Zimmer Biomet Annual Report 2014

Plain-text annual report

2 0 1 4 A N N U A L R E P O R T Financial Highlights (Dollars in millions except per-share amounts) Sales b y Geographic Segment 2010 2011 2012 2013 2014 56% 27% 17% Americas $2,432 Europe 1,099 Asia Pacific 689 $2,441 1,214 797 $2,476 $2,620 $2,594 1,178 818 1,212 791 1,269 810 Consolidated $4,220 $4,452 $4,472 $4,623 $4,673 Sales b y Product Category 2010 2011 2012 2013 2014 Reconstructive $3,210 $3,355 $3,350 $3,434 $3,496 42% Knees Hips 28% Extremities Dental Trauma Spine 4% 5% 1,798 1,262 150 219 246 234 7% 9% 5% Surgical & Other 311 1,836 1,356 163 248 286 225 338 1,834 1,342 174 238 308 209 367 1,910 1,330 194 239 316 202 432 1,966 1,326 204 243 317 207 410 Consolidated $4,220 $4,452 $4,472 $4,623 $4,673 % Change 2013-2014 Constant Reported Currency(1) -1% 5% 2% 1% -1% 5% 8% 2% % Change 2013-2014 Constant Reported Currency(1) 2% 3% 0% 5% 1% 0% 2% -5% 1% 3% 4% 1% 6% 2% 2% 3% -3% 2% Net Sales Zimmer delivered solid global Operating Proﬁt Zimmer continued to achieve Operating Cash Flow Zimmer’s operating cash ﬂows Diluted Earnings per Share The ongoing success of Zimmer’s revenues in 2014, recording solid adjusted operating proﬁt continued to support the ongoing value creation framework constant currency net sales margins in 2014. The Company commercialization of new supported a steady 5.4% growth growth of 2.4%. Focused commercial execution has recorded six consecutive offerings in 2014, while funding in adjusted earnings per share quarters of year-over-year strategic investments and for 2014. supported strong growth in the adjusted operating margin programs to enhance stockholder Asia Paciﬁc and Europe, Middle expansion through value, including increased East and Africa regions, as well process-driven improvements dividends and a disciplined as a steady performance in the that have delivered signiﬁcant share repurchase program ahead Americas. Global sales were cost savings and efﬁciencies. of the transformational also supported by accelerated contributions from certain global businesses. 1% Reported 3 7 6 4 , 3 2 6 4 , 2 5 4 4 , 2 7 4 4 , 0 2 2 4 , 5% Adjusted(2) 0% Reported 2 3 2 1 , 7 1 9 9 6 2 1 , 4 2 0 1 , 9 1 3 1 , 7 4 0 1 , 0 7 3 1 , 6 3 0 1 , 4 3 4 1 , 5 3 0 1 , combination with Biomet. 9% Reported 4 9 1 1 , 7 7 1 1 , 2 5 1 1 , 3 5 0 1 , 3 6 9 5% Adjusted(2) -5% Reported 5 7 5 . 3 4 4 . 0 3 5 . 9 2 4 . 0 8 4 . 3 0 4 . 3 3 4 . 7 9 2 . 6 0 6 . 9 1 4 . 10 11 12 13 14 10 11 12 13 14 10 11 12 13 14 10 11 12 13 14 (1) “Constant Currency” refers to sales growth resulting from translating current and prior-period sales at the same predetermined foreign currency exchange rate. The translated results are then used to determine year-over-year percentage increases or decreases that exclude the effect of changes in foreign currency exchange rates. See the reconciliation of this non-GAAP financial measure to the most directly comparable GAAP measure on page 79. (2) “Adjusted” refers to performance measures that exclude inventory step-up and other inventory and manufacturing charges, special items, the provision for certain Durom® Acetabular Component product claims, goodwill impairment, financing and other expenses related to the pending Biomet merger and certain tax adjustments. See the reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures on page 79. To Our Stockholders: Since 1927, the people of Zimmer have been committed to restoring mobility, alleviating pain and improving quality of life for patients around the world. We proudly carried on that tradition in 2014, with an enduring commitment to our core values. Through the execution of a proven strategic framework, we continued to meet our ﬁnancial commitments and return substantial value to our stockholders. Zimmer delivered steady sales growth throughout 2014, with notable contributions coming from across our diversiﬁed portfolio. Sales for the year totaled $4.67 billion, with fully diluted adjusted earnings per share of $6.06, which was an increase of 5.4% over the prior year. Our performance was highlighted by solid growth in the Europe, Middle East and Africa region and the Asia Paciﬁc region, including key emerging markets. Throughout the year, Zimmer released a number of new offerings from our innovation pipeline, while continuing to expand ongoing product releases. We also continued executing a business transformation agenda, achieving process efﬁciencies and cost savings across our operations. As a result, we improved our operating margin in each quarter of 2014, further supporting our ability to fund our capital allocation priorities. In April 2014, we embarked upon a new chapter in our history by announcing our planned combination with Biomet. When the combination is ﬁnalized, we will be known as Zimmer Biomet. This landmark expansion of our global organization will support our mission to lead the industry by providing innovative products and solutions that deliver exceptional value to healthcare providers, their patients and our stockholders. Driving Growth Through Innovation Through a broad-based approach to innovation, Zimmer has built a legacy of offering solutions that embrace the unique needs of our surgeon customers and their patients. In 2014, we introduced a broad range of new products to an expanded customer base and achieved milestone clinical acceptance. We continue to be excited about Persona® The Personalized Knee System. Built on the clinical legacy of our leading NexGen® and Natural-Knee® Systems, the Persona Knee offers unprecedented anatomical accuracy and innovative features. This revolutionary total knee system, as well as its accompanying suite of intelligent instrument offerings, continues to garner customer acclaim and capture market growth. Promising sales of the Persona System contributed to the steady performance of our market-leading Knee franchise in 2014. Turning to our Hips business, in 2014, our hip liners featuring Vivacit-E® Vitamin E Highly Crosslinked bearing material successfully completed more than 90 million cycles of laboratory wear-testing, without signs of oxidation or strength reduction. This platform technology, which we apply across our reconstructive portfolio, has now become the only orthopaedic bearing material laboratory tested to mimic the number of walking steps and environment patients typically experience during a lifetime following hip replacement. During the year, Zimmer also began European commercialization of a differentiated new diagnostic technology, the Synovasure® PJI Alpha Defensin Test for Periprosthetic Joint Infection. It was an exciting year for our Spine business, which successfully launched 12 new products in 2014. These portfolio additions included the Optio-C® Anterior Cervical System, a next generation, modular stand-alone cervical device, and the Virage® OCT Spinal Fixation System, winner of the Life Science Alley New Technology Showcase. Zimmer also added six new products to our comprehensive family of Puros® Demineralized Bone Matrix Grafting solutions for spinal surgery. In addition, we continued to expand our biologics portfolio for the early stages of joint disease, which includes the Gel-One® Cross-linked Hyaluronate for early intervention, and joint preservation solutions such as the Zimmer Knee Creations™ Subchondroplasty® Procedure. In October, we completed the acquisition of Massachusetts-based ETEX Holdings, Inc., which offers bone void ﬁller technologies for early joint disease. We are pleased to have the opportunity to offer these innovative solutions. These new products reﬂect our vision to introduce solutions that make a meaningful difference for our surgeon customers and their patients. Technologies such as these also advance our objective to become the single-solution provider at every stage of the continuum of care, offering the most personalized and appropriate therapies for every condition and patient. Operational Excellence: Delivering Savings and Funding Growth In 2014, Zimmer continued to drive an ambitious global transformation, quality and operational excellence agenda. We are achieving efﬁciencies and process improvement with these programs and applying innovative thinking to nearly every aspect of our operations. Ongoing operational excellence programs include our strategic sourcing campaign for supplies and raw materials, the implementation of manufacturing best practices and the optimization of our logistics and inventory management systems. Since launching our global operational excellence initiatives in 2009, they have been a testament to continuously improving our business. Cost savings from these programs have supported operating margin expansion and funded growth-driving investments, including our research and development programs. The success of these initiatives also reinforces our conﬁdence in our ability to continue creating and returning value to stockholders in the future, as a combined entity with Biomet. Zimmer Biomet: Enhancing Our Leadership in the Global Musculoskeletal Healthcare Industry We continue to be excited as we anticipate concluding our historic combination with Biomet. Under the leadership of an experienced executive team drawn from both organizations, Zimmer Biomet will build upon the guiding principles and best practices that have made both companies innovation pioneers. As we have communicated previously, the compelling synergies inherent in this planned combination include operational excellence, manufacturing optimization and go-to- market strategies. Zimmer Biomet will offer attractive growth potential through a broader and more scalable portfolio of musculoskeletal solutions, including enhanced cross- selling opportunities. In addition to more diversiﬁed revenues, we expect to beneﬁt from signiﬁcant cash ﬂow generation and double-digit accretion to adjusted diluted earnings per share. Perhaps most important, this combination will signiﬁcantly enhance the resources and capabilities of our research and development pipeline. As a combined entity, Zimmer Biomet will be able to more rapidly and efﬁciently bring a comprehensive portfolio of solutions and services to the global market. Since announcing the transaction, we have worked closely with the leadership team and highly talented business units of Biomet. The success of this early collaboration has given us a greater appreciation for our shared values and capabilities on a combined basis. Our corporate cultures clearly represent a natural ﬁt, and we are proud to share a history of innovation based in Warsaw, Indiana. Our joint planning teams have done an impressive job of meeting key integration planning milestones, and we expect the transaction to close in the ﬁrst quarter of 2015 or shortly thereafter. As we forge ahead with integration planning activities, Zimmer will remain intently-focused on the highest level of customer support and driving our ongoing new product releases. A Transformational Year Ahead Our results in 2014 are evidence of Zimmer’s sustained focus on our strategic growth platform. We continued to drive the execution of our innovation and commercial strategies, while strengthening our culture of quality and operational excellence and growing our participation in exciting new markets. Looking to 2015, we remain bullish on our ability to seize the opportunities offered by the $45 billion global market for musculoskeletal technologies and treatments. While the year ahead promises to be a transformational one for Zimmer, we believe the Company is well positioned to continue delivering on our commitments. We will remain focused on clinical innovations that enhance the quality, efﬁciency and cost-effectiveness of musculoskeletal care for an evolving healthcare environment. On that basis, we will continue offering exceptional value to healthcare providers, their patients and healthcare systems. We will also carry forward our track record of operational excellence and sound capital management into this next phase of our development, backed by a comprehensive product portfolio and robust innovation pipeline. Zimmer’s ongoing success is in large part attributable to the dedicated efforts of more than 9,000 Team Members around the world. We join them in thanking you for the privilege to serve the global healthcare community, and for your ongoing support for Zimmer. David C. Dvorak President and Chief Executive Ofﬁcer Larry C. Glasscock Chairman of the Board UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For year ended December 31, 2014 Commission file number 001-16407 ZIMMER HOLDINGS, INC. (Exact name of registrant as specified in its charter) Delaware (State of Incorporation) 345 East Main Street Warsaw, Indiana 13-4151777 (IRS Employer Identification No.) 46580 (Address of principal executive offices) (Zip Code) Registrant’s telephone number, including area code: (574) 267-6131 Securities registered pursuant to Section 12(b) of the Act: Title of each class Common Stock, $.01 par value Name of each exchange on which registered New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes Í No ‘ Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ‘ No Í Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes Í No ‘ Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes Í No ‘ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Í Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One): Large accelerated filer Í Accelerated filer ‘ Non-accelerated filer ‘ (Do not check if a smaller reporting company) Smaller reporting company ‘ Indicate by checkmark whether the registrant is a shell company (as defined Exchange Act Rule 12b-2). Yes ‘ No Í The aggregate market value of shares held by non-affiliates was $17,501,425,466 (based on the closing price of these shares on the New York Stock Exchange on June 30, 2014 and assuming solely for the purpose of this calculation that all directors and executive officers of the registrant are “affiliates”). As of February 16, 2015, 169,902,991 shares of the registrant’s $.01 par value common stock were outstanding. Document Portions of the Proxy Statement with respect to the 2015 Annual Meeting of Stockholders Form 10-K Part III Documents Incorporated by Reference Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T Cautionary Note About Forward-Looking Statements This Annual Report on Form 10-K includes “forward-looking” statements within the meaning of federal securities laws. Forward-looking statements may be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as “may,” “will,” “can,” “should,” “would,” “could,” “anticipate,” “expect,” “plan,” “seek,” “believe,” “predict,” “estimate,” “potential,” “project,” “assume,” “guide,” “target,” “forecast,” “intend,” “strategy,” “is confident that,” “future,” “opportunity,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. A detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward- looking statements is included in the section titled “Risk Factors” (refer to Part I, Item 1A of this report). Readers of this report are cautioned not to place undue reliance on these forward-looking statements. While we believe the assumptions on which the forward-looking statements are based are reasonable, there can be no assurance that these forward-looking statements will prove to be accurate. We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. TABLE OF CONTENTS PART I Item 1. Item 1A. Item 1B. Item 2. Item 3. Item 4. PART II Item 5. Item 6. Item 7. Business Risk Factors Unresolved Staff Comments Properties Legal Proceedings Mine Safety Disclosures Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Selected Financial Data Management’s Discussion and Analysis of Financial Condition and Results of Operations Item 7A. Quantitative and Qualitative Disclosures About Market Risk Financial Statements and Supplementary Data Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Controls and Procedures Other Information Directors, Executive Officers and Corporate Governance Executive Compensation Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Certain Relationships and Related Transactions and Director Independence Principal Accounting Fees and Services Item 8. Item 9. Item 9A. Item 9B. PART III Item 10. Item 11. Item 12. Item 13. Item 14. PART IV Item 15. Exhibits, Financial Statement Schedules Page 3 3 9 16 17 17 17 18 18 19 20 30 35 71 71 71 72 72 72 72 72 72 73 73 2 Z I M M E R HOL D I NG S , I NC . PART I Item 1. Business Overview We are a global leader in the design, development, manufacture and marketing of orthopaedic reconstructive, spinal and trauma devices, biologics, dental implants and related surgical products. We also provide other healthcare related services. In this report, “Zimmer,” “we,” “us,” “our” and similar words refer collectively to Zimmer Holdings, Inc. and its subsidiaries. Zimmer Holdings refers to the parent company only. Zimmer Holdings was incorporated in Delaware in 2001. Our history dates to 1927, when Zimmer Manufacturing Company, a predecessor, was founded in Warsaw, Indiana. On August 6, 2001, Zimmer Holdings was spun off from its former parent and became an independent public company. On April 24, 2014, we entered into a definitive agreement to merge with LVB Acquisition, Inc. (LVB), the parent company of Biomet, Inc. (Biomet), in a cash and stock transaction valued at approximately $13.35 billion. We will pay $10.35 billion in cash, subject to certain adjustments, and issue 32.7 million shares of our common stock. In connection with the Biomet merger, we will pay off all of LVB’s outstanding funded debt, and the aggregate cash merger consideration will be reduced by such amount. The Biomet merger, which is subject to customary closing conditions and regulatory approvals, is expected to close in the first quarter of 2015. The merger will position the combined company as a leader in the $45 billion musculoskeletal industry. The Biomet merger is expected to be a transformational event for us and have significant effects on all aspects of our business. The description of our business in this report is for Zimmer on a standalone basis and does not address the consequences of the planned Biomet merger. Customers, Sales and Marketing Our primary customers include orthopaedic surgeons, neurosurgeons, oral surgeons, dentists, hospitals, stocking distributors, healthcare dealers and, in their capacity as agents, healthcare purchasing organizations or buying groups. These customers range from large multinational enterprises to independent clinicians and dentists. We have operations in more than 25 countries and market products in more than 100 countries. We manage our operations through three major geographic segments – the Americas, which is comprised principally of the U.S. and includes other North, Central and South American markets; Europe, which is comprised principally of Europe and includes the Middle East and African markets; and Asia Pacific, which is comprised primarily of Japan and includes other Asian and Pacific markets. We market and sell products through three principal channels: 1) direct to healthcare institutions, such as hospitals, referred to as direct channel accounts; 2) through stocking distributors and healthcare dealers; and 3) directly to dental 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T practices and dental laboratories. With direct channel accounts, inventory is generally consigned to sales agents or customers. With sales to stocking distributors, healthcare dealers, dental practices and dental laboratories, title to product passes upon shipment or upon implantation of the product. Direct channel accounts represented approximately 75 percent of our net sales in 2014. No individual direct channel account, stocking distributor, healthcare dealer, dental practice or dental laboratory accounted for more than 1 percent of our net sales for 2014. We stock inventory in our warehouse facilities and retain title to consigned inventory in sufficient quantities so that products are available when needed for surgical procedures. Safety stock levels are determined based on a number of factors, including demand, manufacturing lead times and quantities required to maintain service levels. We also carry trade accounts receivable balances based on credit terms that are generally consistent with local market practices. We utilize a network of sales associates, sales managers and support personnel, some of whom are employed or contracted by independent distributors and sales agencies. We invest a significant amount of time and expense in training sales associates in how to use specific products and how to best inform surgeons of product features and uses. Sales force representatives must have strong technical selling skills and medical education to provide technical support for surgeons. In response to the different healthcare systems throughout the world, our sales and marketing strategies and organizational structures differ by region. We utilize a global approach to sales force training, marketing and medical education to provide consistent, high quality service. Additionally, we keep current with key surgical developments and other issues related to orthopaedic surgeons, neurosurgeons, dentists and oral surgeons and the medical procedures they perform. The following is a summary of our three reportable segments. See Note 17 to the consolidated financial statements for more information regarding our segments. Americas. The Americas is our largest geographic segment, accounting for $2,594.2 million, or 56 percent, of 2014 net sales, with the U.S. accounting for 92 percent of net sales in this region. The U.S. sales force consists of a combination of employees and independent sales agents, most of whom sell products exclusively for Zimmer. The sales force in the U.S. receives a commission on product sales and is responsible for many operating decisions and costs. In this region, we contract with group purchasing organizations and managed care accounts and have promoted unit growth by offering volume discounts to customer healthcare institutions within a specified group. Generally, we are designated as one of several preferred purchasing sources for specified products, although members are not obligated to purchase our products. Contracts with group purchasing organizations generally have a term of three years, with extensions as warranted. 