such reviews. We establish liabilities for loss contingencies when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. For matters where a loss is believed to be reasonably possible, but not probable, no accrual has been made.
Litigation
Durom® Cup-related claims: On July 22, 2008, we temporarily suspended marketing and distribution of the Durom Cup in the U.S. Subsequently, a number of product liability lawsuits were filed against us in various U.S. and foreign jurisdictions. The plaintiffs seek damages for personal injury, and they generally allege that the Durom Cup contains defects that result in complications and premature revision of the device. We have settled some of these claims and others are still pending. The majority of the pending U.S. lawsuits are currently in a federal Multidistrict Litigation (“MDL”) in the District of New Jersey (In Re: Zimmer Durom Hip Cup Products Liability Litigation). Multi-plaintiff state court cases are pending in St. Clair County, Illinois (Santas, et al. v. Zimmer, Inc., et al.) and Los Angeles County, California (McAllister, et al. v. Zimmer, Inc., et al.). As of December 31, 2015, case specific discovery in these lawsuits was ongoing. The initial trial in Santas took place in November 2014, the initial trial in the MDL took place in May 2015 and the initial trial in McAllister took place in July 2015. Other lawsuits are pending in various jurisdictions, and additional claims may be asserted in the future.
Since 2008, we have recognized expense of $479.4 million for Durom Cup-related claims, including $7.7 million during the year ended December 31, 2015 that is reported on the “Certain claims” line of our consolidated statement of earnings. We recognized $21.5 million and $47.0 million in expense for Durom Cup-related claims during the years ended December 31, 2014 and 2013, respectively.
We maintain insurance for product liability claims, subject to self-insurance retention requirements. As of December 31, 2015, we have exhausted our self-insured retention under our insurance program and have a claim for insurance proceeds for ultimate losses which exceed the self-insured retention amount, subject to a 20 percent co-payment requirement and a cap. We believe our contracts with the insurance carriers are enforceable for these claims and, therefore, it is probable that we will recover some amount from our insurance carriers. We have received a portion of the insurance proceeds we estimate we will recover. We have a $95.3 million receivable in “Other assets” remaining on our consolidated balance sheet as of December 31, 2015 for estimated insurance recoveries for Durom Cup-related claims. As is customary in this process,
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our insurance carriers have reserved all rights under their respective policies and could still ultimately deny coverage for some or all of our insurance claims.
Our estimate as of December 31, 2015 of the remaining liability for all Durom Cup-related claims is $314.6 million, of which $50.0 million is classified as short-term in “Other current liabilities” and $264.6 million is classified as long-term in “Other long-term liabilities” on our consolidated balance sheet. We expect to pay the majority of the Durom Cup-related claims within the next few years.
Our understanding of clinical outcomes with the Durom Cup and other large diameter hip cups continues to evolve. We rely on significant estimates in determining the provisions for Durom Cup-related claims, including our estimate of the number of claims that we will receive and the average amount we will pay per claim. The actual number of claims and the actual amount we pay per claim may differ from our estimates. Among other factors, since our understanding of the clinical outcomes is still evolving, we cannot reasonably estimate the possible loss or range of loss that may result from Durom Cup-related claims in excess of the losses we have accrued.