3 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T In the Americas, we monitor and rank independent sales Products agents and our direct sales force across a range of performance metrics, including the achievement of sales targets and maintenance of efficient levels of working capital. Europe. The European geographic segment accounted for $1,269.5 million, or 27 percent, of 2014 net sales, with France, Germany, Italy, Spain, Switzerland and the United Kingdom collectively accounting for 68 percent of net sales in the region. This segment also includes other key markets, including Benelux, Nordic, Central and Eastern Europe, the Middle East and Africa. Our sales force in this segment is comprised of direct sales associates, commissioned agents, independent distributors and sales support personnel. We emphasize the advantages of our clinically proven, established designs and innovative solutions and new and enhanced materials and surfaces. In most European countries, healthcare is sponsored by the government and therefore government budgets impact healthcare spending, which can affect our sales in this segment. Asia Pacific. The Asia Pacific geographic segment accounted for $809.6 million, or 17 percent, of 2014 net sales, with Japan being the largest market within this segment, accounting for 42 percent of the region’s sales. This segment also includes key markets such as Australia, New Zealand, Korea, China, Taiwan, India, Thailand, Singapore, Hong Kong and Malaysia. In Japan and most countries in the Asia Pacific region, we maintain a network of dealers, who act as order agents on behalf of hospitals in the region, and sales associates, who build and maintain relationships with orthopaedic surgeons, neurosurgeons and dental surgeons in their markets. The knowledge and skills of these sales associates play a critical role in providing service, product information and support to surgeons. We have a research and development center in Beijing, China, which focuses on products and technologies designed to meet the unique needs of Asian patients and their healthcare providers. Seasonality Our business is seasonal in nature to some extent, as many of our products are used in elective procedures, which typically decline during the summer months and can increase at the end of the year once annual deductibles have been met on health insurance plans. Distribution Our products include orthopaedic reconstructive implants, spinal and trauma devices, biologics, dental implants and related surgical products. ORTHOPAEDIC RECONSTRUCTIVE IMPLANTS Knees Total knee replacement surgeries typically include a femoral component, a patella (knee cap), a tibial tray and an articular surface (placed on the tibial tray). Knee replacement surgeries include first-time, or primary, joint replacement procedures and revision procedures for the replacement, repair or enhancement of an implant or component from a previous procedure. There are also procedures for partial reconstruction of the knee, which treat limited knee degeneration and involve the replacement of only one side, or compartment, of the knee with a unicompartmental knee prosthesis. Our knee portfolio also includes early intervention and joint preservation products, which seek to preserve the joint by repairing or regenerating damaged tissues and by treating osteoarthritis. Our significant knee brands include the following: (cid:129) Persona® The Personalized Knee System (cid:129) NexGen® Complete Knee Solution (cid:129) Natural-Knee® II System (cid:129) Innex® Total Knee System (cid:129) Zimmer® Unicompartmental High Flex Knee (cid:129) Zimmer Patient Specific Instruments (cid:129) Gel-One®1 Cross-linked Hyaluronate Hips Total hip replacement surgeries replace both the head of the femur and the socket portion of the pelvis (acetabulum) of the natural hip. Hip procedures include first-time, or primary, joint replacement as well as revision procedures. Hip implant procedures involve the use of bone cement to attach or affix the prosthetic components to the surrounding bone, or are press-fit into bone, which means that they have a surface that bone affixes to through either ongrowth or ingrowth technologies. Our significant hip brands include the following: (cid:129) Zimmer M/L Taper Hip Prosthesis and Zimmer M/L Taper Hip Prosthesis with Kinectiv® Technology (cid:129) Alloclassic® (Zweymüller®) Hip System (cid:129) CLS® Spotorno® Hip Stem and CLS Brevius® Stem We operate distribution facilities domestically in Southaven, Mississippi; and Carlsbad, California and internationally in Australia, Canada, China, France, Germany, India, Italy, Japan, Korea, Russia, South Africa, Spain, Switzerland, the United Kingdom, and various other countries. We generally ship our orders via expedited courier. We do not consider our backlog of firm orders to be material to an understanding of our business. with Kinectiv Technology (cid:129) Fitmore® Hip Stem (cid:129) Avenir® Müller Stem (cid:129) Wagner SL Revision® Hip Stem (cid:129) Continuum® Acetabular System (cid:129) Trilogy® IT Acetabular System (cid:129) Allofit® IT Alloclassic Acetabular System (cid:129) Trabecular MetalTM Modular Acetabular System 4 1 Registered trademark of Seikagaku Corporation Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T (cid:129) Vivacit-E® Highly Crosslinked Polyethylene Liners (cid:129) BIOLOX®2 delta Heads Extremities Our extremity portfolio, including shoulder, elbow and ankle products, is designed to treat arthritic conditions, soft tissue injuries and fractures. Our significant extremity brands include the following: (cid:129) Zimmer Trabecular Metal Reverse Shoulder System (cid:129) Bigliani/Flatow® Complete Shoulder Solution Family (cid:129) Sidus® Stem-Free Shoulder (cid:129) Zimmer Trabecular Metal Total Ankle (cid:129) Zimmer Coonrad/Morrey Total Elbow (cid:129) Nexel® Total Elbow DENTAL Our dental products division manufactures and/or distributes: (1) dental reconstructive implants – for individuals who are totally without teeth or are missing one or more teeth; (2) dental prosthetic products – aimed at providing a more natural restoration to resemble the original teeth; and (3) dental regenerative products – for soft tissue and bone rehabilitation. Our significant dental brands include the following: (cid:129) Tapered Screw-Vent® Implant System (cid:129) Hex-Lock® Contour Abutment and Restorative Products (cid:129) Puros® Allograft Products3 TRAUMA Trauma products include devices used to stabilize damaged or broken bones and their surrounding tissues to support the body’s natural healing processes. Fractures are most often stabilized using internal fixation devices such as plates, screws, nails, wires and pins, but may also be stabilized using external fixation devices. Biologics treatments are used in conjunction with traditional trauma devices to encourage healing and replace bone lost during an injury. Our significant trauma brands include the following: (cid:129) Zimmer Natural Nail® System (cid:129) NCB® Polyaxial Locking Plate System (cid:129) Zimmer Periarticular Locking Plate System (cid:129) Zimmer Universal Locking System (cid:129) Cable-Ready® Cable Grip System Our significant spine brands include the following: (cid:129) PathFinder NXT® Minimally Invasive Pedicle Screw System (cid:129) Trabecular Metal Implants (cid:129) Sequoia® Pedicle Screw System (cid:129) Trinica® Select Anterior Cervical Plate System (cid:129) Dynesys® Dynamic Stabilization System SURGICAL We develop, manufacture and market products that support reconstructive, trauma, spine and dental implant procedures, with a focus on bone cements, surgical wound site management, blood management and fluid waste management. Our significant surgical brands include the following: (cid:129) Transposal® and Transposal Ultra® Fluid Waste Management Systems (cid:129) PALACOS®4 Bone Cement (cid:129) A.T.S.® Automatic Tourniquet Systems Research and Development We have extensive research and development activities to develop new surgical techniques, materials, biologics and product designs. The research and development teams work closely with our strategic brand marketing function. The rapid commercialization of innovative new materials, biologics products, implant and instrument designs and surgical techniques remains one of our core strategies and continues to be an important driver of sales growth. We are broadening our offerings in each of our product categories and exploring new technologies with possible applications in multiple areas. Our primary research and development facility is located in Warsaw, Indiana. We have other research and development personnel based in, among other places, Montreal, Canada; Beijing, China; Winterthur, Switzerland; Austin, Texas; Minneapolis, Minnesota; Carlsbad, California; Philadelphia, Pennsylvania; Dover, Ohio; and Parsippany, New Jersey. As of December 31, 2014, we employed approximately 1,000 research and development employees worldwide. We expect to continue to identify innovative technologies, which may include acquiring complementary products or businesses, establishing technology licensing arrangements or strategic alliances. SPINE Government Regulation and Compliance Our Spine products division designs, manufactures and distributes medical devices and surgical instruments to deliver comprehensive solutions for those with back or neck pain caused by degenerative conditions, deformities or traumatic injury of the spine. 2 Registered trademark of CeramTec GmbH 3 Manufactured by RTI Surgical in Alachua, FL and Tutogen Medical GmbH, Germany (an RTI Surgical, Inc. company) and distributed by Zimmer Dental, Inc. We are subject to government regulation in the countries in which we conduct business. In the U.S., numerous laws and regulations govern all the processes by which medical devices are brought to market. These include, among others, the Federal Food, Drug and Cosmetic Act and regulations issued or promulgated thereunder. The Food and Drug Administration (FDA) has enacted regulations that control all aspects of the development, manufacture, advertising, promotion and postmarket surveillance of medical products, including medical devices. In addition, the FDA controls the 4 Registered trademark of Heraeus Medical GmbH 5 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T access of products to market through processes designed to ensure that only products that are safe and effective are made available to the public. Most of our new products fall into an FDA classification that requires the submission of a Premarket Notification (510(k)) to the FDA. This process requires us to demonstrate that the device to be marketed is at least as safe and effective as, that is, substantially equivalent to, a legally marketed device. We must submit information that supports our substantial equivalency claims. Before we can market the new device, we must receive an order from the FDA finding substantial equivalence and clearing the new device for commercial distribution in the U.S. Other devices we develop and market are in a category (class) for which the FDA has implemented stringent clinical investigation and Premarket Approval (PMA) requirements. The PMA process requires us to provide clinical and laboratory data that establishes that the new medical device is safe and effective. The FDA will approve the new device for commercial distribution if it determines that the data and information in the PMA application constitute valid scientific evidence and that there is reasonable assurance that the device is safe and effective for its intended use(s). All of our devices marketed in the U.S. have been cleared or approved by the FDA, with the exception of some devices which were in commercial distribution prior to May 28, 1976. The FDA has grandfathered these devices, so new FDA submissions are not required. Both before and after a product is commercially released, we have ongoing responsibilities under FDA regulations. The FDA reviews design and manufacturing practices, labeling and record keeping, and manufacturers’ required reports of adverse experiences and other information to identify potential problems with marketed medical devices. We are also subject to periodic inspection by the FDA for compliance with the FDA’s Quality System regulations among other FDA requirements, such as restrictions on advertising and promotion. The Quality System regulations govern the methods used in, and the facilities and controls used for, the design, manufacture, packaging and servicing of all finished medical devices intended for human use. If the FDA were to conclude that we are not in compliance with applicable laws or regulations, or that any of our medical devices are ineffective or pose an unreasonable health risk, the FDA could require us to notify healthcare professionals and others that the devices present unreasonable risks of substantial harm to the public health, order a recall, repair, replacement, or refund payment of such devices, detain or seize adulterated or misbranded medical devices, or ban such medical devices. regulatory requirements on the import of our products, including inspection and possible sanctions for noncompliance. We are also subject to foreign trade controls administered by certain U.S. government agencies, including the Bureau of Industry and Security within the Commerce Department and the Office of Foreign Assets Control within the Treasury Department. There are also requirements of state, local and foreign governments that we must comply with in the manufacture and marketing of our products. In many of the foreign countries in which we market our products, we are subject to local regulations affecting, among other things, design and product standards, packaging requirements and labeling requirements. Many of the regulations applicable to our devices and products in these countries are similar to those of the FDA. The member countries of the European Union have adopted the European Medical Device Directive, which creates a single set of medical device regulations for products marketed in all member countries. Compliance with the Medical Device Directive and certification to a quality system enable the manufacturer to place a CE mark on its products. To obtain authorization to affix the CE mark to a product, a recognized European Notified Body must assess a manufacturer’s quality systems and the product’s conformity to the requirements of the Medical Device Directive. We are subject to inspection by the Notified Bodies for compliance with these requirements. Further, we are subject to various federal, state and foreign laws concerning healthcare fraud and abuse, including false claims and anti-kickback laws, as well as the U.S. Physician Payments Sunshine Act and similar state and foreign healthcare professional payment transparency laws. These laws are administered by, among others, the U.S. Department of Justice, the Office of Inspector General of the Department of Health and Human Services, state attorneys general and various foreign government agencies. Many of these agencies have increased their enforcement activities with respect to medical device manufacturers in recent years. Violations of these laws are punishable by criminal and/or civil sanctions, including, in some instances, fines, imprisonment and, within the U.S., exclusion from participation in government healthcare programs, including Medicare, Medicaid and Veterans Administration (VA) health programs. Our operations in foreign countries are subject to the extraterritorial application of the U.S. Foreign Corrupt Practices Act. Our global operations are also subject to foreign anti-corruption laws, such as the UK Bribery Act, among others. As part of our global compliance program, we seek to address anti-corruption risks proactively. The FDA may also impose operating restrictions, enjoin Our facilities and operations are also subject to complex and/or restrain certain conduct resulting in violations of applicable law pertaining to medical devices, and assess civil or criminal penalties against our officers, employees or us. The FDA may also recommend prosecution to the U.S. Department of Justice. The FDA, in cooperation with U.S. Customs and Border Protection (CBP), administers controls over the import of medical devices into the U.S. The CBP imposes its own federal, state, local and foreign environmental and occupational safety laws and regulations, including those relating to discharges of substances in the air, water and land, the handling, storage and disposal of wastes and the clean-up of properties by pollutants. We do not expect that the ongoing costs of compliance with these environmental requirements will have a material impact on our consolidated earnings, capital expenditures or competitive position. 6 Z I M M E R HOL D I NG S , I NC . Competition The orthopaedics and broader musculoskeletal care industry is highly competitive. In the global markets for reconstructive implants, trauma and related surgical products, our major competitors include: the DePuy Synthes Companies of Johnson & Johnson, Stryker Corporation, Biomet, and Smith & Nephew plc. In the Americas geographic segment, we and the DePuy Synthes Companies, Stryker Corporation, Biomet, and Smith & Nephew, Inc. (a subsidiary of Smith & Nephew plc) account for a large majority of the total reconstructive and trauma implant sales. There are also many smaller competitors actively engaging in this market. Some of these smaller competitors have success by focusing on smaller subsegments of the industry. The European reconstructive implant and trauma product markets are more fragmented than those markets in the Americas or the Asia Pacific segments. The variety of philosophies held by European surgeons regarding hip reconstruction, for example, has fostered the existence of many regional European companies, including Aesculap AG (a subsidiary of B. Braun), Limacorporate S.p.A., Waldemar LINK GmbH & Co., KG and Mathys AG, which, in addition to the global competitors, compete with us. Many hip implants sold in Europe are products developed specifically for the European market. We intend to continue to develop and produce specially tailored products to meet specific European needs. In the Asia Pacific market for reconstructive implant and trauma products, we compete primarily with the DePuy Synthes Companies, Stryker Corporation, Smith & Nephew plc and Biomet, as well as regional companies, including Japan Medical Materials Corporation and Japan Medical Dynamic Marketing, Inc. Factors, such as the dealer system and complex regulatory environments, make it difficult for smaller companies, particularly those that are non-regional, to compete effectively with the market leaders in the more developed healthcare markets in the Asia Pacific region. In the spinal implant category, we compete globally primarily with the spinal and biologic business of Medtronic, Inc., the DePuy Synthes Companies, Stryker Corporation, Biomet Spine (a subsidiary of Biomet), NuVasive, Inc. and Globus Medical, Inc. In the dental implant category, we compete primarily with Nobel Biocare Holding AG, Straumann Holding AG, Dentsply International and Biomet 3i (a subsidiary of Biomet). Competition within the industry is primarily based on technology, innovation, quality, reputation and customer service. A key factor in our continuing success in the future will be our ability to develop new products and improve existing products and technologies. 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T Ireland; and Beijing, China. We also strategically outsource some manufacturing to qualified suppliers who are highly capable of producing components. The manufacturing operations at our facilities are designed to incorporate the cellular concept for production and to implement tenets of a manufacturing philosophy focused on continuous improvement efforts in product quality, lead time reduction and capacity optimization. Our continuous improvement efforts are driven by Lean and Six Sigma methodologies. In addition, at certain of our manufacturing facilities, many of the employees are cross-trained to perform a broad array of operations. We generally target operating our manufacturing facilities at optimal levels of total capacity. We continually evaluate the potential to in-source and out-source production as part of our manufacturing strategy to provide value to our stakeholders. We have improved our manufacturing processes to protect our profitability and offset the impact of inflationary costs. We have, for example, employed computer-assisted robots and multi-axis grinders to precision polish medical devices; automated certain manufacturing and inspection processes, including on-machine inspection and process controls; purchased state-of-the-art equipment; in-sourced core products and processes; and negotiated cost reductions from third-party suppliers. We use a diverse and broad range of raw materials in the manufacturing of our products. We purchase all of our raw materials and select components used in manufacturing our products from external suppliers. In addition, we purchase some supplies from single sources for reasons of quality assurance, sole source availability, cost effectiveness or constraints resulting from regulatory requirements. We work closely with our suppliers to assure continuity of supply while maintaining high quality and reliability. To date, we have not experienced any significant difficulty in locating and obtaining the materials necessary to fulfill our production schedules. Intellectual Property Patents and other proprietary rights are important to the continued success of our business. We also rely upon trade secrets, know-how, continuing technological innovation and licensing opportunities to develop and maintain our competitive position. We protect our proprietary rights through a variety of methods, including confidentiality agreements and proprietary information agreements with vendors, employees, consultants and others who may have access to proprietary information. We own or control through licensing arrangements more than 4,500 issued patents and patent applications throughout the world that relate to aspects of the technology incorporated in many of our products. Manufacturing and Raw Materials Employees We manufacture our products at various sites. Our significant manufacturing locations include Warsaw, Indiana; Winterthur, Switzerland; Ponce, Puerto Rico; Dover, Ohio; Carlsbad, California; Parsippany, New Jersey; Shannon, As of December 31, 2014, we employed approximately 10,000 employees worldwide, including approximately 1,000 employees dedicated to research and development. Approximately 5,600 employees are located within the U.S. 7 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T and approximately 4,400 employees are located outside of the U.S., primarily throughout Europe and in Japan. We have approximately 4,200 employees dedicated to manufacturing our products worldwide. The Warsaw, Indiana production facility employs approximately 1,800 employees. Approximately 190 U.S. employees are members of a trade union covered by a collective bargaining agreement. We have a collective bargaining agreement with the United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied Industrial and Service Workers International Union, AFL-CIO, CLC for and on behalf of Local 2737-15 covering employees at the Dover, Ohio facility, which continues in effect until May 15, 2015. EXECUTIVE OFFICERS The following table sets forth certain information with respect to our executive officers as of February 19, 2015. Name David C. Dvorak James T. Crines Joseph A. Cucolo Derek M. Davis Katarzyna Mazur-Hofsaess, M.D., Ph.D. Stephen H.L. Ooi Chad F. Phipps Age Position 51 55 55 46 51 61 43 President and Chief Executive Officer Executive Vice President, Finance and Chief Financial Officer President, Americas Vice President, Finance and Corporate Controller and Chief Accounting Officer President, Europe, Middle East and Africa President, Asia Pacific Senior Vice President, General Counsel and Secretary Mr. Dvorak was appointed President, Chief Executive Officer and a member of the Board of Directors in May 2007. From December 2005 to April 2007, he served as Group President, Global Businesses and Chief Legal Officer. Prior to that, he had served as Executive Vice President, Corporate Services, Chief Counsel and Secretary, as well as Chief Compliance Officer, since October 2003. Mr. Dvorak joined Zimmer in 2001. Mr. Crines was appointed Executive Vice President, Finance and Chief Financial Officer in May 2007. From December 2005 to April 2007, he served as Senior Vice President, Finance, Operations and Corporate Controller and Chief Accounting Officer. Prior to that, he had served as Senior Vice President, Finance/Controller and Information Technology since October 2003. Mr. Crines joined Zimmer in 1995. Mr. Cucolo was appointed President, Americas in September 2012. He is responsible for sales and management of the direct and indirect sales channels in the Americas region, including the United States, Canada and Latin America. From 1997 until he joined Zimmer as President, Americas, Mr. Cucolo was sole owner and President of Zimmer New England, Inc., an independent third-party distributor of Zimmer products in the northeast region of the United States. Prior to that, Mr. Cucolo was employed by Zimmer as a sales representative and territory manager in the New York area from 1987 to 1997. Mr. Davis was appointed Vice President, Finance and Corporate Controller and Chief Accounting Officer in May 2007. He has responsibility for internal and external reporting, planning and analysis, and corporate and business unit accounting. From March 2006 to May 2007, he served as Director, Financial Planning and Accounting. Prior to that, he had served as Director, Finance, Operations and Logistics since December 2003. Mr. Davis joined Zimmer in 2003. Dr. Mazur-Hofsaess was appointed President, Europe, Middle East and Africa in April 2013. She is responsible for the sales, 8 marketing and distribution of products in the European, Middle Eastern and African (EMEA) regions. Dr. Mazur- Hofsaess joined Zimmer in February 2010 as Senior Vice President, EMEA Sales and Marketing and was appointed President, EMEA Reconstructive in February 2012. She has approximately 20 years’ experience within the pharmaceutical, diagnostics and medical device sectors. Prior to joining Zimmer, Dr. Mazur-Hofsaess served in various management positions with Abbott Laboratories since 2001, including service as Vice President, Diagnostics – Europe. Mr. Ooi was appointed President, Asia Pacific in December 2005. He is responsible for the financial performance of the business in the Asia Pacific region, including sales, marketing and distribution of products. Prior to being appointed President, Asia Pacific, Mr. Ooi had served as President, Australasia since September 2003. He joined Zimmer in 1986. Mr. Phipps was appointed Senior Vice President, General Counsel and Secretary in May 2007. He has global responsibility for our legal affairs and he serves as Secretary to the Board of Directors. Mr. Phipps also oversees our Corporate Compliance, Government Affairs, Corporate Marketing and Communications and Public Relations activities. From December 2005 to May 2007, he served as Associate General Counsel and Corporate Secretary. Prior to that, he had served as Associate Counsel and Assistant Secretary since September 2003. Mr. Phipps joined Zimmer in 2003. Available Information Our Internet address is www.zimmer.com. We routinely post important information for investors on our website in the “Investor Relations” section, which may be accessed from our homepage at www.zimmer.com or directly at http:// investor.zimmer.com. We use this website as a means of disclosing material, non-public information and for complying Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T with our disclosure obligations under Regulation FD. Accordingly, investors should monitor the Investor Relations section of our website, in addition to following our press releases, Securities and Exchange Commission (SEC) filings, public conference calls, presentations and webcasts. Our goal is to maintain the Investor Relations website as a portal through which investors can easily find or navigate to pertinent information about us, free of charge, including: (cid:129) our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), as soon as reasonably practicable after we electronically file that material with or furnish it to the SEC; (cid:129) announcements of investor conferences and events at which our executives talk about our products and competitive strategies. Podcasts and archives of these events are also available; (cid:129) press releases on quarterly earnings, product announcements, legal developments and other material news that we may post from time to time; (cid:129) corporate governance information including our Corporate Governance Guidelines, Code of Business Conduct, Code of Ethics for Chief Executive Officer and Senior Financial Officers, information concerning our Board of Directors and its committees, including the charters of the Audit Committee, Compensation and Management Development Committee, Corporate Governance Committee and Research, Innovation and Technology Committee, and other governance-related policies; (cid:129) stockholder services information, including ways to contact our transfer agent and information on how to sign up for direct deposit of dividends or enroll in our dividend reinvestment plan; and (cid:129) opportunities to sign up for email alerts and RSS feeds to have information provided in real time. The information available on our website is not incorporated by reference in, or a part of, this or any other report we file with or furnish to the SEC. Item 1A. Risk Factors Risk factors which could cause actual results to differ from our expectations and which could negatively impact our financial condition and results of operations are discussed below and elsewhere in this report. Additional risks and uncertainties not presently known to us or that are currently not believed to be significant to our business may also affect our actual results and could harm our business, financial condition and results of operations. If any of the risks or uncertainties described below or any additional risks and uncertainties actually occur, our business, results of operations and financial condition could be materially and adversely affected. Risks Relating to the Proposed Biomet Merger and the Combined Company Following the Merger The following risk factors relate to certain risks and uncertainties associated with the pending Biomet merger and the combined company following the merger. The following discussion does not, however, contain all risks and uncertainties that relate to Biomet and its business on a standalone basis, which additional risks and uncertainties may also affect our actual results and could harm our business, financial condition and results of operations following the completion of the Biomet merger. There is no assurance when or if the merger will be completed. Any delay in completing the merger may substantially reduce the benefits that we expect to obtain from the merger. Completion of the merger is subject to the satisfaction or waiver of a number of conditions. There can be no assurance that we and LVB will be able to satisfy the closing conditions or that closing conditions beyond our control will be satisfied or waived. We and LVB can agree at any time to terminate the merger agreement, even though LVB stockholders have approved the merger, and we and LVB can also terminate the merger agreement under other specified circumstances. If the merger and the integration of the companies’ respective businesses are not completed within the expected timeframe, such delay may materially and adversely affect the synergies and other benefits that we expect to achieve as a result of the merger and could result in additional transaction costs, loss of revenue or other effects associated with uncertainty about the merger. We expect to incur substantial expenses related to the merger and the integration of Biomet. We expect to incur substantial expenses in connection with the merger and the integration of Biomet. There are a large number of processes, policies, procedures, operations, technologies and systems that must be integrated, including purchasing, accounting and finance, sales, billing, payroll, manufacturing, marketing and employee benefits. While we expect to incur integration and restructuring costs following completion of the merger in 2015 that are estimated to exceed $400 million in the first two years post-merger, many of the expenses that will be incurred are, by their nature, difficult to estimate accurately. These expenses could, particularly in the near term, exceed the savings that we expect to achieve from elimination of duplicative expenses and the realization of economies of scale and cost savings. Although we expect that the realization of efficiencies related to the integration of the businesses may offset incremental transaction, merger-related and restructuring costs over time, we cannot give any assurance that this net benefit will be achieved in the near term, or at all. We and LVB may be unable to obtain the regulatory approvals required to complete the merger. Completion of the merger is conditioned upon, among other conditions, the expiration or termination of any waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, the approval of the European Commission and the receipt of approval or expiration or termination of any waiting period under applicable antitrust, competition, fair trade or similar laws of Japan. We and LVB are pursuing all required consents, orders and approvals in accordance with the merger agreement. These consents, 9 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T orders and approvals may impose conditions on or require divestitures relating to our or Biomet’s divisions, operations or assets, or may impose requirements, limitations or costs or place restrictions on the conduct of the combined company’s business. The merger agreement requires us and LVB, among other things, to accept all such conditions, divestitures, requirements, limitations, costs or restrictions that may be imposed by regulatory entities. Such conditions, divestitures, requirements, limitations, costs or restrictions may jeopardize or delay completion of the merger, may reduce the anticipated benefits of the merger or may result in the abandonment of the merger. Further, no assurance can be given that the required consents, orders and approvals will be obtained or that the required conditions to closing will be satisfied, and, even if all such consents, orders and approvals are obtained and such conditions are satisfied, no assurance can be given as to the terms, conditions and timing of such consents, orders and approvals. The pendency of the merger could have an adverse effect on our and/or Biomet’s business, financial condition, results of operations or business prospects. The pendency of the merger could disrupt our and/or Biomet’s businesses in the following ways, among others: (cid:129) our and/or Biomet’s employees may experience uncertainty regarding their future roles in the combined company, which might adversely affect our and/or Biomet’s ability to retain, recruit and motivate key personnel; (cid:129) the attention of our and/or Biomet’s management may be directed towards the completion of the merger and other transaction-related considerations and may be diverted from the day-to-day business operations of us and/or Biomet, as applicable, and matters related to the merger may require commitments of time and resources that could otherwise have been devoted to other opportunities that might have been beneficial to us and/or Biomet, as applicable; and (cid:129) customers, suppliers and other third parties with business relationships with us and/or Biomet may decide not to renew or may decide to seek to terminate, change and/or renegotiate their relationships with us and/or Biomet as a result of the merger, whether pursuant to the terms of their existing agreements with us and/or Biomet or otherwise. Any of these matters could adversely affect the businesses of, or harm the financial condition, results of operations or business prospects of, us and/or Biomet. Failure to complete the merger could negatively impact our future business and financial results. If the merger is not completed, our ongoing business may be adversely affected. We will be subject to several risks, including the following: (cid:129) having to pay certain costs relating to the merger, such as legal, accounting, financial advisory, filing and printing fees; and (cid:129) focusing our management on the merger instead of on pursuing other opportunities that could have been beneficial to us and our stockholders, without realizing any of the benefits of having the merger completed. 10 We cannot assure you that, if the merger is not completed, these risks will not materialize and will not materially adversely affect our business and financial results. Successful integration of Biomet with us and successful operation of the combined company are not assured. Also, integrating our business with that of Biomet may divert the attention of management away from operations. If the merger is completed, Biomet will become an indirect wholly owned subsidiary of ours, but will initially continue its operations on a basis that is separate from our operations. There can be no assurance that after the merger Biomet will be able to maintain and grow its business and operations. In addition, the market segments in which Biomet operates may experience declines in demand and/or new competitors. Integrating and coordinating certain aspects of the operations and personnel of Biomet with ours will involve complex operational, technological and personnel-related challenges. This process will be time-consuming and expensive, will disrupt the businesses of both companies and may not result in the full benefits expected by us and Biomet, including cost synergies expected to arise from supply chain efficiencies and overlapping general and administrative functions. The potential difficulties, and resulting costs and delays, include: (cid:129) managing a larger combined company; (cid:129) consolidating corporate and administrative infrastructures; (cid:129) issues in integrating manufacturing, warehouse and distribution facilities, research and development and sales forces; (cid:129) difficulties attracting and retaining key personnel; (cid:129) loss of customers and suppliers and inability to attract new customers and suppliers; (cid:129) unanticipated issues in integrating information technology, communications and other systems; (cid:129) incompatibility of purchasing, logistics, marketing, administration and other systems and processes; and (cid:129) unforeseen and unexpected liabilities related to the merger or Biomet’s business. Additionally, the integration of our and Biomet’s operations, products and personnel may place a significant burden on management and other internal resources. The diversion of management’s attention, and any difficulties encountered in the transition and integration process, could harm the combined company’s business, financial condition and operating results. We will incur substantial additional indebtedness in connection with the merger and may not be able to meet all of our debt obligations. In connection with the merger, we entered into a $7.66 billion bridge credit agreement and a $4.35 billion bank credit agreement. Proceeds from the bank credit agreement and the anticipated issuance by us of up to $7.66 billion in aggregate principal amount of senior unsecured notes (or, if senior unsecured notes are not issued and sold prior to the closing date of the merger, drawings under the bridge credit agreement) will be used to finance, in part, the cash consideration for the merger, pay fees and the expenses incurred in connection with the merger and pay off all of Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T Biomet’s funded debt. Our debt outstanding as of December 31, 2014 was approximately $1.43 billion and, immediately after the completion of the merger, the combined company’s debt is anticipated to be approximately $12.09 billion. As of December 31, 2014, our debt service obligations, comprised of principal and interest (excluding capital leases and equipment notes), during the next 12 months would, in the absence of the merger, have been approximately $64.0 million. As a result of the increase in debt related to the merger, demands on the combined company’s cash resources will increase after the completion of the merger. The increased level of debt could, among other things: (cid:129) require the combined company to dedicate a large portion of its cash flow from operations to the servicing and repayment of its debt, thereby reducing funds available for working capital, capital expenditures, research and development expenditures and other general corporate requirements; (cid:129) limit the combined company’s ability to obtain additional financing to fund future working capital, capital expenditures, research and development expenditures and other general corporate requirements; (cid:129) limit the combined company’s flexibility in planning for, or reacting to, changes in its business and the industry in which we operate; (cid:129) restrict the combined company’s ability to make strategic acquisitions or dispositions or to exploit business opportunities; (cid:129) place the combined company at a competitive disadvantage compared to its competitors that have less debt; (cid:129) adversely affect the combined company’s credit rating, with the result that the cost of servicing the combined company’s indebtedness might increase and its ability to obtain surety bonds could be impaired; (cid:129) adversely affect the market price of our common stock; and (cid:129) limit the combined company’s ability to apply proceeds from an offering or asset sale to purposes other than the servicing and repayment of debt. If we are unable to obtain alternate financing through senior unsecured notes, it is unlikely that we will be able to repay the outstanding amounts under the bridge loan at maturity on the 364th day after completion of the merger. Any debt incurred to refinance the bridge loan may be on unfavorable terms. The merger may cause dilution to our earnings per share, which may negatively affect the market price of our common stock. Although we anticipate that the merger will have an immediate accretive impact on the combined company’s adjusted earnings per share, this expectation is based on factors that may not be realized and estimates that may materially change. We could also encounter additional transaction-related costs or other factors, such as the failure to realize all of the benefits anticipated to result from the merger. In addition, we expect that LVB stockholders and holders of LVB equity-based awards immediately prior to the merger will own, in the aggregate, approximately 16% of our outstanding shares after the merger, based on the number of outstanding shares of our common stock on December 31, 2014. Once additional shares are issued in the merger, the combined company’s earnings per share may be lower than our adjusted earnings per share would have been in the absence of the merger. All of these factors could cause dilution to earnings per share or decrease or delay the expected accretive effect of the merger, and cause a decrease in the market price of our common stock. There can be no assurance that any increase in adjusted earnings per share will occur, even over the long term. Any increase in adjusted earnings per share as a result of the merger is likely to require us, among other things, to successfully manage the combined company’s operations to increase our consolidated earnings after the merger. Risks Relating to Our Business Regardless of Whether the Proposed Biomet Merger is Consummated Our success depends on our ability to effectively develop and market our products against those of our competitors. We operate in a highly competitive environment. Our present or future products could be rendered obsolete or uneconomical by technological advances by one or more of our present or future competitors or by other therapies, including biological therapies. To remain competitive, we must continue to develop and acquire new products and technologies. Competition is primarily on the basis of: (cid:129) technology; (cid:129) innovation; (cid:129) quality; (cid:129) reputation; and (cid:129) customer service. In markets outside of the U.S., other factors influence competition as well, including: (cid:129) local distribution systems; (cid:129) complex regulatory environments; and (cid:129) differing medical philosophies and product preferences. Our competitors may: (cid:129) have greater financial, marketing and other resources than us; (cid:129) respond more quickly to new or emerging technologies; (cid:129) undertake more extensive marketing campaigns; (cid:129) adopt more aggressive pricing policies; or (cid:129) be more successful in attracting potential customers, employees and strategic partners. Any of these factors, alone or in combination, could cause us to have difficulty maintaining or increasing sales of our products. If we fail to retain the independent agents and distributors upon whom we rely heavily to market our products, customers may not buy our products and our revenue and profitability may decline. Our marketing success in the U.S. and abroad depends significantly upon our agents’ and distributors’ sales and service expertise in the marketplace. Many of these agents have developed professional relationships with existing and potential customers because of the agents’ detailed knowledge of products and instruments. A loss of a significant number of these agents could have a material adverse effect on our business and results of operations. 11 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T If we do not introduce new products in a timely manner, our products may become obsolete over time, customers may not buy our products and our revenue and profitability may decline. Demand for our products may change, in certain cases, in ways we may not anticipate because of: (cid:129) evolving customer needs; (cid:129) changing demographics; (cid:129) slowing industry growth rates; (cid:129) declines in the reconstructive implant market; (cid:129) the introduction of new products and technologies; (cid:129) evolving surgical philosophies; and (cid:129) evolving industry standards. Without the timely introduction of new products and enhancements, our products may become obsolete over time. If that happens, our revenue and operating results would suffer. The success of our new product offerings will depend on several factors, including our ability to: (cid:129) properly identify and anticipate customer needs; (cid:129) commercialize new products in a timely manner; (cid:129) manufacture and deliver instruments and products in sufficient volumes on time; (cid:129) differentiate our offerings from competitors’ offerings; (cid:129) achieve positive clinical outcomes for new products; (cid:129) satisfy the increased demands by healthcare payors, providers and patients for shorter hospital stays, faster post- operative recovery and lower-cost procedures; (cid:129) innovate and develop new materials, product designs and surgical techniques; and (cid:129) provide adequate medical education relating to new products. In addition, new materials, product designs and surgical techniques that we develop may not be accepted quickly, in some or all markets, because of, among other factors: (cid:129) entrenched patterns of clinical practice; (cid:129) the need for regulatory clearance; and (cid:129) uncertainty with respect to third-party reimbursement. Moreover, innovations generally require a substantial investment in research and development before we can determine their commercial viability and we may not have the financial resources necessary to fund the production. In addition, even if we are able to successfully develop enhancements or new generations of our products, these enhancements or new generations of products may not produce revenue in excess of the costs of development and they may be quickly rendered obsolete by changing customer preferences or the introduction by our competitors of products embodying new technologies or features. If third-party payors decline to reimburse our customers for our products or reduce reimbursement levels, the demand for our products may decline and our ability to sell our products profitably may be harmed. We sell our products and services to hospitals, doctors, dentists and other healthcare providers, all of which receive reimbursement for the healthcare services provided to their patients from third-party payors, such as domestic and international government programs, private insurance plans and managed care programs. These third-party payors may 12 deny reimbursement if they determine that a device used in a procedure was not in accordance with cost-effective treatment methods, as determined by the third-party payor, or was used for an unapproved indication. Third-party payors may also decline to reimburse for experimental procedures and devices. In addition, third-party payors are increasingly attempting to contain healthcare costs by limiting both coverage and the level of reimbursement for medical products and services. If third-party payors reduce reimbursement levels to hospitals and other healthcare providers for our products, demand for our products may decline, or we may experience increased pressure to reduce the prices of our products, which could have a material adverse effect on our sales and results of operations. We have also experienced downward pressure on product pricing and other effects of healthcare reform in our international markets. If key participants in government healthcare systems reduce the reimbursement levels for our products, our sales and results of operations may be adversely affected. The U.S. healthcare reform law includes provisions that may materially adversely affect our business and results of operations. The Patient Protection and Affordable Care Act of 2010, as amended by the Health Care and Education Affordability Reconciliation Act of 2010 (collectively, the Affordable Care Act), was signed into law in March 2010 and mandates health insurance coverage and other healthcare reforms with staggered effective dates from 2010 to 2018. As part of the Affordable Care Act, in January 2013 we began paying a 2.3 percent medical device excise tax on the vast majority of our U.S sales. We continue to identify ways to reduce spending in other areas to offset the earnings impact due to the tax. We have not been able to pass along the cost of the tax to hospitals, which continue to face cuts to their Medicare reimbursement under the Affordable Care Act and other legislation. Nor have we been able to offset the cost of the tax through higher sales volumes resulting from the expansion of health insurance coverage because of the demographics of the current uninsured population. The medical device excise tax regulations and subsequent guidance from the U.S. Department of Treasury have not lessened the burden of complying with the excise tax statute. In addition, without the implementation of proper safeguards, the Affordable Care Act’s Medicare payment reforms, such as accountable care organizations and bundled payments, could provide additional incentives for healthcare providers to reduce spending on some of our medical device products and reduce utilization of hospital procedures that use our products. Accordingly, while it is still too early to fully understand and predict the full impact of the Affordable Care Act on our business, ongoing implementation could have a material adverse effect on our results of operations and cash flows. The ongoing cost-containment efforts of healthcare purchasing organizations may have a material adverse effect on our results of operations. Many customers for our products have formed group purchasing organizations in an effort to contain costs. Group Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T purchasing organizations negotiate pricing arrangements with medical supply manufacturers and distributors, and these negotiated prices are made available to a group purchasing organization’s affiliated hospitals and other members. If we are not one of the providers selected by a group purchasing organization, affiliated hospitals and other members may be less likely to purchase our products, and, if the group purchasing organization has negotiated a strict compliance contract for another manufacturer’s products, we may be precluded from making sales to members of the group purchasing