Margo and Daniel Polett v. Zimmer, Inc. et al.: On August 20, 2008, Margo and Daniel Polett filed an action against us and an unrelated third party, Public Communications, Inc. (“PCI”), in the Court of Common Pleas, Philadelphia, Pennsylvania seeking an unspecified amount of damages for injuries and loss of consortium allegedly suffered by Mrs. Polett and her spouse, respectively. The complaint alleged that defendants were negligent in connection with Mrs. Polett’s participation in a promotional video featuring one of our knee products. The case was tried in November 2010 and the jury returned a verdict in favor of plaintiffs. The jury awarded $27.6 million in compensatory damages and apportioned fault 30 percent to plaintiffs, 34 percent to us and 36 percent to PCI. Under applicable law, we may be liable for any portion of the damages apportioned to PCI that it does not pay. On December 2, 2010, we and PCI filed a motion for post-trial relief seeking a judgment notwithstanding the verdict, a new trial or a remittitur. On June 10, 2011, the trial court entered an order denying our motion for post-trial relief and affirming the jury verdict in full and entered judgment for $20.3 million against us and PCI. On June 29, 2011, we filed a notice of appeal to the Superior Court of Pennsylvania and posted a bond for the verdict amount plus interest. Oral argument before the appellate court in Philadelphia, Pennsylvania was held on March 13, 2012. On March 1, 2013, the Superior Court of Pennsylvania vacated the $27.6 million judgment and remanded the case for a new trial. On March 15, 2013, plaintiffs filed a motion for re-argument en banc, and on March 28, 2013, we filed our response in opposition. On May 9, 2013, the Superior Court of Pennsylvania granted plaintiffs’ motion for re-argument en banc. Oral argument (re-argument en banc) before the Superior Court of Pennsylvania was held on October 16, 2013. On December 20, 2013, the Court issued
its opinion again vacating the trial court judgment and remanding the case for a new trial. On January 21, 2014, plaintiffs filed a petition for allowance of appeal in the Supreme Court of Pennsylvania, which was granted on May 21, 2014. Oral argument before the Supreme Court of Pennsylvania took place on October 8, 2014. On October 27, 2015, the Supreme Court of Pennsylvania reversed the order of the Superior Court of Pennsylvania and remanded the case to that court to consider the question of whether the trial court erred in refusing to remit the jury’s compensatory damages award. Although we are defending this lawsuit vigorously, its ultimate resolution is uncertain.
NexGen Knee System claims: Following a wide-spread advertising campaign conducted by certain law firms beginning in 2010, a number of product liability lawsuits have been filed against us in various jurisdictions. The plaintiffs seek damages for personal injury, alleging that certain products within the NexGen Knee System suffer from defects that cause them to loosen prematurely. The majority of the cases are currently pending in a federal MDL in the Northern District of Illinois (In Re: Zimmer NexGen Knee Implant Products Liability Litigation). Other cases are pending in other state and federal courts, and additional lawsuits may be filed. As of December 31, 2015, discovery in these lawsuits was ongoing. The initial bellwether trial took place in October 2015. We have not accrued an estimated loss relating to these lawsuits because we believe the plaintiffs’ allegations are not consistent with the record of clinical success for these products. As a result, we do not believe that it is probable that we have incurred a liability, and we cannot reasonably estimate any loss that might eventually be incurred. Although we are vigorously defending these lawsuits, their ultimate resolution is uncertain.
Biomet metal-on-metal hip implant claims: Biomet is a defendant in a number of product liability lawsuits relating to metal-on-metal hip implants. The majority of these cases involve the M2a-Magnum hip system. The majority of the cases are currently consolidated in one federal MDL proceeding in the U.S. District Court for the Northern District of Indiana (In Re: Biomet M2a Magnum Hip Implant Product Liability Litigation). Other cases are pending in various state and foreign courts.
On February 3, 2014, Biomet announced the settlement of the MDL. Lawsuits filed in the MDL by April 15, 2014 may participate in the settlement. Biomet continues to evaluate the inventory of lawsuits in the MDL pursuant to the categories and procedures set forth in the settlement agreement. The final amount of payments under the settlement is uncertain. The settlement does not affect certain other claims relating to Biomet’s metal-on-metal hip products that are pending in various state and foreign courts, or other claims that may be filed in the future. Our estimate as of December 31, 2015 of the remaining liability for all Biomet metal-on-metal hip implant claims is $33.4 million.
Biomet has exhausted the self-insured retention in its insurance program and has been reimbursed for claims related
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to its metal-on-metal products up to its policy limits in the program. Zimmer Biomet will be responsible for any amounts by which the ultimate losses exceed the amount of Biomet’s third-party insurance coverage. As of December 31, 2015, Biomet had received all of the insurance proceeds it expects to recover under the excess policies.