organization for the duration of the contractual arrangement. Our failure to respond to the cost-containment efforts of group purchasing organizations may cause us to lose market share to our competitors and could have a material adverse effect on our sales and results of operations. We are subject to various governmental regulations relating to the manufacturing, labeling and marketing of our products, non-compliance with which could adversely affect our business, financial condition and results of operations. selling our products and could have a material adverse effect on our business, financial condition and results of operations. In 2012, we received a warning letter from the FDA citing concerns relating to certain manufacturing and validation processes pertaining to Trilogy Acetabular System products manufactured at our Ponce, Puerto Rico manufacturing facility. As of December 31, 2014, the warning letter remains pending. Until the violations are corrected, we may become subject to additional regulatory action by the FDA, the FDA may refuse to grant premarket approval applications and/or the FDA may refuse to grant export certificates, any of which could have a material adverse effect on our business, financial condition and results of operations. Additional information regarding this and other FDA regulatory matters can be found in Note 19 to our consolidated financial statements (See Part II, Item 8 of this report). Our products and operations are also often subject to the rules of industrial standards bodies, such as the International Standards Organization. If we fail to adequately address any of these regulations, our business could be harmed. The medical devices we design, develop, manufacture and If we fail to comply with healthcare fraud and abuse market are subject to rigorous regulation by the FDA and numerous other federal, state and foreign governmental authorities. The process of obtaining regulatory approvals to market a medical device can be costly and time consuming and approvals might not be granted for future products on a timely basis, if at all. Delays in receipt of, or failure to obtain, approvals for future products could result in delayed realization of product revenues or in substantial additional costs. Both before and after a product is commercially released, we have ongoing responsibilities under FDA regulations. Compliance with the FDA’s requirements, including the Quality System regulation, recordkeeping regulations, labeling and promotional requirements and adverse event reporting regulations, is subject to continual review and is monitored rigorously through periodic inspections by the FDA, which may result in observations on Form 483, and in some cases warning letters, that require corrective action, or other forms of enforcement. If the FDA were to conclude that we are not in compliance with applicable laws or regulations, or that any of our medical devices are ineffective or pose an unreasonable health risk, the FDA could ban such medical devices, detain or seize adulterated or misbranded medical devices, order a recall, repair, replacement, or refund of payment of such devices, refuse to grant pending premarket approval applications, refuse to provide certificates to foreign governments for exports, and/or require us to notify healthcare professionals and others that the devices present unreasonable risks of substantial harm to the public health. The FDA may also impose operating restrictions on a company-wide basis, enjoin and restrain certain violations of applicable law pertaining to medical devices and assess civil or criminal penalties against our officers, employees or us. The FDA may also recommend prosecution to the U.S. Department of Justice. Any adverse regulatory action, depending on its magnitude, may restrict us from effectively marketing and laws and regulations, we could face substantial penalties and our business, operations and financial condition could be adversely affected. Our industry is subject to various federal, state and foreign laws and regulations pertaining to healthcare fraud and abuse, including the federal False Claims Act, the federal Anti- Kickback Statute, the federal Stark law, the federal Physician Payments Sunshine Act and similar state and foreign laws. Violations of these laws are punishable by criminal and/or civil sanctions, including, in some instances, fines, imprisonment and, within the U.S., exclusion from participation in government healthcare programs, including Medicare, Medicaid and Veterans Administration (VA) health programs. The interpretation and enforcement of these laws and regulations are uncertain and subject to rapid change. We conduct a significant amount of our sales activity outside of the U.S., which subjects us to additional business risks and may cause our profitability to decline due to increased costs. We sell our products in more than 100 countries and derived almost 50 percent of our net sales in 2014 from outside the U.S. We intend to continue to pursue growth opportunities in sales internationally, including in emerging markets, which could expose us to additional risks associated with international sales and operations. Our international operations are, and will continue to be, subject to a number of risks and potential costs, including: (cid:129) changes in foreign medical reimbursement policies and programs; (cid:129) unexpected changes in foreign regulatory requirements; (cid:129) differing local product preferences and product requirements; (cid:129) fluctuations in foreign currency exchange rates; (cid:129) diminished protection of intellectual property in some countries outside of the U.S.; 13 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T (cid:129) trade protection measures and import or export requirements that may prevent us from shipping products to a particular market and may increase our operating costs; (cid:129) foreign exchange controls that might prevent us from repatriating cash earned in countries outside the U.S.; (cid:129) complex data privacy requirements and labor relations laws; (cid:129) extraterritorial effects of U.S. laws such as the Foreign Corrupt Practices Act; (cid:129) effects of foreign anti-corruption laws, such as the UK Bribery Act; (cid:129) difficulty in staffing and managing foreign operations; (cid:129) labor force instability; (cid:129) potentially negative consequences from changes in tax laws; and (cid:129) political and economic instability. Violations of foreign laws or regulations could result in fines, criminal sanctions against us, our officers or our employees, prohibitions on the conduct of our business and damage to our reputation. We may have additional tax liabilities. We are subject to income taxes in the U.S. and many foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. We regularly are under audit by tax authorities. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different from our historical income tax provisions and accruals. The results of an audit or litigation could have a material effect on our financial statements in the period or periods for which that determination is made. We earn a significant amount of our operating income from outside the U.S., and any repatriation of funds representing earnings of foreign subsidiaries may significantly impact our effective tax rates. In addition, there have been proposals to change U.S. tax laws that would significantly impact how U.S. multinational corporations are taxed on foreign earnings. Although we cannot predict whether or in what form this proposed legislation will pass, if enacted it could have a material adverse impact on our tax expense and cash flow. We are subject to risks arising from currency exchange rate fluctuations, which can increase our costs, cause our profitability to decline and expose us to counterparty risks. Pending and future product liability claims and litigation could adversely impact our financial condition and results of operations and impair our reputation. Our business exposes us to potential product liability risks that are inherent in the design, manufacture and marketing of medical devices. In the ordinary course of business, we are the subject of product liability lawsuits alleging that component failures, manufacturing flaws, design defects or inadequate disclosure of product-related risks or product-related information resulted in an unsafe condition or injury to patients. As previously reported, we are defending product liability lawsuits relating to the Durom® Acetabular Component (Durom Cup) and certain products within the NexGen Knee System. The majority of the Durom Cup cases are pending in a federal Multidistrict Litigation in the District of New Jersey (In Re: Zimmer Durom Hip Cup Products Liability Litigation) and the majority of the NexGen Knee System cases are pending in a federal Multidistrict Litigation in the Northern District of Illinois (In Re: Zimmer NexGen Knee Implant Products Liability Litigation). We are also currently defending a number of other product liability lawsuits and claims related to various other products. Any product liability claim brought against us, with or without merit, can be costly to defend. Product liability lawsuits and claims, safety alerts or product recalls, regardless of their ultimate outcome, could have a material adverse effect on our business and reputation and on our ability to attract and retain customers. Although we maintain third-party product liability insurance coverage, we have substantial self-insured retention amounts that we must pay in full before obtaining any insurance proceeds to satisfy a judgment or settlement. Furthermore, even if any product liability loss is covered by our insurance, it is possible that claims against us may exceed the coverage limits of our insurance policies and we would have to pay the amount of any settlement or judgment that is in excess of our policy limits. Product liability claims in excess of applicable insurance could have a material adverse effect on our business, financial condition and results of operations. We are substantially dependent on patent and other proprietary rights, and failing to protect such rights or to be successful in litigation related to our rights or the rights of others may result in our payment of significant monetary damages and/or royalty payments, negatively impact our ability to sell current or future products, or prohibit us from enforcing our patent and other proprietary rights against others. A substantial portion of our foreign revenues is generated Claims of intellectual property infringement and litigation in Europe and Japan. The U.S. Dollar value of our foreign- generated revenues varies with currency exchange rate fluctuations. Significant increases in the value of the U.S. Dollar relative to the Euro or the Japanese Yen, as well as other currencies, could have a material adverse effect on our results of operations. Although we address currency risk management through regular operating and financing activities, and, on a limited basis, through the use of derivative financial instruments, those actions may not prove to be fully effective. regarding patent and other intellectual property rights are commonplace in our industry and are frequently time consuming and costly. At any given time, we may be involved as either plaintiff or defendant in a number of patent infringement actions, the outcomes of which may not be known for prolonged periods of time. While it is not possible to predict the outcome of patent and other intellectual property litigation, such litigation could result in our payment of significant monetary damages and/or royalty payments, negatively impact our ability to sell current or future products, or prohibit us from enforcing our patent and proprietary rights 14 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T against others, which could have a material adverse effect on our business and results of operations. Patents and other proprietary rights are essential to our business. We rely on a combination of patents, trade secrets and non-disclosure and other agreements to protect our proprietary intellectual property, and we will continue to do so. While we intend to defend against any threats to our intellectual property, these patents, trade secrets and other agreements may not adequately protect our intellectual property. Further, our currently pending or future patent applications may not result in patents being issued to us, patents issued to or licensed by us in the past or in the future may be challenged or circumvented by competitors, and such patents may be found invalid, unenforceable or insufficiently broad to protect our technology or to provide us with any competitive advantage. Third parties could obtain patents that may require us to negotiate licenses to conduct our business, and the required licenses may not be available on reasonable terms or at all. In addition, intellectual property rights may be unavailable or of limited effect in some foreign countries. If we do not obtain sufficient international protection for our intellectual property, our competitiveness in international markets could be impaired, which could limit our growth and revenue. We also attempt to protect our trade secrets, proprietary know-how and continuing technological innovation with security measures, including the use of non-disclosure and other agreements with our employees, consultants and collaborators. We cannot be certain that these agreements will not be breached, that we will have adequate remedies for any breach, that others will not independently develop substantially equivalent proprietary information, or that third parties will not otherwise gain access to our trade secrets or proprietary knowledge. We are involved in legal proceedings that may result in adverse outcomes. In addition to intellectual property and product liability claims and lawsuits, we are involved in various commercial litigation and claims and other legal proceedings that arise from time to time in the ordinary course of our business. Although we believe we have substantial defenses in these matters, litigation and other claims are subject to inherent uncertainties and management’s view of these matters may change in the future. Given the uncertain nature of legal proceedings generally, we are not able in all cases to estimate the amount or range of loss that could result from an unfavorable outcome. We could in the future incur judgments or enter into settlements of claims that could have a material adverse effect on our results of operations in any particular period. We are increasingly dependent on sophisticated information technology and if we fail to effectively maintain or protect the integrity of our information systems and data, our business could be adversely affected. We are increasingly dependent on sophisticated information technology for our products and infrastructure. As a result of technology initiatives, recently enacted regulations, changes in our system platforms and integration of new business acquisitions, we have been consolidating and integrating the number of systems we operate and have upgraded and expanded our information systems capabilities. Our information systems require an ongoing commitment of significant resources to maintain, protect, and enhance existing systems and develop new systems to keep pace with continuing changes in information technology, evolving systems and regulatory standards, and the increasing need to protect patient and customer information. In addition, third parties may attempt to gain unauthorized access to our products or systems and may obtain data relating to patients or our proprietary information. If we fail to maintain or protect our information systems and data integrity effectively, we could lose existing customers, have difficulty attracting new customers, have problems in determining product cost estimates and establishing appropriate pricing, have difficulty preventing, detecting, and controlling fraud, have disputes with customers, physicians, and other healthcare professionals, have regulatory sanctions or penalties imposed, have increases in operating expenses, incur expenses or lose revenues as a result of a data privacy breach, or suffer other adverse consequences. While we have invested heavily in the protection of our data and information technology, there can be no assurance that our activities related to consolidating the number of systems we operate, upgrading and expanding our information systems capabilities, protecting and enhancing our systems and implementing new systems will be successful or that systems issues will not arise in the future. Any significant breakdown, intrusion, interruption, corruption, or destruction of these systems could have a material adverse effect on our business. Future material impairments in the carrying value of our intangible assets, including goodwill, would negatively affect our operating results. Our assets include intangible assets, primarily goodwill. The goodwill results from our acquisition activity and represents the excess of the consideration transferred over the fair value of the net assets acquired. We assess at least annually whether events or changes in circumstances indicate that the carrying value of our intangible assets may not be recoverable. If the operating performance at one or more of our business units falls significantly below current levels, if competing or alternative technologies emerge, or if market conditions or future cash flow estimates for one or more of our businesses decline, we could be required, under current U.S. accounting rules, to record a non-cash charge to operating earnings for the amount of the impairment. Any write-off of a material portion of our unamortized intangible assets would negatively affect our results of operations. We depend on a limited number of suppliers for some key raw materials and outsourced activities. We use a number of suppliers for raw materials that we need to manufacture our products and to outsource some key manufacturing activities. These suppliers must provide the materials and perform the activities to our standards for us to meet our quality and regulatory requirements. Some key raw materials and outsourced activities can only be obtained from a 15 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T single source or a limited number of sources. A prolonged disruption or other inability to obtain these materials or outsource key manufacturing activities could materially and adversely affect our ability to satisfy demand for our products. The “conflict minerals” rule may adversely affect the sourcing, availability and pricing of materials used in the manufacture of our products, may increase our costs, cause our profitability to decline and harm our reputation. We are subject to the SEC’s rule regarding disclosure of the use of certain minerals, known as “conflict minerals” (tantalum, tin and tungsten (or their ores) and gold), which are mined from the Democratic Republic of the Congo and adjoining countries. We filed a report on Form SD with the SEC regarding such matters on June 2, 2014 and are required to file on an annual basis going forward. This rule could adversely affect the sourcing, availability and pricing of materials used in the manufacture of our products, which could adversely affect our manufacturing operations and our profitability. In addition, we are incurring additional costs to comply with this rule, including costs related to determining the source of any relevant minerals and metals used in our products. We have a complex supply chain and we may not be able to sufficiently verify the origins of the minerals and metals used in our products through the due diligence procedures that we implement. As a result, we may face reputational challenges with our customers and other stakeholders. Item 1B. Unresolved Staff Comments Not Applicable. 16 Z I M M E R HOL D I NG S , I NC . Item 2. Properties We have the following properties: Location Use Warsaw, Indiana Parsippany, New Jersey Warsaw, Indiana Warsaw, Indiana Carlsbad, California Minneapolis, Minnesota Southaven, Mississippi Dover, Ohio Research & Development, Manufacturing, Warehousing, Marketing & Administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Corporate Headquarters & The Zimmer Institute . . . . . . . . . . . . . . . . . . . . . . . Offices, Manufacturing & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Offices, Research & Development & Manufacturing . . . . . . . . . . . . . . . . . . . . . Offices & Research & Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Distribution Center . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Research & Development, Manufacturing & . . . . . . . . . . . . . . . . . . . . . . . . . . . . Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Office, Research & Development, Manufacturing, Warehousing & The Zimmer Institute . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Offices & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Memphis, Tennessee Offices, Administration, Research & Development . . . . . . . . . . . . . . . . . . . . . . Austin, Texas Offices & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sydney, Australia Offices & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mississauga, Canada Offices & Manufacturing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Beijing, China Offices & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Shanghai, China Offices & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Saint Priest, France Distribution Center . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eschbach, Germany Offices & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Freiburg, Germany Offices & Manufacturing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Shannon, Ireland Offices & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Milan, Italy Offices, Service Center & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gotemba, Japan Offices & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tokyo, Japan Offices & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Seoul, Korea Offices, Manufacturing & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Ponce, Puerto Rico Offices & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Singapore Offices & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Barcelona, Spain Offices, Research & Development & Manufacturing . . . . . . . . . . . . . . . . . . . . . Winterthur, Switzerland Münsingen, Switzerland Offices & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Swindon, United Kingdom Offices & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T Owned /Leased Square Feet Owned Owned Leased Leased Owned Leased Owned Leased Leased Leased Leased Leased Leased Leased Leased Leased Owned Leased Owned Leased Owned Leased Leased Owned Leased Leased Leased Owned Leased 1,400,000 117,000 83,000 125,000 51,000 189,000 138,000 64,000 132,000 30,000 71,000 60,000 52,000 89,000 52,000 13,000 94,000 75,000 125,000 55,000 87,000 20,000 34,000 225,000 19,000 30,000 425,000 76,000 10,000 We believe the current facilities, including manufacturing, warehousing, research and development and office space, provide sufficient capacity to meet ongoing demands. In addition to the above, we maintain more than 100 other offices and warehouse facilities in more than 25 countries around the world, including the U.S., Australia, Canada, China, France, Germany, India, Italy, Japan, Korea, Russia, South Africa, Spain, Switzerland, the United Kingdom. We believe that all of the facilities and equipment are in good condition, well maintained and able to operate at present levels. Item 3. Legal Proceedings Information pertaining to legal proceedings in which we are involved can be found in Note 19 to our consolidated financial statements (see Part II, Item 8 of this report). Item 4. Mine Safety Disclosures Not Applicable. 17 Z I M M E R HOL D I NG S , I NC . PART II 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Our common stock is traded on the New York Stock Exchange and the SIX Swiss Exchange under the symbol “ZMH.” The high and low sales prices for our common stock on the New York Stock Exchange and the dividends declared for the calendar quarters of fiscal years 2014 and 2013 are set forth as follows: QUARTERLY HIGH-LOW SHARE PRICES AND DECLARED DIVIDENDS Year Ended December 31, 2014: First Quarter Second Quarter Third Quarter Fourth Quarter Year Ended December 31, 2013: First Quarter Second Quarter Third Quarter Fourth Quarter High Low Declared Dividends $ 98.95 $108.33 $105.68 $116.14 $90.77 $90.48 $94.73 $95.33 $ 76.75 $ 81.92 $ 85.08 $ 93.70 $67.34 $72.31 $74.85 $80.55 $0.22 $0.22 $0.22 $0.22 $0.20 $0.20 $0.20 $0.20 We expect to continue paying cash dividends on a quarterly basis; however, future dividends are subject to approval of the Board of Directors and may be adjusted as business needs or market conditions change. As further discussed in Item 7 of this report, our debt facilities restrict the payment of dividends under certain circumstances. The number of holders of our common stock on February 16, 2015 was approximately 237,703. On February 19, 2015, the closing price of our common stock, as reported on the New York Stock Exchange, was $120.20 per share. The information required by this Item concerning equity compensation plans is incorporated by reference to Item 12 of this report. 