Heraeus trade secret misappropriation lawsuits: In December 2008, Heraeus Kulzer GmbH (together with its affiliates, “Heraeus”) initiated legal proceedings in Germany against Biomet, Biomet Europe BV and certain other subsidiaries of Biomet, Inc., alleging that Biomet, Inc. and Biomet Europe BV misappropriated Heraeus trade secrets when developing Biomet Europe’s Refobacin and Biomet Bone Cement line of cements (“European Cements”). The lawsuit sought to preclude the defendants from producing, marketing and offering for sale their current line of European Cements and to compensate Heraeus for any damages incurred (alleged to be in excess of 30.0 million). On December 20, 2012, the trial court dismissed Biomet, Inc., Biomet Europe BV, Biomet Deutschland GmbH and other defendants from the lawsuit. Biomet Orthopaedics Switzerland GmbH was the only Biomet entity remaining as a defendant.
Following an appeal by Heraeus, on June 5, 2014, the German appeals court (i) enjoined Biomet, Inc., Biomet Europe BV and Biomet Deutschland GmbH from manufacturing, selling or offering the European Cements to the extent they contain certain raw materials in particular specifications; (ii) held the defendants jointly and severally liable to Heraeus for any damages from the sale of European Cements since 2005; and (iii) ruled that no further review may be sought. Damages have not been determined. The judgment is not final and the defendants are seeking review (including review of the appeals court ruling that no further review may be sought) from Germany’s Supreme Court. No prediction can be made as to the likelihood of review being granted by Germany’s Supreme Court.
As a result, Biomet Europe BV and Biomet Deutschland GmbH are enjoined from the manufacture, marketing, sale and offering of European Cements in Germany. While Heraeus has indicated that it intends to take the position that the judgment would prohibit the manufacture, marketing, sale and offering of European Cements outside of Germany as well and is attempting to enforce the judgment in a limited number of other European jurisdictions, Biomet, Inc., Biomet Europe BV and Biomet Deutschland GmbH are vigorously contesting any enforcement of the judgment beyond Germany. Biomet, Inc., Biomet Europe BV and Biomet Deutschland GmbH thus filed a declaratory action in Germany on August 3, 2014 to have the court determine the reach of the appeals court decision.
On September 8, 2014, Heraeus filed a complaint against a Biomet supplier, Esschem, Inc. (“Esschem”), in the United States District Court for the Eastern District of Pennsylvania. The lawsuit contains allegations that focus on two copolymer compounds that Esschem sells to Biomet, which Biomet incorporates into certain bone cement products that compete
with Heraeus’ bone cement products. The complaint alleges that Biomet helped Esschem to develop these copolymers, using Heraeus trade secrets that Biomet allegedly misappropriated. The complaint asserts a claim under the Pennsylvania Trade Secrets Act, as well as other various common law tort claims, all based upon the same trade secret misappropriation theory. Heraeus is seeking to enjoin Esschem from supplying the copolymers to any third party and actual damages in an unspecified amount. The complaint also seeks punitive damages, costs and attorneys’ fees. If Esschem is enjoined, Biomet may not be able to obtain the copolymers from another supplier and as a result may not be able to continue to manufacture the subject bone cement products. Although Heraeus has not named Biomet as a party to this lawsuit, Biomet has agreed, at Esschem’s request and subject to certain limitations, to indemnify Esschem for any liability, damages and legal costs related to this matter. On November 3, 2014, the court entered an order denying Heraeus’ motion for a temporary restraining order.