18 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T 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): STATEMENT OF EARNINGS DATA Net sales Net earnings of Zimmer Holdings, Inc. Earnings per common share Basic Diluted Dividends declared per share of common stock Average common shares outstanding Basic Diluted BALANCE SHEET DATA Total assets Long-term debt Other long-term obligations Stockholders’ equity 2014 2013 2012 2011 2010 $4,673.3 720.1 $4,623.4 761.0 $4,471.7 755.0 $4,451.8 760.8 $4,220.2 596.9 $ $ 4.26 4.19 0.88 $ $ 4.49 4.43 0.80 $ $ 4.32 4.29 0.54 $ $ 4.05 4.03 0.18 $ $ 2.98 2.97 – 169.0 171.7 169.6 171.8 174.9 176.0 187.6 188.7 200.0 201.1 $9,634.7 1,425.5 648.6 6,522.6 $9,580.6 1,672.3 576.6 6,300.1 $9,012.4 1,720.8 559.3 5,866.3 $8,515.3 1,576.0 557.4 5,514.8 $7,999.9 1,142.1 384.0 5,771.3 19 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis should be read in conjunction with the consolidated financial statements and the corresponding notes included elsewhere in this Form 10-K. Certain percentages presented in this discussion and analysis are calculated from the underlying whole-dollar amounts and therefore may not recalculate from the rounded numbers used for disclosure purposes. Certain amounts in the 2013 and 2012 consolidated financial statements have been reclassified to conform to the 2014 presentation. Despite the increase in net sales, net earnings decreased, driven by increased spending on our operational excellence initiatives, integration planning expenses related to the pending Biomet merger, a $70.0 million contingent legal liability recognized in 2014, and increased debt issuance costs and unused commitment fees recognized on new debt facilities that we entered into in May 2014 in order to fund the pending Biomet merger. Forward-looking financial information provided in this 2015 Outlook management’s discussion and analysis does not include estimated results of operations, cash flows or financial position related to the pending Biomet merger, except for certain costs and expenses we expect to incur that are necessary to consummate the merger and that we will incur for integration planning prior to the merger closing. The Biomet merger is expected to be a transformational event for us and have significant effects on all aspects of our business. This management’s discussion and analysis of our historical financial condition and results of operations on a standalone basis is not indicative of the financial condition and results of operations for future periods on a combined company basis following the merger. EXECUTIVE LEVEL OVERVIEW 2014 Results Our 2014 sales results reflected increased growth as compared with 2013. Sales from recent product introductions, such as Persona The Personalized Knee System, as well as a stable joint replacement market, drove sales volume and product mix growth. This was partially offset by continued pricing pressure, negative effects from changes in foreign currency exchange rates, and a year-over-year decline in sales of our Transposal Fluid Waste Management System. RESULTS OF OPERATIONS Net Sales by Reportable Segment The pending Biomet merger, which we expect to close in the first quarter of 2015, will have a significant impact on our 2015 operating results. This report does not include guidance for 2015 on a combined company basis. However, for Zimmer on a standalone basis, we project that our net sales will face significant headwinds from the U.S. Dollar strengthening against the Euro, Japanese Yen and various other currencies around the world based upon recent foreign currency exchange rates. Additionally for net sales, we expect to experience volume and mix growth from a stable joint replacement market and continued pricing pressure. In regards to expenses on a Zimmer standalone basis, due to our hedging program, we project that the expected decrease in net sales caused by changes in foreign currency exchange rates will be partially offset by hedge gains to be recognized in 2015. We expect research and development (R&D) spending will remain similar compared to prior years as a percentage of net sales. For our selling, general and administrative (SG&A) expenses, we expect to continue to realize efficiencies from our operational excellence initiatives. However, since many of our fixed SG&A expenses are denominated in U.S. Dollars, such as corporate and business unit headquarter expenses and intangible asset amortization, our SG&A expenses may not decrease in similar proportion to net sales decreases expected from changes in foreign currency exchange rates. The following tables present net sales by reportable segment and the components of the percentage changes (dollars in millions): Americas Europe Asia Pacific Total 20 Year Ended December 31, 2014 2013 % Inc/(Dec) Volume/ Mix Price Foreign Exchange $2,594.2 $2,619.8 (1)% 2% (3)% 1,269.5 1,212.6 809.6 791.0 $4,673.3 $4,623.4 5 2 1 7 9 4 –% – (6) (2) (1) (2) (1) Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T Americas Europe Asia Pacific Total Year Ended December 31, 2013 2012 % Inc/(Dec) Volume/ Mix Price Foreign Exchange $2,619.8 $2,476.3 1,212.6 1,177.4 791.0 818.0 6% 3 (3) $4,623.4 $4,471.7 3 8% (2)% 2 8 7 (1) (1) (2) –% 2 (10) (2) “Foreign Exchange” as used in the tables in this report represents the effect of changes in foreign currency exchange rates on sales growth. Net Sales by Product Category The following tables present net sales by product category and the components of the percentage changes (dollars in millions): Year Ended December 31, 2014 2013 % Inc (Dec) Volume/ Mix Price Foreign Exchange Reconstructive Knees Hips Extremities Total Dental Trauma Spine Surgical and other Total Reconstructive Knees Hips Extremities Total Dental Trauma Spine Surgical and other Total $1,965.8 1,326.4 204.3 $1,909.9 1,330.5 193.8 3,496.5 3,434.2 242.8 316.7 207.2 410.1 239.3 315.6 202.3 432.0 $4,673.3 $4,623.4 3% – 5 2 1 – 2 (5) 1 7% (3)% (1)% 4 9 (3) (3) (1) (1) 6 2 3 5 (3) 4 (3) – (1) (2) – (2) (1) (1) (2) (1) (2) (1) Year Ended December 31, 2013 2012 % Inc (Dec) Volume/ Mix Price Foreign Exchange $1,909.9 1,330.5 193.8 $1,833.8 1,342.0 173.8 3,434.2 3,349.6 239.3 315.6 202.3 432.0 237.7 307.9 208.9 367.6 $4,623.4 $4,471.7 4% (1) 11 3 1 2 (3) 18 3 7% (2)% (1)% 3 14 (2) (2) (2) (1) 6 – 6 (1) 21 7 (2) – (1) (2) – (2) (1) 1 (3) – (3) (2) 21 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T The following table presents net sales by product category by region (dollars in millions): Reconstructive Knees Americas Europe Asia Pacific Hips Americas Europe Asia Pacific Extremities Americas Europe Asia Pacific Total Dental Americas Europe Asia Pacific Trauma Americas Europe Asia Pacific Spine Americas Europe Asia Pacific Surgical and other Americas Europe Asia Pacific Total Year Ended December 31, 2014 2013 2012 2014 vs. 2013 % Inc (Dec) 2013 vs. 2012 % Inc (Dec) $1,157.4 498.6 309.8 $1,135.3 468.3 306.3 $1,077.9 447.3 308.6 607.8 448.9 269.7 149.6 40.6 14.1 621.0 445.0 264.5 148.1 34.0 11.7 606.7 446.0 289.3 133.8 29.0 11.0 3,496.5 3,434.2 3,349.6 142.1 80.3 20.4 147.3 82.1 87.3 131.3 50.8 25.1 258.7 68.2 83.2 141.6 78.6 19.1 155.6 76.4 83.6 129.6 49.8 22.9 288.6 60.5 82.9 137.8 79.8 20.1 155.2 69.5 83.2 140.0 49.3 19.6 224.9 56.5 86.2 $4,673.3 $4,623.4 $4,471.7 2% 6 1 (2) 1 2 1 19 20 2 – 2 7 (5) 8 4 1 2 10 (10) 13 – 1 5% 5 (1) 2 – (9) 11 17 7 3 3 (2) (5) – 10 – (7) 1 17 28 7 (4) 3 Demand (Volume and Mix) Trends Increased volume and changes in the mix of product sales contributed 4 percentage points of year-over-year sales growth in 2014, which was a lower growth rate than experienced in 2013 compared to 2012. In 2013, accelerated growth was fueled by the introduction of new products, such as Persona The Personalized Knee System and the Transposal Fluid Waste Management System. In 2014, while new products continued to drive sales growth, their impact on a year-over- year basis was not as significant. We believe long-term indicators point toward sustained growth driven by an aging global population, growth in emerging markets, obesity, proven clinical benefits, new material technologies, advances in surgical techniques and more active lifestyles, among other factors. In addition, demand for clinically proven premium products and patient specific devices are expected to continue to positively affect sales growth in markets that recognize the value of these advanced technologies. Pricing Trends Global selling prices had a negative effect of 2 percent on year-over-year sales during 2014. The negative 2 percent was 22 consistent with prior years as we continued to experience pricing pressure from governmental healthcare cost containment efforts and from local hospitals and health systems. For 2015, we expect continued pricing pressure similar to prior years. Foreign Currency Exchange Rates For 2014, foreign currency exchange rates resulted in a 1 percent decrease in sales, driven by the strengthening of the U.S. Dollar versus the Japanese Yen as well as a few other currencies in other regions in which we operate. If foreign currency exchange rates remain consistent with December 31, 2014 rates, we estimate that a stronger dollar versus foreign currency exchange rates will have a greater negative effect on sales in 2015 than in 2014. We address currency risk through regular operating and financing activities and through the use of foreign currency forward contracts and foreign currency options solely to manage foreign currency volatility and risk. Changes to foreign currency exchange rates affect sales growth, but due to gains/losses on hedge contracts and options, which are recorded in cost of products sold, the effect on net earnings in the near term is expected to be partially offset. Z I M M E R HOL D I NG S , I NC . Sales by Product Category Knees Knee sales increased 3 percent in 2014 compared to a 4 percent increase in 2013. Our Knee product category has benefited from recent product introductions, such as Persona The Personalized Knee System and joint preservation solutions. However, the volume/mix growth from new product introductions has been tempered by pricing pressure in all our reporting segments. In 2014, we continued a broader launch of Persona The Personalized Knee System. We intend to continue to deploy implant and instrument sets for this knee system to all geographic regions in 2015 and beyond. Our NexGen Complete Knee Solution product line is still our leading global knee system in terms of sales. Products driving growth in this category, in addition to Persona The Personalized Knee System, included the Zimmer Unicompartmental High Flex Knee and our joint preservation solutions. In Europe, changes in foreign currency exchange rates affected Knee sales in 2014 and 2013 by negative 1 percent and positive 2 percent, respectively. In Asia Pacific, changes in foreign currency exchange rates had negative effects on Knee sales of 5 percent and 9 percent in 2014 and 2013, respectively. Hips Hip sales were flat in 2014 after a decline of 1 percent in 2013. Positive volume and mix trends continue to be offset by pricing pressure. Leading hip stem sales were the Zimmer M/L Taper Hip Prosthesis, the Zimmer M/L Taper Hip Prosthesis with Kinectiv Technology, the CLS Spotorno Stem from the CLS Hip System, the Alloclassic Zweymüller Hip Stem and the Fitmore Hip Stem. Products experiencing growth in this category included the Avenir Müller Stem, the Wagner SL Revision Hip Stem, the Continuum Acetabular System, the Trilogy IT Acetabular System, the Allofit IT Alloclassic Acetabular System, Vivacit-E Highly Crosslinked Polyethylene Liners and BIOLOX delta Heads. In Europe, changes in foreign currency exchange rates affected Hip sales in 2014 and 2013 by negative 1 percent and positive 2 percent, respectively. In Asia Pacific, changes in foreign currency exchange rates had negative effects on Hip sales of 6 percent and 11 percent in 2014 and 2013, respectively. Extremities Extremities sales increased 5 percent in 2014 compared to an 11 percent increase in 2013. The sales increase in both years reflected growth from our shoulder systems, such as the Zimmer Trabecular Metal Reverse Shoulder System and the 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T Sidus Stem-Free Shoulder, and a broader product portfolio to compete in the foot and ankle and hand and wrist areas of the Extremities category. The broader portfolio includes the Zimmer Trabecular Metal Total Ankle and products from the acquisition of NORMED Medizin-Technik GmbH in June 2013. Dental Dental sales increased 1 percent in 2014, which was the same as the prior year sales growth. Increased sales of dental reconstructive implants and digital solutions have been partially offset by decreases in restorative products. Sales were led by the Tapered Screw-Vent Implant System. In our Dental product category, in certain markets, especially in our Asia Pacific region, our customers are distributors. The timing of distributor purchases can have a significant influence on sales in those markets in any particular year. Trauma Trauma sales were flat in 2014 and increased by 2 percent in 2013. New product launches, especially in our Europe and Asia Pacific reporting segments, positively affected sales in both years. The Zimmer Natural Nail System and Zimmer Periarticular Locking Plates System led Trauma sales. Spine Spine sales increased 2 percent in 2014 after a decline of 3 percent in 2013. In 2014, we continued to focus on and had success in commercializing offerings across our core fusion portfolio and market adjacencies, including minimally invasive surgeries. Solid sales of the PathFinder NXT Minimally Invasive Pedicle Screw System and Trabecular Metal Technology products were partially offset by a decline in sales of other spine products. Surgical and other Surgical and other sales declined by 5 percent in 2014 after an 18 percent sales increase in 2013. The primary cause of the sales fluctuations in this product category was the Transposal Fluid Waste Management System. This system is comprised of a capital equipment component that is used with a one-time use disposable manifold component. In 2013, our system benefitted from commercial disruption experienced by a competitive product, increasing demand for the capital equipment component. With that competitive product back on the market in 2014 and since many customers bought our capital equipment component in 2013, sales of the capital equipment component decreased significantly in 2014. However, this decrease was partially offset by an increase in sales of the related disposable manifold component. Other products leading sales in this category were PALACOS Bone Cement, tourniquets and wound debridement devices. 23 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T The following table presents estimated* 2014 global market size and market share information (dollars in billions): Reconstructive Knees Hips Extremities Total Dental Trauma Spine*** Global Market Size $ 7.6 6.5 1.9 $16.0 $ 3.4 $ 5.9 $ 9.0 Global Market % Growth** Zimmer Market Share Zimmer Market Position 3% 2 12 4 3 5 2 26% 21 11 22 7 5 2 1 2 6 1 5 4 8 * Estimates are not precise and are based on competitor annual filings, Wall Street equity research and Company estimates ** Excludes the effect of changes in foreign currency exchange rates on sales growth *** Spine includes related orthobiologics Expenses as a Percent of Net Sales Year Ended December 31, 2014 2013 2012 2014 vs. 2013 Inc (Dec) 2013 vs. 2012 Inc (Dec) 26.7% 27.8% 25.2% (1.1) 2.6 4.0 4.4 5.0 (0.4) (0.6) 39.0 0.5 – 7.6 22.1 39.7 1.0 – 4.7 22.4 40.4 0.3 2.1 3.5 23.4 (0.7) (0.5) – 2.9 (0.3) (0.7) 0.7 (2.1) 1.2 (1.0) Cost of products sold Research and development Selling, general and administrative Certain claims Goodwill impairment Special items Operating margin Cost of Products Sold The following table sets forth the factors that contributed to the gross margin changes in each of 2014 and 2013 compared to the prior year: Prior year gross margin Lower average selling prices Average cost per unit Excess and obsolete inventory Discontinued products and other certain excess Year Ended December 31, 2014 2013 72.2% (0.6) 0.4 0.4 74.8% (0.4) (1.2) (0.2) and obsolete inventory charges 0.9 (1.0) Certain inventory and manufacturing related charges related to quality Foreign currency hedges Inventory step-up U.S. medical device excise tax Other Current year gross margin 0.1 0.5 0.1 (0.5) (0.2) (0.3) 0.5 (0.1) (0.2) 0.3 73.3% 72.2% The increase in gross margin percentage in 2014 compared to 2013 was primarily due to significant excess and obsolete inventory charges recorded in 2013 related to products we intend to discontinue. We also recognized higher hedge gains in 2014 from our foreign currency hedging program compared to 2013. Under the hedging program, for 24 derivatives which qualify as hedges of future cash flows, the effective portion of changes in fair value is temporarily recorded in other comprehensive income and then recognized in cost of products sold when the hedged items affect earnings. Further, we experienced improved product category mix, resulting in lower average costs per unit sold. These favorable items were partially offset by lower average selling prices and the U.S. medical device excise tax. While we began paying the medical device excise tax in 2013, based upon the levels of inventory we were carrying before the excise tax was effective on January 1, 2013, we did not recognize any significant expenses from the excise tax until the fourth quarter of 2013. We are in discussions with the Internal Revenue Service (IRS) as to what an appropriate constructive sales price used to compute our excise tax obligations should be under IRS excise tax regulations and our specific business model. Our ultimate medical device excise tax and liability may differ from the amount we have estimated. Accordingly, the amount we have recognized as expense is an estimate and subject to change. The decrease in gross margin in 2013 was primarily due to higher average costs per unit sold as a result of changes in product and geographic mix and increased excess and obsolescence charges related to products we intend to discontinue. Additionally, lower average selling prices and certain inventory and manufacturing related charges connected to quality enhancement and remediation efforts reduced gross margin. These negative effects were partially offset by hedge gains recorded in 2013 from our foreign currency hedging program versus hedge losses recorded in 2012. Operating Expenses R&D expenses and R&D as a percentage of sales have declined in the last three years. The lower spending reflected a natural decline from certain large projects that achieved commercialization, including Persona The Personalized Knee System, and a dedication of resources to our quality and operational excellence initiatives. We expect R&D spending in 2015 to increase and be between 4 and 4.5 percent of sales as we transition our resources towards new projects as our quality and operational excellence initiatives continue to progress. SG&A expenses have remained relatively consistent while SG&A as a percentage of sales has decreased over the last three years. Improvement in SG&A expenditures as a percentage of sales reflects the effects of our operational excellence initiatives. Although variable expenses naturally increase with higher sales, our SG&A expenses as a percentage of sales has decreased due to our operational excellence initiatives which produced lower variable and fixed costs in SG&A as net sales increased. Additionally, selling and distribution expenses are lower in our Europe and Asia Pacific reporting segments compared to our Americas reporting segment. The mix of revenues with high sales growth in Europe and Asia Pacific compared to the Americas helped to lower SG&A as a percentage of sales in 2014 when compared to 2013. Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T “Certain claims” expense is for estimated liabilities to Durom Cup patients undergoing revision surgeries. We recorded additional expense of $21.5 million in 2014, bringing the total recorded expense to $420.3 million for these claims, excluding a subset of Durom Cup claims that were recorded in SG&A. The additional expense recorded in 2014 was the result of new developments related to international claims activity. For more information regarding these claims, see Note 19 to the consolidated financial statements. In connection with our annual goodwill impairment test performed in the fourth quarter of 2012, we noted that the carrying values of the net assets of our U.S. Spine reporting unit were in excess of the reporting unit’s estimated fair value. As a result, we recorded a goodwill impairment charge of $96.0 million in 2012. We did not record a goodwill impairment charge in 2014 or 2013, as our annual goodwill impairment tests revealed that the carrying values of the net assets of our U.S. Spine reporting unit were less than their estimated fair value. For more information regarding goodwill impairment and the factors that led to the 2012 impairment, see Note 8 to the consolidated financial statements. “Special items” have increased significantly in the past three years. The increase in 2014 was a result of higher professional fees related to the pending Biomet merger, increased other professional fees, contract labor and dedicated project personnel related to our quality and operational excellence initiatives, increased intangible asset impairments and a $70.0 million accrual for a certain litigation matter. We continue to implement our quality and operational excellence initiatives, which are intended to improve our future operating results by centralizing or outsourcing certain functions and improving quality, distribution, sourcing, manufacturing and our information technology systems. “Special items” expenses include consulting and professional fees, dedicated personnel costs, severance benefits as well as other costs for those programs. In addition to expenses for our quality and operational excellence programs, we recognize expenses related to integration of acquired businesses, impairment of assets, certain R&D agreements, certain litigation settlements, contract termination expenses and other items as “Special items.” See Note 2 to the consolidated financial statements for more information regarding “Special items” charges. Other Expense, Interest Income, Interest Expense, and Income Taxes Other expense represents debt issuance costs and unused commitment fees recognized for our senior credit facility and bridge credit agreement that we entered into in May 2014 in order to fund the pending Biomet merger. Interest income and expense, net, was lower in 2014 compared to 2013 and 2012. In the second half of 2013, we entered into additional fixed-to-variable rate interest swaps designated as fair value hedges. In the 2014 periods, the variable rates we paid on the swaps were lower than the fixed rate on the hedged debt and, therefore, interest expense decreased. Our effective tax rate (ETR) on earnings before income taxes for the years ended December 31, 2014, 2013 and 2012 was 23.8 percent, 22.6 percent and 24.0 percent, respectively. The variation of our ETR has largely been affected by “Special items”, “Certain claims”, goodwill impairment charges and a $34.3 million benefit in 2012 from the recognition of deferred tax assets related to a legal entity restructuring. Higher “Special items” and “Certain claims” expense favorably affect our ETR because most of these expenses have been incurred within jurisdictions with higher tax rates, resulting in lower taxable income in these higher tax jurisdictions. Goodwill impairment negatively affects our ETR because no tax benefit is recorded on the charge. In 2014, a portion of our “Special items” were for non-deductible expenses incurred related to the pending Biomet merger, which increased our ETR relative to 2013. In 2013, in addition to the effect of “Special items” and “Certain claims”, our ETR benefited from the retroactive reinstatement of the R&D tax credit and other tax benefits applicable to us that applied to 2012 and 2013. Due to the timing of the extension and the applicable rules of accounting principles generally accepted in the United States of America (GAAP), we recognized the 2012 benefit in 2013. Despite the $34.3 million benefit in 2012 from the recognition of deferred tax assets related to a legal entity restructuring, the 2012 ETR was higher than 2014 and 2013 due to the goodwill impairment charge and lower “Certain claims” and “Special items” expenses. The items discussed accounted for the majority of the variation in our ETRs in the past three years. Segment Operating Profit For our reporting segments, operating profit increased in Europe and Asia