On October 15, 2015, Heraeus initiated expedited proceedings against Biomet France, Biomet SAS, Biomet Europe BV, Biomet, Inc., Biomet Orthopedics Switzerland GmbH and Biomet Global Supply Chain Center BV before the Commercial Court in Paris seeking to enjoin these entities from importing the certain raw materials subject to the rulings in Germany and from manufacturing, selling or exporting the bone cements made from those raw materials, including under the names of the European Cements. On November 16, 2015, the presiding judge ruled that it had no jurisdiction over Biomet, Inc. and on December 4, 2015, the judge denied the preliminary measures requested by Heraeus. Heraeus has not appealed this ruling or filed an action on the merits before the Commercial Court in Paris. On December 8, 2015, Heraeus filed separate proceedings against Biomet France, Biomet SAS and Biomet France Holding before the Commercial Court of Roman-Sur-Isere seeking to gain access to certain documents which had been seized during searches of Biomet France’s premises in June 2015. Biomet is defending itself vigorously in this proceeding, which is still ongoing.
Heraeus continues to initiate other related legal proceedings in Europe seeking various forms of relief, including injunctive relief and damages, against Biomet-related entities relating to the European Cements.
No assurance can be made as to the time or resources that will be needed to devote to this litigation or its final outcome.
Stryker patent infringement lawsuit: On December 10, 2010, Stryker Corporation and related entities (“Stryker”) filed suit against us in the U.S. District Court for the Western District of Michigan, alleging that certain of our Pulsavac® Plus Wound Debridement Products infringe three U.S. patents assigned to Stryker. The case was tried beginning on January 15, 2013, and on February 5, 2013, the jury found that we infringed certain claims of the subject patents. The jury awarded $70.0 million in monetary damages for lost profits. The jury also found that we willfully infringed the subject
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patents. We filed multiple post-trial motions, including a motion seeking a new trial. On August 7, 2013, the trial court issued a ruling denying all of our motions and awarded treble damages and attorneys’ fees to Stryker. We filed a notice of appeal to the Court of Appeals for the Federal Circuit to seek reversal of both the jury’s verdict and the trial court’s rulings on our post-trial motions. Oral argument before the Court of Appeals for the Federal Circuit took place on September 8, 2014. On December 19, 2014, the Federal Circuit issued a decision affirming the $70.0 million lost profits award but reversed the willfulness finding, vacating the treble damages award and vacating and remanding the attorneys’ fees award. We accrued an estimated loss of $70.0 million related to this matter in the three month period ended December 31, 2014. On January 20, 2015, Stryker filed a motion with the Federal Circuit for a rehearing en banc. On March 23, 2015, the Federal Circuit denied Stryker’s petition. Stryker subsequently filed a petition for certiorari to the U.S. Supreme Court. In July 2015, we paid the final award of $90.3 million, which includes the original $70.0 million plus pre- and post-judgment interest and damages for sales that occurred post-trial but prior to our entry into a license agreement with Stryker. On October 19, 2015, the U.S. Supreme Court granted Stryker’s petition for certiorari. Oral argument took place on February 23, 2016. Although we are defending this lawsuit vigorously, the ultimate resolution of this matter is uncertain. In the future, we could be required to record a charge of up to $140.0 million that could have a material adverse effect on our results of operations.
Bonutti patent infringement lawsuits: On May 3, 2013, Bonutti Skeletal Innovations LLC (“Bonutti Skeletal”), a company formed to hold certain patents acquired from Dr. Peter M. Bonutti and an affiliate of patent licensing firm Acacia Research Group LLC (“Acacia”), filed suit against Biomet in the U.S. District Court for the Eastern District of Texas, alleging a failure to pay royalties due under a license agreement with Dr. Bonutti, misuse of confidential information and infringement of 15 U.S. patents. Prior to the filing of this lawsuit, on March 8, 2013, Biomet had filed a complaint for declaratory judgment with the U.S. District Court for the Northern District of Indiana seeking a judgment of non-infringement and invalidity of the patents at issue, and Acacia entered counterclaims of infringement seeking damages in an amount yet to be determined and injunctive relief. On September 17, 2013, the May 3, 2013 case filed in the Eastern District of Texas was dismissed. On March 31, 2014, Biomet entered into a settlement and license agreement with Bonutti Skeletal settling all claims related to five of the patents at issue for a one-time payment, and on June 25, 2014, the U.S. District Court for the Northern District of Indiana issued an order dismissing the claims related to those patents with prejudice. The litigation then proceeded with respect to the remaining patents at issue.
On September 10, 2012, Bonutti Skeletal filed suit against Zimmer in the U.S. District Court for the District of Delaware,
alleging infringement of three U.S. patents. An amended complaint was filed on January 15, 2013, alleging infringement of three additional patents. Zimmer requested an Inter Partes Review (“IPR”) of three of the patents at issue. IPRs were granted for two of the patents. Zimmer moved for a stay of the case during the pendency of the IPRs, and on April 7, 2014, the court granted the stay. In May 2015, the U.S. Patent and Trademark Office issued its decision in the IPRs, invalidating all of the challenged patent claims in both patents. Bonutti Skeletal decided not to appeal that decision. On June 30, 2015, the court lifted the stay and the litigation then proceeded with respect to the remaining patents at issue.
On October 30, 2015, the Bonutti litigation was settled in a joint settlement of the legacy Biomet litigation and legacy Zimmer litigation related to the same entity.
Regulatory Matters, Government Investigations and Other Matters
FDA warning letters: In September 2012, Zimmer received a warning letter from 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. We have provided detailed responses to the FDA as to our corrective actions and will continue to work expeditiously to address the issues identified by the FDA during inspections in Ponce and Zhejiang. As of December 31, 2015, these warning letters remained pending. Until the violations are corrected, we may be subject to additional regulatory action by the FDA, including seizure, injunction and/or civil monetary penalties. Additionally, requests for Certificates to Foreign Governments related to products manufactured at the Ponce and Zhejiang facilities may not be granted and premarket approval applications for Class III devices to which the quality system regulation deviations at these facilities are reasonably related will not be approved until the violations have been corrected. In addition to responding to the warning letters described above, we are in the process of addressing various FDA Form 483 inspectional observations at certain of our manufacturing facilities. The ultimate outcome of these matters is presently uncertain.
Biomet DPA and Consent: On March 26, 2012, Biomet entered into a Deferred Prosecution Agreement (“DPA”) with the DOJ and a Consent with the SEC related to an investigation by the DOJ and the SEC into possible violations of the 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
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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 former employees and executives. Biomet continues to cooperate with the SEC and DOJ and expects that discussions with the SEC and the DOJ will continue. While we are devoting significant time and resources to these matters, we can give no assurances as to their final outcome.
Other Government Investigations and Document Requests: 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 the Office of Foreign Assets Control of the U.S. Department of the Treasury (“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 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 Office of the Inspector General of the U.S. Department of Health and Human Services 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.
21. Quarterly Financial Information (Unaudited)
(in millions, except per share data)
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Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) that are designed to provide reasonable assurance that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures. Because of inherent limitations, disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of disclosure controls and procedures are met.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of December 31, 2015, the end of the period covered by this report, our disclosure controls and procedures are effective at a reasonable assurance level.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management’s report on internal control over financial reporting appears on page 34 of this report and is incorporated herein by reference.
Remediation of Previously Reported Material Weakness
As discussed in our Quarterly Report on Form 10-Q for the quarter ended September 30, 2015, in the three month period ended September 30, 2015, our management identified a material weakness in our internal control over financial reporting. A material weakness is 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. The material weakness in our internal control over financial reporting that
we identified was a result of us not enhancing the level of resources and processes necessary to analyze and determine the appropriate accounting treatment of non-routine, complex transactions under GAAP commensurate with the additional complexities existing subsequent to the Biomet merger. As a result of this material weakness, we inappropriately accounted for the divestiture of certain Biomet product lines and rights in the three month period ended June 30, 2015, and we subsequently revised our financial statements for that period.
As of December 31, 2015, we have remediated the previously reported material weakness in our internal control over financial reporting. We have implemented the following changes in our internal control over financial reporting that contributed to the remediation of the material weakness described above:
•
we enhanced our processes for analyzing and determining the appropriate accounting treatment for non-routine, complex transactions under GAAP;
•
we enhanced our policies and procedures related to analysis of non-routine, complex transactions, including, but not limited to, increased management oversight; and
•
we added additional, experienced resources to augment our existing corporate accounting resources.