Pacific in 2014 compared to 2013, while in the Americas it decreased. The decrease in the Americas was primarily from lower gross profit due to lower sales and the effect of the U.S. medical device excise tax. In Europe, the increase in operating profit was driven by increased sales coupled with controlled operating expenses. Operating expenses increased at a lower percentage compared to sales increases due to our operational excellence initiatives and the nature of fixed versus variable expenses resulting in operating margin expansion in Europe. The increase in operating profit in Asia Pacific was driven by increases in sales from volume and product mix. While changes in foreign currency exchange rates tempered sales growth in Asia Pacific, this decline was largely offset by increased hedge gains recorded in 2014 versus 2013. Non-GAAP operating performance measures We use financial measures that differ from financial measures determined in accordance with GAAP to evaluate our operating performance. These non-GAAP financial measures exclude the impact of inventory step-up, certain inventory and manufacturing related charges connected to quality enhancement and remediation efforts, “Certain claims,” goodwill impairment, “Special items,” other expenses related to financing obtained for the pending Biomet merger and any related effects on our income tax provision associated with 25 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T these items. We use this information internally and believe it is helpful to investors because it allows more meaningful period- to-period comparisons of our ongoing operating results, it helps to perform trend analysis and to better identify operating trends that may otherwise be masked or distorted by these types of items, and it provides a higher degree of transparency of certain items. Certain of these non-GAAP financial measures are used as metrics for our incentive compensation programs. Our non-GAAP adjusted net earnings used for internal management purposes for the years ended December 31, 2014, 2013 and 2012 were $1,041.0 million, $988.4 million, and $932.5 million, respectively, and our non-GAAP adjusted diluted earnings per share were $6.06, $5.75, and $5.30, respectively. The following are reconciliations from our GAAP net earnings and diluted earnings per share to our non-GAAP adjusted net earnings and non-GAAP adjusted diluted earnings per share used for internal management purposes (in millions, except per share amounts). Net Earnings of Zimmer Holdings, Inc. Inventory step-up and other inventory and manufacturing related charges Certain claims Goodwill impairment Special items Other expense on Biomet merger financing Taxes on above items and other certain Year ended December 31, 2014 2013 2012 $ 720.1 $ 761.0 $755.0 21.2 21.5 – 356.5 39.6 70.5 47.0 – 216.7 4.8 15.0 96.0 155.4 – – tax adjustments* (117.9) (106.8) (93.7) Adjusted Net Earnings $1,041.0 $ 988.4 $932.5 * The tax effect is calculated based upon the statutory rates for the jurisdictions where the items were incurred. Diluted EPS Inventory step-up and other inventory and manufacturing related charges Certain claims Goodwill impairment Special items Other expense on Biomet merger financing Taxes on above items and other certain tax adjustments* Adjusted Diluted EPS Year ended December 31, 2014 2013 2012 $ 4.19 $ 4.43 $ 4.29 0.12 0.13 – 2.08 0.23 0.41 0.27 – 1.26 – 0.03 0.09 0.54 0.88 – (0.69) (0.62) (0.53) $ 6.06 $ 5.75 $ 5.30 * The tax effect is calculated based upon the statutory rates for the jurisdictions where the items were incurred. LIQUIDITY AND CAPITAL RESOURCES Cash flows provided by operating activities were $1,052.8 million in 2014, compared to $963.1 million in 2013. The principal source of cash from operating activities was net earnings. Non-cash items included in net earnings accounted for another $346.4 million of operating cash in 2014. All other 26 items of operating cash flows reflect a use of $12.6 million of cash in 2014, compared to a use of $84.9 million in 2013. The increased cash flows provided by operating activities in 2014 were primarily due to improved cash flows generated from receivables collections, especially in Europe, lower funding necessary for our U.S. pension plans, and receipt of insurance proceeds related to Durom Cup product liability claims. These favorable items were partially offset by higher tax payments for certain unresolved matters in order to limit the potential impact of IRS interest charges and inventory investments. At December 31, 2014, we had 64 days of sales outstanding in trade accounts receivable, which was 1 day less than at December 31, 2013. Our days of sales outstanding reflect the reimbursement patterns of the healthcare industry in the markets where we compete. Collection of trade accounts receivable is influenced by insurance reimbursements and government budgets, among other things. Days of sales outstanding are lowest in our Americas reporting segment, as the U.S. healthcare system has a higher percentage of private- pay insurers who generally pay more quickly than government- based healthcare systems. In our Europe and Asia Pacific reporting segments, days of sales outstanding are higher, as healthcare is typically sponsored by governments which tend to pay more slowly. Additionally, there are some seasonal trends in our days of sales outstanding as it usually trends higher in our third quarter due to lower sales volumes and is lower in our fourth quarter when sales volumes are at their highest. Our days of sales outstanding in the past three years have ranged between 64 and 73 days. We were at the low end of this range as of December 31, 2014 due to improved collections in Europe. At December 31, 2014, we had 337 days of inventory on hand, an increase of 52 days compared to December 31, 2013. In order to maintain high service levels to our hospital customers in numerous geographic regions, we consign inventory to them, including all the various sizes of a particular product, so that our products are available when needed for a surgical procedure. As a result, we have a significant amount of inventory on hand. There are some seasonal trends in our days of inventory on hand, as it usually trends higher in our third quarter due to lower sales volumes and is lower in our fourth quarter when sales volumes are at their highest. Other factors that can affect our days of inventory on hand include when we build inventory for new product launches, or the level of excess and obsolete inventory charges and gains/losses related to foreign currency that is reported in cost of products sold in any particular period. Our days of inventory on hand in the past three years have ranged between 285 and 356 days. As of December 31, 2014, our days of inventory on hand were near the high end of this range. The higher inventory balance and days of inventory on hand were driven by the ongoing global commercialization of new product offerings, the effects of placing more inventory into distributor and hospital consignment and additional inventory in certain Eastern European markets where we now have a direct sales presence instead of selling to a distributor. Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T Cash flows used in investing activities were $469.4 million in 2014, compared to $282.5 million in 2013. Additions to instruments were relatively consistent between 2014 and 2013 as we continued to invest in instruments for significant product launches, such as Persona The Personalized Knee System. Spending on other property, plant and equipment increased in 2014 compared to 2013, reflecting cash outlays necessary to complete new product-related investments and to replace older machinery and equipment. We invest some of our cash and cash equivalents in highly-rated debt securities. The purchases and any sales or maturities of these investments are reflected as cash flows from investing activities. The timing of these investments can vary from period to period depending on the maturity of the debt securities and other cash and cash equivalent needs. In the past three years, we have made a number of business acquisitions including ETEX Holdings, Inc., Knee Creations, LLC, NORMED Medizin-Technik GmbH, Dornoch Medical Systems, Inc., and Synvasive Technology, Inc. Cash flows used in financing activities were $562.4 million in 2014, compared to $467.3 million in 2013. In 2014, we returned cash to our stockholders in the form of cash dividends of $145.5 million and share repurchases of $400.5 million. In association with the debt facilities we entered into for the pending Biomet merger, we incurred $64.1 million of debt issuance costs. In 2014, $250.0 million of our outstanding senior notes matured and were paid. Additionally, financing cash flows continued to benefit from our increased stock price, with many employees exercising stock options. In 2014, our Board of Directors declared cash dividends of $0.22 per share in each quarter. We expect to continue paying cash dividends on a quarterly basis; however, future dividends are subject to approval of the Board of Directors and may be adjusted as business needs or market conditions change. The 2014 dividend declarations equated to an annualized rate of $0.88 per share, which represented a 10 percent increase over the 2013 annualized rate. As of December 31, 2014, $599.5 million remained authorized under our $1.0 billion share repurchase program, which has no expiration date. Due to the pending merger with Biomet, we suspended repurchases after the first quarter of 2014. Upon completion of the merger, in the near to medium term we intend to use our cash flows for debt repayment and dividends. As discussed more completely in Note 15 to our consolidated financial statements, the IRS has issued proposed adjustments for years 2006 through 2009 reallocating profits between certain of our U.S. and foreign subsidiaries. We have disputed these proposed adjustments and continue to pursue resolution with the IRS. Although the ultimate timing for resolution of the disputed tax issues is uncertain, future payments may be significant to our operating cash flows. Also as discussed in Note 19 to our consolidated financial statements, we have recorded a short-term liability of $50.0 million and long-term liability of $307.2 million related to Durom Cup product liability claims. We expect to continue paying these claims over the next few years. We expect to be reimbursed a portion of these payments for product liability claims from insurance carriers. We have received an initial amount of the insurance proceeds we estimate to recover. We have a long-term receivable of $170.3 million remaining for future expected reimbursements from our insurance carriers. We expect to fund the $10.35 billion cash portion of the pending Biomet merger with existing cash on hand, as well as proceeds to be obtained from a $3.0 billion 5-year unsecured term loan (Term Loan) and senior notes that we expect to issue. We have also entered into a $7.66 billion bridge credit agreement (Bridge Credit Agreement) that may be used to fund the pending merger if we are unable to issue senior notes. The lenders’ commitments under the Bridge Credit Agreement will be reduced dollar-for-dollar by the amount of net cash proceeds we receive from the issuance of the senior notes. Currently, we have three tranches of senior notes outstanding: $500 million aggregate principal amount of 4.625 percent notes due November 30, 2019, $300 million aggregate principal amount of 3.375 percent notes due November 30, 2021 and $500 million aggregate principal amount of 5.75 percent notes due November 30, 2039. Interest on each series is payable on May 30 and November 30 of each year until maturity. We may redeem the senior notes at our election in whole or in part at any time prior to maturity at a redemption price equal to the greater of (i) 100 percent of the principal amount of the notes being redeemed; or (ii) the sum of the present values of the remaining scheduled payments of principal and interest (not including any portion of such payments of interest accrued as of the date of redemption), discounted to the date of redemption on a semi-annual basis at the Treasury Rate (as defined in the debt agreement), plus 20 basis points in the case of the 2019 and 2021 notes, and 25 basis points in the case of the 2039 notes. We will also pay the accrued and unpaid interest on the senior notes to the redemption date. We have a senior credit facility (Senior Credit Facility) that contains: (i) the 5-year unsecured Term Loan in the principal amount of $3.0 billion, and (ii) a 5-year unsecured multicurrency revolving facility (Multicurrency Revolving Facility) in the principal amount of $1.35 billion. The Senior Credit Facility replaces a previous credit agreement that provided for a $1.35 billion revolving credit facility that would have matured in May 2017. The Multicurrency Revolving Facility will mature in May 2019, with two one-year extensions available at our option. Borrowings under the Multicurrency Revolving Facility may be used for general corporate purposes. There were no borrowings outstanding under the Multicurrency Revolving Facility as of December 31, 2014. The availability of the Term Loan is conditioned on, among other things, the consummation of the Biomet merger. The Term Loan will mature five years after the initial borrowing. Borrowings under the Term Loan may only be used by us to fund, in part, the Biomet merger, including the payment of any indebtedness of LVB and its subsidiaries, and to pay all or a portion of the costs incurred by us in connection with the Biomet merger. We must reduce unused commitments under the Term Loan and prepay the borrowings under the Term Loan with any net cash proceeds received from specified asset sales, issuances or sales of equity and incurrences of borrowed 27 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T money indebtedness, subject to certain exceptions. The commitments under the Term Loan automatically terminate on the earliest to occur of (i) the funding and disbursement of Term Loan funds to us, (ii) April 24, 2015, as such date may be extended pursuant to the merger agreement or (iii) termination of the merger agreement. We and certain of our wholly owned foreign subsidiaries are the borrowers under the Senior Credit Facility. Borrowings under the Senior Credit Facility bear interest at floating rates based upon indices determined by the currency of the borrowings plus an applicable margin determined by reference to our senior unsecured long-term credit rating, or at an alternate base rate, or, in the case of borrowings under the Multicurrency Revolving Facility only, at a fixed-rate determined through a competitive bid process. The Senior Credit Facility contains customary affirmative and negative covenants and events of default for an unsecured financing arrangement, including, among other things, limitations on consolidations, mergers and sales of assets. Financial covenants include a consolidated indebtedness to consolidated EBITDA ratio of no greater than 3.0 to 1.0 in periods prior to any Term Loan funding and no greater than 5.0 to 1.0 in periods after the Term Loan is funded. If our credit rating falls below investment grade, additional restrictions would result, including restrictions on investments and payment of dividends. We were in compliance with all covenants under the Senior Credit Facility as of December 31, 2014. applicable margin determined by reference to our senior unsecured long-term credit rating, or at an alternate base rate. The Bridge Credit Agreement contains customary affirmative and negative covenants and events of default for an unsecured financing arrangement, including, among other things, limitations on consolidations, mergers and sales of assets. Financial covenants include a consolidated indebtedness to consolidated EBITDA ratio of no greater than 5.0 to 1.0. We were in compliance with all covenants under the Bridge Credit Agreement as of December 31, 2014. If our credit rating falls below investment grade, additional restrictions would result, including restrictions on investments and payment of dividends. We will pay a funding fee if we borrow under the Bridge Credit Agreement as well as duration fees based on the outstanding principal amount of the loans in the amount and on the dates specified in the Bridge Credit Agreement. In addition, we pay a fee on the daily actual unused commitment for the period from and including July 23, 2014 through the day the commitments under the Bridge Credit Agreement terminate. We have a term loan agreement with one of the lenders under the Senior Credit Facility for 11.7 billion Japanese Yen (Japan Term Loan) that will mature on May 31, 2018. Borrowings under the Japan Term Loan bear interest at a fixed rate of 0.61 percent per annum until maturity. We also have other available uncommitted credit facilities Commitments under the Senior Credit Facility are subject totaling $31.9 million. to certain fees. On the Multicurrency Revolving Facility, we pay a facility fee at a rate determined by reference to our senior unsecured long-term credit rating. On the Term Loan, we pay a fee on the daily actual unused commitment for the period from and including July 23, 2014 through the day the commitments under the Term Loan terminate. The Bridge Credit Agreement is a 364-day unsecured committed bridge facility in the principal amount of $7.66 billion. Funding of loans under the Bridge Credit Agreement is conditioned on, among other things, the consummation of the Biomet merger. Any loans under the Bridge Credit Agreement will mature 364 days after the funding date of the loans. The Bridge Credit Agreement requires us to reduce unused commitments and prepay the loans with any net cash proceeds received from specified asset sales, issuances or sales of equity and incurrences of borrowed money indebtedness, such as new senior notes we intend to issue, subject to certain exceptions. Commitments under the Bridge Credit Agreement automatically terminate on the earliest to occur of: (i) the funding and disbursement of the loans, (ii) April 24, 2015, as such date may be extended pursuant to the merger agreement, or (iii) termination of the merger agreement. Proceeds of loans under the Bridge Credit Agreement may only be used to fund, in part, the Biomet merger, including the payment of any indebtedness of LVB and its subsidiaries, and to pay all or a portion of the costs incurred by us in connection with the Biomet merger. Zimmer Holdings is the borrower under the Bridge Credit Agreement. Borrowings under the Bridge Credit Agreement bear interest at floating rates based upon LIBOR plus an 28 We currently have investment grade credit ratings from Standard and Poor’s Ratings Services (S&P) of A- and Moody’s Investor Services (Moody’s) of Baa1. After the announcement of the Biomet merger, S&P placed a CreditWatch with negative implications on our rating and has indicated that it expects to lower our rating to BBB if the merger is completed. Moody’s placed our rating on review for downgrade and expects to lower our rating to Baa3 if the merger is completed. We place our cash and cash equivalents in highly-rated financial institutions and limit the amount of credit exposure to any one entity. We invest only in high-quality financial instruments in accordance with our internal investment policy. As of December 31, 2014, we had short-term and long- term investments in debt securities with a fair value of $868.9 million. These investments are in debt securities of many different issuers and, therefore, we believe we have no significant concentration of risk with a single issuer. All of these debt securities remain highly-rated and we believe the risk of default by the issuers is low. As of December 31, 2014, $1,090.1 million of our cash and cash equivalents and short-term and long-term investments were held in jurisdictions outside of the U.S. and are expected to be indefinitely reinvested for continued use in foreign operations. Repatriation of these assets to the U.S. may have tax consequences. $844.0 million of this amount is denominated in U.S. Dollars and, therefore, bears no foreign currency translation risk. The balance of these assets is denominated in currencies of the various countries where we operate. Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T Management believes that cash flows from operations and available borrowings under the Senior Credit Facility or from the public and private debt markets are sufficient to meet our working capital, capital expenditure and debt service needs and to fund our pending merger with Biomet, as well as return cash to stockholders in the form of dividends. Should additional investment opportunities arise, we believe that our earnings, balance sheet and cash flows will allow us to obtain additional capital, if necessary. CONTRACTUAL OBLIGATIONS We have entered into contracts with various third parties in the normal course of business that will require future payments. The following table illustrates our contractual obligations (in millions): Contractual Obligations Total 2015 2016 and 2017 2018 and 2019 2020 and Thereafter Long-term debt $1,402.9 $ – $ – $602.9 $ 800.0 Interest payments Operating leases 910.9 182.9 64.0 46.5 127.3 124.3 63.1 41.0 595.3 32.3 Purchase obligations Other long-term liabilities Total contractual obligations 11.5 8.9 2.6 – – 405.1 – 154.5 125.4 125.2 $2,913.3 $119.4 $347.5 $893.6 $1,552.8 $63.3 million of the other long-term liabilities on our balance sheet as of December 31, 2014 are liabilities related to defined benefit pension plans. Defined benefit plan liabilities are based upon the underfunded status of the respective plans; they are not based upon future contributions. Due to uncertainties regarding future plan asset performance, changes in interest rates and our intentions with respect to voluntary contributions, we are unable to reasonably estimate future contributions beyond 2015. Therefore, this table does not include any amounts related to future contributions to our plans. See Note 14 to our consolidated financial statements for further information on our defined benefit plans. Also included in other long-term liabilities on our balance sheet are liabilities related to unrecognized tax benefits and corresponding interest and penalties thereon. Due to the uncertainties inherent in these liabilities, such as the ultimate timing and resolution of tax audits, we are unable to reasonably estimate the amount or period in which potential tax payments related to these positions will be made. Therefore, this table does not include any obligations related to unrecognized tax benefits. Additionally, other long-term liabilities on our balance sheet include long-term deferred tax liabilities, primarily related to intangible assets acquired in business combinations and fixed assets. We have excluded these liabilities from this table as well, as they do not represent liabilities that will be settled in cash. See Note 15 to our consolidated financial statements for further information on these tax-related accounts. We have entered into various agreements that may result in future payments dependent upon various events such as the achievement of certain product R&D milestones, sales milestones, or, at our discretion, to maintain exclusive rights to distribute a product. Since there is uncertainty on the timing or whether such payments will have to be made, we have not included them in this table. These payments could range from $0 to $60 million. CRITICAL ACCOUNTING ESTIMATES Our financial results are affected by the selection and application of accounting policies and methods. Significant accounting policies which require management’s judgment are discussed below. Excess Inventory and Instruments – We must determine as of each balance sheet date how much, if any, of our inventory may ultimately prove to be unsaleable or unsaleable at our carrying cost. Similarly, we must also determine if instruments on hand will be put to productive use or remain undeployed as a result of excess supply. Accordingly, inventory and instruments are written down to their net realizable value. To determine the appropriate net realizable value, we evaluate current stock levels in relation to historical and expected patterns of demand for all of our products and instrument systems and components. The basis for the determination is generally the same for all inventory and instrument items and categories except for work-in-process inventory, which is recorded at cost. Obsolete or discontinued items are generally destroyed and completely written off. Management evaluates the need for changes to inventory and instruments net realizable values based on market conditions, competitive offerings and other factors on a regular basis. Income Taxes - Our income tax expense, deferred tax assets and liabilities and reserves for unrecognized tax benefits reflect management’s best assessment of estimated future taxes to be paid. We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgments and estimates are required in determining the consolidated income tax expense. We estimate income tax expense and income tax liabilities and assets by taxable jurisdiction. Realization of deferred tax assets in each taxable jurisdiction is dependent on our ability to generate future taxable income sufficient to realize the benefits. We evaluate deferred tax assets on an ongoing basis and provide valuation allowances unless we determine it is “more likely than not” that the deferred tax benefit will be realized. Federal income taxes are provided on the portion of the income of foreign subsidiaries that is expected to be remitted to the U.S. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our global operations. We are subject to regulatory review or audit in virtually all of those jurisdictions and those reviews and audits may require extended periods of time to resolve. We record our income tax provisions based on our knowledge of all relevant facts and circumstances, including existing tax laws, our experience with previous settlement agreements, the 29 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T status of current examinations and our understanding of how the tax authorities view certain relevant industry and commercial matters. We recognize tax liabilities in accordance with the Financial Accounting Standards Board’s (FASB) guidance on income taxes and we adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which they are determined. Commitments and Contingencies – Accruals for product liability and other claims are established with the assistance of internal and external legal counsel based on current information and historical settlement information for claims, related legal fees and for claims incurred but not reported. We use an actuarial model to assist management in determining an appropriate level of accruals for product liability claims. Historical patterns of claim loss development over time are statistically analyzed to arrive at factors which are then applied to loss estimates in the actuarial model. In addition to our general product liability, we have recorded provisions totaling $471.7 million related to the Durom Cup, including $21.5 million in 2014. See Note 19 to our consolidated financial statements for further discussion of the Durom Cup. Goodwill and Intangible Assets – We evaluate the carrying value of goodwill and indefinite life intangible assets annually, or whenever events or circumstances indicate the carrying value may not be recoverable. We evaluate the carrying value of finite life intangible assets whenever events or circumstances indicate the carrying value may not be recoverable. Significant assumptions are required to estimate the fair value of goodwill and intangible assets, most notably estimated future cash flows generated by these assets. As such, these fair value measurements use significant unobservable inputs. Changes to these assumptions could require us to record impairment charges on these assets. In the fourth quarter of 2012, we determined our U.S. Spine reporting unit’s carrying value was in excess of its estimated fair value. Fair value was determined using a weighting of income and market approaches. Fair value under the income approach was determined by discounting to present value the estimated future cash flows of the reporting unit. Fair value under the market approach utilized the guideline public company methodology, which uses valuation indicators determined from other businesses that are similar to our U.S. Spine reporting unit. As a result, we recorded a goodwill impairment charge for the U.S. Spine reporting unit of $96.0 million in 2012. See Note 8 to our consolidated financial statements for further discussion and the factors that contributed to these impairment charges and the factors that could lead to further impairment. In 2014 and 2013, we employed a similar combination of income and market approaches to estimate this reporting unit’s fair value and determined there were no 30 impairment charges necessary. For our annual impairment test in 2014, the goodwill balance of the U.S. Spine reporting unit was $41.0 million. Due to improved operating performance of our U.S. Spine reporting unit and improving macroenomic conditions, including higher valuation indicators used in our market approach, the U.S. Spine reporting unit’s estimated fair value was in excess of its carrying value of net assets by 24 percent for our 2014 impairment test. Our international Spine goodwill and related net assets are not tested separately for goodwill impairment as they are part of reporting units that contain other product categories. We have four other reporting units with goodwill assigned to them. Our 2013 annual impairment test indicated the estimated fair value of the U.S. Dental reporting unit was in excess of its carrying value of net assets by 11 percent. For the annual impairment test in 2014, the goodwill balance of the U.S. Dental reporting unit was $169.1 million. In our 2014 annual impairment test, due to improved operating performance and improving macroenomic conditions, including higher valuation indicators used in our market approach, the U.S. Dental reporting unit’s estimated fair value was in excess of its carrying value of net assets by 24 percent. In 2014, for our three other reporting units’ annual impairment test, we performed a qualitative assessment of changes in fair value from the 2013 income approach. A qualitative assessment was performed because the estimated fair value of each of the reporting units was significantly in excess of the carrying value of its net assets in the 2013 impairment test. Share-based Payment – We measure share-based payment expense at the grant date based on the fair value of the award and recognize expense over the requisite service period. Determining the fair value of share-based awards at the grant date requires judgment, including estimating the expected life of stock options and the expected volatility of our stock. Additionally, we must estimate the amount of share- based awards that are expected to be forfeited. We estimate expected volatility based upon the implied volatility of actively traded options on our stock. The expected life of stock options and estimated forfeitures are based upon our employees’ historical exercise and forfeiture behaviors. The assumptions used in determining the grant date fair value and the expected forfeitures represent management’s best estimates. RECENT ACCOUNTING PRONOUNCEMENTS See Note 2 to our consolidated financial statements to see how recent accounting pronouncements have affected or may affect our financial position, results of operations or cash flows. Item 7A. Quantitative and Qualitative Disclosures About Market Risk MARKET RISK We are exposed to certain market risks as part of our ongoing business operations, including risks from changes in foreign currency exchange rates, interest rates and commodity Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T prices that could affect our financial condition, results of operations and cash flows. We manage our exposure to these and other market risks through regular operating and financing activities and through the use of derivative financial instruments. We use derivative financial instruments solely as risk management tools and not for speculative investment purposes. FOREIGN CURRENCY EXCHANGE RISK We operate on a global basis and are exposed to the risk that our financial condition, results of operations and cash flows could be adversely affected by changes in foreign currency exchange rates. We are primarily exposed to foreign currency exchange rate risk with respect to transactions and net assets denominated in Euros, Swiss Francs, Japanese Yen, British Pounds, Canadian Dollars, Australian Dollars, Korean Won, Swedish Krona, Czech Koruna, Thai Baht, Taiwan Dollars, South African Rand, Russian Rubles and Indian Rupees. We manage the foreign currency exposure centrally, on a combined basis, which allows us to net exposures and to take advantage of any natural offsets. To reduce the uncertainty of foreign currency exchange rate movements on transactions denominated in foreign currencies, we enter into derivative financial instruments in the form of foreign currency exchange forward contracts and options with major financial institutions. These forward contracts and options are designed to hedge anticipated foreign currency transactions, primarily intercompany sale and purchase transactions, for periods consistent with commitments. Realized and unrealized gains and losses on these contracts and options that qualify as cash flow hedges are temporarily recorded in other comprehensive income, then recognized in cost of products sold when the hedged item affects net earnings. For contracts outstanding at December 31, 2014, we had obligations to purchase U.S. Dollars and sell Euros, Japanese Yen, British Pounds, Canadian Dollars, Australian Dollars, Korean Won, Swedish Krona, Czech Koruna, Thai Baht, Taiwan Dollars, South African Rand, Russian Rubles and Indian Rupees and purchase Swiss Francs and sell U.S. Dollars at set maturity dates ranging from January 2015 through June 2017. The notional amounts of outstanding forward contracts entered into with third parties to purchase U.S. Dollars at December 31, 2014 were $1,289.8 million. The notional amounts of outstanding forward contracts entered into with third parties to purchase Swiss Francs at December 31, 2014 were $306.3 million. The weighted average contract rates outstanding at December 31, 2014 were Euro:USD 1.34, USD:Swiss Franc: 0.91, USD:Japanese Yen 97.30, British Pound:USD 1.62, USD:Canadian Dollar 1.08, Australian Dollar:USD 0.89, USD:Korean Won 1,115, USD:Swedish Krona 6.74, USD:Czech Koruna 19.98, USD:Thai Baht 33.01, USD:Taiwan Dollar 29.48, USD:South African Rand 11.11, USD:Russian Ruble 37.37 and USD:Indian Ruppee 67.14. We maintain written policies and procedures governing our risk management activities. Our policy requires that critical terms of hedging instruments be the same as hedged forecasted transactions. On this basis, with respect to cash flow hedges, changes in cash flows attributable to hedged transactions are generally expected to be completely offset by changes in the fair value of hedge instruments. As part of our risk management program, we also perform sensitivity analyses to assess potential changes in revenue, operating results, cash flows and financial position relating to hypothetical movements in currency exchange rates. A sensitivity analysis of changes in the fair value of foreign currency exchange forward contracts outstanding at December 31, 2014 indicated that, if the U.S. Dollar uniformly changed in value by 10 percent relative to the various currencies, with no change in the interest differentials, the fair value of those contracts would increase or decrease earnings before income taxes in periods through June 2017, depending on the direction of the change, by the following average approximate amounts (in millions): Currency Euro Swiss Franc Japanese Yen British Pound Canadian Dollar Australian Dollar Korean Won Swedish Krona Czech Koruna Thai Baht Taiwan Dollars South African Rand Russian Rubles Indian Rupees Average Amount $53.7 31.3 27.2 15.0 9.6 12.8 3.4 2.2 0.4 1.0 2.0 0.5 0.6 0.6 Any change in the fair value of foreign currency exchange forward contracts as a result of a fluctuation in a currency exchange rate is expected to be largely offset by a change in the value of the hedged transaction. Consequently, foreign currency exchange contracts would not subject us to material risk due to exchange rate movements because gains and losses on these contracts offset gains and losses on the assets, liabilities and transactions being hedged. We had net assets in legal entities with non-U.S. Dollar functional currencies of $2,113.5 million at December 31, 2014, primarily in Euros, Japanese Yen and Australian Dollars. $1,221.0 million of the net asset exposure at December 31, 2014 related to goodwill recorded in the Europe and Asia Pacific geographic segments. We enter into foreign currency forward exchange contracts with terms of one month to manage currency exposures for monetary assets and liabilities denominated in a currency other than an entity’s functional currency. As a result, foreign currency remeasurement gains/losses recognized in earnings are generally offset with gains/losses on the foreign currency forward exchange contracts in the same reporting period. 31 Z I M M E R HOL D I NG S , I NC . COMMODITY PRICE RISK We purchase raw material commodities such as cobalt chrome, titanium, tantalum, polymer and sterile packaging. We enter into supply contracts generally with terms of 12 to 24 months, where available, on these commodities to alleviate the effect of market fluctuation in prices. As part of our risk management program, we perform sensitivity analyses related to potential commodity price changes. A 10 percent price change across all these commodities would not have a material effect on our consolidated financial position, results of operations or cash flows. INTEREST RATE RISK In the normal course of business, we are exposed to market risk from changes in interest rates that could affect our results of operations and financial condition. We manage our exposure to interest rate risks through our regular operations and financing activities. We invest our cash and cash equivalents primarily in highly-rated corporate commercial paper and bank deposits. We also have short-term and long-term investments in highly- rated corporate debt securities, U.S. government and agency debt securities, U.S. government treasury funds, municipal bonds, foreign government debt securities, commercial paper and certificates of deposit. The primary investment objective is to ensure capital preservation of our invested principal funds. Currently, we do not use derivative financial instruments in our investment portfolio. We are exposed to interest rate risk on our debt obligations and our cash and cash equivalents. We have multiple fixed-to-variable interest rate swap agreements that we have designated as fair value hedges of the fixed interest rate obligations on our senior notes due 2019 and 2021. The total notional amounts are $250 million and $300 million for the senior notes due 2019 and 2021, respectively. On the interest rate swap agreements for the senior notes due 2019, we receive a fixed interest rate of 4.625 percent and pay variable interest equal to the three-month LIBOR plus an average of 133 basis points. On the interest rate swap agreements for the senior notes due 2021, we receive a fixed interest rate of 3.375 percent and pay variable interest equal to the three-month LIBOR plus an average of 99 basis points. The interest rate swap agreements are intended to manage our exposure to interest rate movements by converting fixed-rate debt into variable-rate debt. The objective of the instruments is to more closely align interest expense with interest income received on cash and cash equivalents. These derivative instruments are designated as fair value hedges under GAAP. Changes in the fair value of the derivative instrument are recorded in earnings and are offset by gains or losses on the underlying debt instrument. In 2014, we entered into forward starting interest rate swaps that we have designated as cash flow hedges of our anticipated issuance of senior notes related to the pending Biomet merger that we anticipate will mature in March 2045. 32 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T The forward starting interest rate swaps mitigate the risk of changes in interest rates prior to completion of the senior notes offering. The total notional amounts of the forward starting interest rate swaps are $1 billion and will settle in March 2015. On the forward starting interest rate swaps, we receive variable interest equal to three-month LIBOR and pay a fixed interest weighted average rate of 3.01 percent. We will defer the effective portion of the forward starting interest rate swaps over the maturity period of the hedged senior notes, which is thirty years, and recognize any ineffective portion immediately in earnings. Based upon our overall interest rate exposure as of December 31, 2014, a change of 10 percent in interest rates, assuming the principal amount outstanding remains constant, would not have a material effect on net interest expense. This analysis does not consider the effect of the change in the level of overall economic activity that could exist in such an environment. CREDIT RISK Financial instruments, which potentially subject us to concentrations of credit risk, are primarily cash and cash equivalents, short-term and long-term investments, derivative instruments, counterparty transactions and accounts receivable. We place our investments in highly-rated financial institutions or highly-rated debt securities and limit the amount of credit exposure to any one entity. We believe we do not have any significant credit risk on our cash and cash equivalents and investments. We are exposed to credit loss if the financial institutions or counterparties issuing the debt security fail to perform. However, this loss is limited to the amounts, if any, by which the obligations of the counterparty to the financial instrument contract exceed our obligation. We also minimize exposure to credit risk by dealing with a diversified group of major financial institutions. We manage credit risk by monitoring the financial condition of our counterparties using standard credit guidelines. We do not anticipate any nonperformance by any of the counterparties. Our concentrations of credit risks with respect to trade accounts receivable is limited due to the large number of customers and their dispersion across a number of geographic areas and by frequent monitoring of the creditworthiness of the customers to whom credit is granted in the normal course of business. Substantially all of our trade receivables are concentrated in the public and private hospital and healthcare industry in the U.S. and internationally or with distributors or dealers who operate in international markets and, accordingly, are exposed to their respective business, economic and country specific variables. Our ability to collect accounts receivable in some countries depends in part upon the financial stability of these hospital and healthcare sectors and the respective countries’ national economic and healthcare systems. Most notably, in Europe healthcare is typically sponsored by the government. Since we sell products to public hospitals in those countries, Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T we are indirectly exposed to government budget constraints. The ongoing financial uncertainties in the Euro zone impact the indirect credit exposure we have to those governments through their public hospitals. As of December 31, 2014, in Greece, Italy, Portugal and Spain, countries that have been widely recognized as presenting the highest risk, our gross short-term and long-term trade accounts receivable combined were $183.1 million. With allowances for doubtful accounts of $9.4 million recorded in those countries, the net balance was $173.7 million, representing 20 percent of our total consolidated short-term and long-term trade accounts receivable balance, net. Italy and Spain accounted for $164.4 million of that net amount. We are actively monitoring the situations in these countries. We maintain contact with customers in these countries on a regular basis. We continue to receive payments, albeit at a slower rate than in the past. We believe our allowance for doubtful accounts is adequate in these countries, as ultimately we believe the governments in these countries will be able to pay. To the extent the respective governments’ ability to fund their public hospital programs deteriorates, we may have to record significant bad debt expenses in the future. While we are exposed to risks from the broader healthcare industry in Europe and around the world, there is no significant net exposure due to any individual customer. Exposure to credit risk is controlled through credit approvals, credit limits and monitoring procedures and we believe that reserves for losses are adequate. 33 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T Management’s Report on Internal Control Over Financial Reporting The management of Zimmer Holdings, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f) or 15d-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, the company’s principal executive and principal financial officers and effected by the company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles and includes those policies and procedures that: (cid:129) Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; (cid:129) 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 (cid:129) Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, the company’s internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The company’s management assessed the effectiveness of the company’s internal control over financial reporting as of December 31, 2014. In making this assessment, the company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013). Based on that assessment, management has concluded that, as of December 31, 2014, the company’s internal control over financial reporting is effective based on those criteria. The company’s independent registered public accounting firm has audited the effectiveness of the company’s internal control over financial reporting as of December 31, 2014, as stated in its report which appears in Item 8 of this Annual Report on Form 10-K. 34 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T Item 8. Financial Statements and Supplementary Data Zimmer Holdings, Inc. Index to Consolidated Financial Statements Financial Statements: Report of Independent Registered Public Accounting Firm Consolidated Statements of Earnings for the Years Ended December 31, 2014, 2013 and 2012 Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2014, 2013 and 2012 Consolidated Balance Sheets as of December 31, 2014 and 2013 Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2014, 2013 and 2012 Consolidated Statements of Cash Flows for the Years Ended December 31, 2014, 2013 and 2012 Notes to Consolidated Financial Statements Page 36 37 38 39 40 41 42 35 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T Report of Independent Registered Public Accounting Firm To the Stockholders and Board of Directors of Zimmer Holdings, Inc.: In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Zimmer Holdings, Inc. and its subsidiaries at December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework 2013 issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Part II, Item 7A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. PricewaterhouseCoopers LLP Chicago, Illinois February 23, 2015 36 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T CONSOLIDATED STATEMENTS OF EARNINGS For the Years Ended December 31, Net Sales Cost of products sold Gross Profit Research and development Selling, general and administrative Certain claims (Note 19) Goodwill impairment (Note 8) Special items (Note 2) Operating expenses Operating Profit Other expense Interest income Interest expense Earnings before income taxes Provision for income taxes Net earnings Less: Net loss attributable to noncontrolling interest Net Earnings of Zimmer Holdings, Inc. Earnings Per Common Share – Basic Earnings Per Common Share – Diluted Weighted Average Common Shares Outstanding Basic Diluted Cash Dividends Declared Per Common Share The accompanying notes are an integral part of these consolidated financial statements. (in millions, except per share amounts) 2014 2013 2012 $4,673.3 1,249.8 $4,623.4 1,286.1 $4,471.7 1,125.2 3,423.5 3,337.3 3,346.5 188.3 1,822.5 21.5 – 356.5 204.2 1,833.8 47.0 – 216.7 225.6 1,807.1 15.0 96.0 155.4 2,388.8 2,301.7 2,299.1 1,034.7 (39.6) 11.9 (63.1) 1,035.6 – 15.6 (70.1) 1,047.4 – 15.6 (72.9) 943.9 224.9 719.0 (1.1) 981.1 221.9 759.2 (1.8) 990.1 237.2 752.9 (2.1) $ 720.1 $ 761.0 $ 755.0 $ $ $ 4.26 4.19 169.0 171.7 0.88 $ $ $ 4.49 4.43 169.6 171.8 0.80 $ $ $ 4.32 4.29 174.9 176.0 0.54 37 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME For the Years Ended December 31, Net Earnings Other Comprehensive Income (Loss): Foreign currency cumulative translation adjustments Unrealized cash flow hedge gains, net of tax Reclassification adjustments on cash flow hedges, net of tax Reclassification adjustments on securities, net of tax Unrealized gains/(losses) on securities, net of tax Adjustments to prior service cost and unrecognized actuarial assumptions, net of tax Total Other Comprehensive Income (Loss) Comprehensive Income Comprehensive Loss Attributable to Noncontrolling Interest Comprehensive Income Attributable to Zimmer Holdings, Inc. The accompanying notes are an integral part of these consolidated financial statements. (in millions) 2014 2013 2012 $ 719.0 $759.2 $752.9 (241.5) (44.4) 55.9 33.4 (18.9) (4.4) (0.4) (0.5) – 0.1 (75.8) 38.5 (281.2) 23.2 46.1 10.9 3.3 – 0.4 11.8 72.5 437.8 782.4 825.4 (1.0) (2.0) (2.2) $ 438.8 $784.4 $827.6 38 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T CONSOLIDATED BALANCE SHEETS As of December 31, ASSETS Current Assets: Cash and cash equivalents Short-term investments Accounts receivable, less allowance for doubtful accounts Inventories Prepaid expenses and other current assets Deferred income taxes Total Current Assets Property, plant and equipment, net Goodwill Intangible assets, net Other assets Total Assets LIABILITIES AND STOCKHOLDERS’ EQUITY Current Liabilities: Accounts payable Income taxes Other current liabilities Total Current Liabilities Other long-term liabilities Long-term debt Total Liabilities Commitments and Contingencies (Note 19) Stockholders’ Equity: Common stock, $0.01 par value, one billion shares authorized, 268.4 million (264.3 million in 2013) issued Paid-in capital Retained earnings Accumulated other comprehensive income Treasury stock, 98.7 million shares (94.5 million shares in 2013) Total Zimmer Holdings, Inc. stockholders’ equity Noncontrolling interest Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity The accompanying notes are an integral part of these consolidated financial statements. (in millions) 2014 2013 $ 1,083.3 612.5 912.1 1,169.0 193.7 318.4 $ 1,080.6 727.0 936.6 1,074.5 107.1 271.9 4,289.0 1,288.8 2,514.2 603.5 939.2 4,197.7 1,224.7 2,611.2 707.7 839.3 $ 9,634.7 $ 9,580.6 $ $ 167.1 72.4 798.5 146.3 221.2 664.1 1,038.0 1,031.6 648.6 576.6 1,425.5 1,672.3 3,112.1 3,280.5 2.7 4,330.7 8,285.2 85.9 (6,183.7) 2.6 4,000.6 7,712.7 367.1 (5,785.7) 6,520.8 1.8 6,297.3 2.8 6,522.6 6,300.1 $ 9,634.7 $ 9,580.6 39 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY Zimmer Holdings, Inc. Stockholders Common Shares Number Amount Paid-in Capital Retained Earnings Accumulated Other Comprehensive Income Treasury Shares Number Amount Noncontrolling Interest Total Stockholders’ Equity (in millions) Balance January 1, 2012 Net earnings Other comprehensive income Cash dividends declared Stock compensation plans, including tax benefits Share repurchases Balance December 31, 2012 Net earnings Other comprehensive income Purchase of additional shares from noncontrolling interest Cash dividends declared Stock compensation plans, including tax benefits Share repurchases Balance December 31, 2013 Net earnings Other comprehensive loss Cash dividends declared Stock compensation plans, including tax benefits Share repurchases 255.9 – – – 1.2 – 257.1 – – – – 7.2 – 264.3 – – – 4.1 – $2.5 – – – $3,399.2 – – – $6,426.8 755.0 – (93.3) $ 271.4 – 72.5 – (77.9) $(4,592.7) – – – – – – $ 7.6 (2.1) (0.1) – $5,514.8 752.9 72.4 (93.3) 0.1 – 2.6 – – – – – – 2.6 – – – 0.1 – 101.4 – 3,500.6 – – (2.6) – 7,085.9 761.0 – (1.1) – – (135.4) 501.1 – 4,000.6 – – – 330.1 – 1.2 – 7,712.7 720.1 – (148.6) 1.0 – – – 343.9 – 23.2 0.1 (7.7) (85.5) – – 6.2 (485.6) (5,072.1) – – – – – – 367.1 – (281.2) – – – 0.1 (9.1) (94.5) – – – – – 5.4 (719.0) (5,785.7) – – – – – 5.4 (1.8) (0.2) (0.6) – – – 2.8 (1.1) 0.1 – 105.1 (485.6) 5,866.3 759.2 23.0 (1.7) (135.4) 507.7 (719.0) 6,300.1 719.0 (281.1) (148.6) – – – (4.2) 2.5 (400.5) – – 333.7 (400.5) Balance December 31, 2014 268.4 $2.7 $4,330.7 $8,285.2 $ 85.9 (98.7) $(6,183.7) $ 1.8 $6,522.6 The accompanying notes are an integral part of these consolidated financial statements. 