Based on the remedial measures taken and implemented, our management has tested the applicable controls and determined that they are designed and operating effectively. As a result, our management has concluded that the material weakness described above has been remediated as of December 31, 2015.
Changes in Internal Control Over Financial Reporting
As described above, there were changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the quarter ended December 31, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Also, as previously noted, we completed our merger with Biomet on June 24, 2015. We are completing the process of reviewing the internal control structure of Biomet and will make appropriate changes as necessary as we integrate Biomet into our overall internal control over financial reporting process.
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Item 9B.
Item 9B.
Other Information
During the fourth quarter of 2015, the Audit Committee of our Board of Directors approved the engagement of PricewaterhouseCoopers LLP, our independent registered public accounting firm, to perform certain non-audit services related to certain tax matters. This disclosure is made pursuant to Section 10A(i)(2) of the Exchange Act.
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PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance
Information required by this item is incorporated by reference from our definitive Proxy Statement for the annual meeting of stockholders to be held on May 3, 2016 (the “2016 Proxy Statement”).
We have adopted the Zimmer Biomet Code of Ethics for Chief Executive Officer and Senior Financial Officers (the “finance code of ethics”), a code of ethics that applies to our Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer and Corporate Controller, and other finance organization senior employees. The finance code of ethics is publicly available in the Investor Relations section of our website, which may be accessed from our homepage at www.zimmerbiomet.com or directly at http://investor.zimmerbiomet.com. If we make any substantive amendments to the finance code of ethics or grant any waiver, including any implicit waiver, from a provision of the code to our Chief Executive Officer, Chief Financial Officer, or Chief Accounting Officer and Corporate Controller, we will disclose the nature of that amendment in the Investor Relations section of our website.
Item 11.
Item 11.
Executive Compensation
Information required by this item is incorporated by reference from our 2016 Proxy Statement.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information required by this item is incorporated by reference from our 2016 Proxy Statement.
Item 13.
Item 13.
Certain Relationships and Related Transactions and Director Independence
Information required by this item is incorporated by reference from our 2016 Proxy Statement.
Item 14.
Item 14.
Principal Accounting Fees and Services
Information required by this item is incorporated by reference from of our 2016 Proxy Statement.
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PART IV
Item 15.
Item 15.
Exhibits, Financial Statement Schedules
(a) 1. Financial Statements
The following consolidated financial statements of Zimmer Biomet Holdings, Inc. and its subsidiaries are set forth in Part II, Item 8.
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Earnings for the Years Ended December 31, 2015, 2014 and 2013
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2015, 2014 and 2013
Consolidated Balance Sheets as of December 31, 2015 and 2014
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2015, 2014 and 2013
Consolidated Statements of Cash Flows for the Years Ended December 31, 2015, 2014 and 2013
Notes to Consolidated Financial Statements
2. Financial Statement Schedule
Schedule II. Valuation and Qualifying Accounts
Other financial statement schedules are omitted because they are not applicable or the required information is shown in the financial statements or the notes thereto.
3. Exhibits
A list of exhibits required to be filed as part of this report is set forth in the Index to Exhibits, which immediately precedes such exhibits and is incorporated herein by reference.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ZIMMER BIOMET HOLDINGS, INC.
By:
/s/ David C. Dvorak
David C. Dvorak
President and Chief Executive Officer
Dated: February 29, 2016
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
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INDEX TO EXHIBITS
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2015 FORM 10-K ANNUAL REPORT
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Exhibit No
Description
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
 Unless otherwise indicated, exhibits incorporated by reference herein were originally filed under SEC File No. 001-16407.
* Management contract or compensatory plan or arrangement.
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SCHEDULE II
ZIMMER HOLDINGS, INC.
VALUATION AND QUALIFYING ACCOUNTS