40 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, Cash flows provided by (used in) operating activities: Net earnings Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization Goodwill impairment Share-based compensation Income tax benefit from stock option exercises Excess income tax benefit from stock option exercises Inventory step-up Deferred income tax provision Changes in operating assets and liabilities, net of acquired assets and liabilities Income taxes payable Receivables Inventories Accounts payable and accrued liabilities Other assets and liabilities Net cash provided by operating activities Cash flows provided by (used in) investing activities: Additions to instruments Additions to other property, plant and equipment Purchases of investments Sales of investments Business combination investments Investments in other assets Net cash used in investing activities Cash flows provided by (used in) financing activities: Payment of senior notes Net proceeds (payments) under revolving credit facilities Proceeds from term loans Dividends paid to stockholders Debt issuance costs Equity issuance costs Proceeds from employee stock compensation plans Excess income tax benefit from stock option exercises Purchase of additional shares from noncontrolling interest Repurchase of common stock Net cash used in financing activities Effect of exchange rates on cash and cash equivalents Increase in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year The accompanying notes are an integral part of these consolidated financial statements. (in millions) 2014 2013 2012 $ 719.0 $ 759.2 $ 752.9 375.8 358.5 363.1 – 49.4 37.2 (11.1) 5.4 – 48.5 38.4 (8.6) 8.0 96.0 55.0 11.0 (2.7) 4.8 (84.2) (126.2) (64.8) (51.9) (40.4) (154.1) 120.1 87.6 96.8 (74.3) (128.4) 38.3 (47.1) 59.2 (45.5) (67.5) 47.8 (57.4) 1,052.8 963.1 1,151.9 (197.4) (192.9) (148.9) (144.9) (100.0) (114.7) (1,350.9) (732.7) (1,130.1) 1,282.2 830.8 (54.3) (4.1) (74.2) (13.5) 878.5 (59.0) (17.9) (469.4) (282.5) (592.1) (250.0) – 2.3 – (97.5) – (145.5) (132.4) (64.1) (0.4) 284.7 11.1 – – – 474.8 8.6 (1.8) – (50.1) 147.3 (94.4) (3.3) – 46.9 2.7 – (400.5) (719.0) (485.6) (562.4) (467.3) (436.5) (18.3) (17.0) (7.3) 2.7 1,080.6 196.3 884.3 116.0 768.3 $ 1,083.3 $1,080.6 $ 884.3 41 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Business We design, develop, manufacture and market orthopaedic reconstructive, spinal and trauma devices, biologics, dental implants and related surgical products. We also provide other healthcare related services. Orthopaedic reconstructive devices restore function lost due to disease or trauma in joints such as knees, hips, shoulders and elbows. Dental reconstructive implants restore function and aesthetics in patients who have lost teeth due to trauma or disease. Spinal devices are utilized by orthopaedic surgeons and neurosurgeons in the treatment of degenerative diseases, deformities and trauma in all regions of the spine. Trauma products are devices used primarily to reattach or stabilize damaged bone and tissue to support the body’s natural healing process. Our related surgical products include surgical supplies and instruments designed to aid in orthopaedic surgical procedures and post-operation rehabilitation. We have operations in more than 25 countries and market our products in more than 100 countries. We operate in a single industry but have three reportable geographic segments, the Americas, Europe and Asia Pacific. The words “we,” “us,” “our” and similar words refer to Zimmer Holdings, Inc. and its subsidiaries. Zimmer Holdings refers to the parent company only. On April 24, 2014, we entered into a definitive agreement to merge with LVB, the parent company of Biomet, in a cash and stock transaction valued at approximately $13.35 billion. We will pay $10.35 billion in cash, subject to certain adjustments, and issue 32.7 million shares of our common stock which had a value of approximately $3.0 billion, based on a stock price of $91.73 per share using the five day volume weighted average price immediately preceding the signing of the agreement. In connection with the merger, we will pay off all of LVB’s outstanding funded debt, and the aggregate cash merger consideration will be reduced by such amount. The merger, which is subject to customary closing conditions and regulatory approvals, is expected to close in the first quarter of 2015. The merger will position the combined company as a leader in the $45 billion musculoskeletal industry. Biomet’s product portfolio includes knee and hip reconstructive products; sports medicine, extremities and trauma products; spine, bone healing and microfixation products; dental reconstructive products; and cement, biologics and other products. The combination will enhance enterprise diversification with broader franchises in the Knee, Hip, Surgical, Spine and Dental categories, as well as in the faster-growing Sports Medicine, Extremities and Trauma categories. We expect to fund the cash portion of the purchase price with existing cash on hand, as well as proceeds obtained from a committed $3.0 billion senior unsecured term loan and up to $7.66 billion in senior unsecured notes we intend to issue. In May 2014, we entered into a $7.66 billion 364-day bridge credit facility. To the extent the senior unsecured notes are not 42 issued and sold on or prior to the closing date of the merger, we intend to draw on the bridge credit facility to finance, in part, the cash consideration for the merger and to pay fees and expenses incurred in connection with the merger. The commitments of the bridge lenders to provide the bridge loan will be permanently reduced dollar-for-dollar by the amount of net cash proceeds we receive from the issuance of senior unsecured notes. See Note 11 and Item 7 in this Form 10-K for further information regarding these debt instruments. 2. Significant Accounting Policies Basis of Presentation – The consolidated financial statements include the accounts of Zimmer Holdings and its subsidiaries in which it holds a controlling financial interest. All significant intercompany accounts and transactions are eliminated. Certain amounts in the 2013 and 2012 consolidated financial statements have been reclassified to conform to the 2014 presentation. Use of Estimates – The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the U.S. which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Foreign Currency Translation – The financial statements of our foreign subsidiaries are translated into U.S. Dollars using period-end exchange rates for assets and liabilities and average exchange rates for operating results. Unrealized translation gains and losses are included in accumulated other comprehensive income in stockholders’ equity. When a transaction is denominated in a currency other than the subsidiary’s functional currency, we recognize a transaction gain or loss when the transaction is settled. Foreign currency transaction gains and losses included in net earnings for the years ended December 31, 2014, 2013 and 2012 were not significant. Revenue Recognition – We sell product through three principal channels: 1) direct to healthcare institutions, referred to as direct channel accounts; 2) through stocking distributors and healthcare dealers; and 3) directly to dental practices and dental laboratories. The direct channel accounts represented approximately 75 percent of our net sales in 2014. Through this channel, inventory is generally consigned to sales agents or customers so that products are available when needed for surgical procedures. No revenue is recognized upon the placement of inventory into consignment as we retain title and maintain the inventory on our balance sheet. Upon implantation, we issue an invoice and revenue is recognized. Pricing for products is generally predetermined by contracts with customers, agents acting on behalf of customer groups or by government regulatory bodies, depending on the market. Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Price discounts under group purchasing contracts are generally linked to volume of implant purchases by customer healthcare institutions within a specified group. At negotiated thresholds within a contract buying period, price discounts may increase. Sales to stocking distributors, healthcare dealers, dental practices and dental laboratories accounted for approximately 25 percent of our net sales in 2014. With these types of sales, revenue is recognized when title to product passes, either upon shipment of the product or in some cases upon implantation of the product. Product is generally sold at contractually fixed prices for specified periods. Payment terms vary by customer, but are typically less than 90 days. If sales incentives are earned by a customer for purchasing a specified amount of our product, we estimate whether such incentives will be achieved and, if so, recognize these incentives as a reduction in revenue in the same period the underlying revenue transaction is recognized. Occasionally products are returned and, accordingly, we maintain an estimated sales return reserve that is recorded as a reduction in revenue. Product returns were not significant for the years ended December 31, 2014, 2013 and 2012. Taxes collected from customers and remitted to governmental authorities are presented on a net basis and excluded from revenues. Shipping and Handling – Amounts billed to customers for shipping and handling of products are reflected in net sales and are not significant. Expenses incurred related to shipping and handling of products are reflected in selling, general and administrative and were $181.9 million, $163.6 million and $139.5 million for the years ended December 31, 2014, 2013 and 2012, respectively. Research and Development – We expense all research and development costs as incurred. Research and development costs include salaries, prototypes, depreciation of equipment used in research and development, consultant fees and service fees paid to collaborative partners. Where contingent milestone payments are due to third parties under research and development arrangements, the milestone payment obligations are expensed when the milestone results are achieved. Litigation – We record a liability for contingent losses, including future legal costs, settlements and judgments, when we consider it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Special Items – We recognize expenses resulting directly from our business combinations, employee termination benefits, certain R&D agreements, certain contract terminations, consulting and professional fees and asset impairment or loss on disposal charges connected with global restructuring, operational and quality excellence initiatives, and other items as “Special items” in our consolidated statement of earnings. “Special items” included (in millions): For the Years Ended December 31, Impairment/loss on disposal of assets Consulting and professional fees Employee severance and retention, including share-based compensation acceleration Dedicated project personnel Certain R&D agreements Relocated facilities Distributor acquisitions Certain litigation matters Contract terminations Contingent consideration adjustments Accelerated software amortization Other 2014 2013 2012 $ 32.4 176.7 $ 10.9 99.1 $ 14.6 90.1 0.9 50.8 4.5 0.7 0.6 70.0 6.2 0.6 6.0 7.1 14.2 34.0 0.8 3.6 0.4 26.9 3.9 9.0 6.0 7.9 8.2 15.1 – 1.8 0.8 13.7 6.6 (2.8) 4.5 2.8 Special items $356.5 $216.7 $155.4 Impairment/loss on disposal of assets relates to impairment of intangible assets that were acquired in business combinations or impairment of or a loss on the disposal of other assets. This caption also includes the effect of reducing the estimated useful life of certain intangible assets to zero, which resulted in the remaining net book values of those assets being amortized immediately. Consulting and professional fees relate to third-party consulting, professional fees and contract labor related to our quality and operational excellence initiatives, third-party consulting fees related to certain information system implementations, third-party integration consulting performed in a variety of areas such as tax, compliance, logistics and human resources for our business combinations and pending merger with Biomet, third-party fees related to severance and termination benefits matters and legal fees related to certain litigation matters. Our quality and operational excellence initiatives are company-wide and include improvements in quality, distribution, sourcing, manufacturing and information technology, among other areas. In 2014, 2013 and 2012, we eliminated positions as we reduced management layers, restructured certain areas, announced closures of certain facilities, and commenced initiatives to focus on business opportunities that best support our strategic priorities. As a result of these changes in our work force and headcount reductions in connection with acquisitions, we incurred expenses related to severance benefits, redundant salaries as we worked through transition periods, share-based compensation acceleration and other employee termination-related costs. The majority of these termination benefits were provided in accordance with our existing or local government policies and are considered 43 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ongoing benefits. These costs were accrued when they became probable and estimable and were recorded as part of other current liabilities. The majority of these costs were paid during the year they were incurred. Dedicated project personnel expenses include the salary, benefits, travel expenses and other costs directly associated with employees who are 100 percent dedicated to our operational and quality excellence initiatives or integration of acquired businesses. Certain R&D agreements relate to agreements with upfront payments to obtain intellectual property to be used in R&D projects that have no alternative future use in other projects. Relocated facilities expenses are the moving costs and the lease expenses incurred during the relocation period in connection with relocating certain facilities. Over the past few years we have acquired a number of U.S. and foreign-based distributors. We have incurred various costs related to the consummation and integration of those businesses. Investments – We invest our excess cash and cash equivalents in debt securities. Our investments include corporate debt securities, U.S. government and agency debt securities, foreign government debt securities, commercial paper and certificates of deposit, and are classified and accounted for as available-for-sale. Available-for-sale debt securities are recorded at fair value on our consolidated balance sheet. Investments with a contractual maturity of less than one year are classified as short-term investments on our consolidated balance sheet, or in other non-current assets if the contractual maturity is greater than one year. Changes in fair value for available-for-sale securities are recorded, net of taxes, as a component of accumulated other comprehensive loss on our consolidated balance sheet. We review our investments for other-than-temporary impairment at each reporting period. If an unrealized loss for any investment is considered to be other-than-temporary, the loss will be recognized in the consolidated statement of earnings in the period the determination is made. See Note 7 for more information regarding our investments. Certain litigation matters relate to net expenses Accounts Receivable – Accounts receivable consists of recognized during the year for the estimated or actual settlement of certain pending litigation and similar claims, including matters where we recognized income from a settlement on more favorable terms than our previous estimate, or we reduced our estimate of a previously recorded contingent liability. These litigation matters have included royalty disputes, patent litigation matters, commercial litigation matters and matters arising from our acquisitions of certain competitive distributorships in prior years. Contract termination costs relate to terminated agreements in connection with the integration of acquired companies and changes to our distribution model as part of business restructuring and operational excellence initiatives. The terminated contracts primarily relate to sales agents and distribution agreements. Contingent consideration adjustments represent the changes in the fair value of contingent consideration obligations to be paid to the prior owners of acquired businesses. Accelerated software amortization is the incremental amortization resulting from a reduction in the estimated life of certain software. Due to an approved plan to replace certain software, the estimated economic useful life of the existing software was decreased to represent the period of time expected to implement replacement software. As a result, the amortization from the shortened life of this software is substantially higher than the previous amortization being recognized. Cash and Cash Equivalents – We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. The carrying amounts reported in the balance sheet for cash and cash equivalents are valued at cost, which approximates their fair value. 44 trade and other miscellaneous receivables. We grant credit to customers in the normal course of business and maintain an allowance for doubtful accounts for potential credit losses. We determine the allowance for doubtful accounts by geographic market and take into consideration historical credit experience, creditworthiness of the customer and other pertinent information. We make concerted efforts to collect all accounts receivable, but sometimes we have to write-off the account against the allowance when we determine the account is uncollectible. The allowance for doubtful accounts was $22.3 million and $22.7 million as of December 31, 2014 and 2013, respectively. Inventories – Inventories are stated at the lower of cost or market, with cost determined on a first-in first-out basis. Property, Plant and Equipment – Property, plant and equipment is carried at cost less accumulated depreciation. Depreciation is computed using the straight-line method based on estimated useful lives of ten to forty years for buildings and improvements and three to eight years for machinery and equipment. Maintenance and repairs are expensed as incurred. We review property, plant and equipment for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. An impairment loss would be recognized when estimated future undiscounted cash flows relating to the asset are less than its carrying amount. An impairment loss is measured as the amount by which the carrying amount of an asset exceeds its fair value. Software Costs – We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use when both the preliminary project stage is completed and it is probable that the software will be used as intended. Capitalized software costs generally include external direct Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) costs of materials and services utilized in developing or obtaining computer software and compensation and related benefits for employees who are directly associated with the software project. Capitalized software costs are included in property, plant and equipment on our balance sheet and amortized on a straight-line or weighted average estimated user basis when the software is ready for its intended use over the estimated useful lives of the software, which approximate three to fifteen years. Instruments – Instruments are hand-held devices used by surgeons during total joint replacement and other surgical procedures. Instruments are recognized as long-lived assets and are included in property, plant and equipment. Undeployed instruments are carried at cost or realizable value. Instruments in the field are carried at cost less accumulated depreciation. Depreciation is computed using the straight-line method based on average estimated useful lives, determined principally in reference to associated product life cycles, primarily five years. We review instruments for impairment whenever events or changes in circumstances indicate that the carrying value of an instrument may not be recoverable. Depreciation of instruments is recognized as selling, general and administrative expense. Goodwill – Goodwill is not amortized but is subject to annual impairment tests. Goodwill has been assigned to reporting units. We perform annual impairment tests by either comparing a reporting unit’s estimated fair value to its carrying amount or doing a qualitative assessment of a reporting unit’s fair value from the last quantitative assessment to determine if there is potential impairment. We may do a qualitative assessment when the results of the previous quantitative test indicated the reporting unit’s estimated fair value was significantly in excess of the carrying value of its net assets and we do not believe there have been significant changes in the reporting unit’s operations that would significantly decrease its estimated fair value or significantly increase its net assets. If a quantitative assessment is performed, the fair value of the reporting unit and the implied fair value of goodwill are determined based upon a discounted cash flow analysis and/or use of a market approach by looking at market values of comparable companies. Significant assumptions are incorporated into our discounted cash flow analyses such as estimated growth rates and risk-adjusted discount rates. We perform this test in the fourth quarter of the year or whenever events or changes in circumstances indicate that the carrying value of the reporting unit’s assets may not be recoverable. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the reporting unit goodwill is less than the carrying value of the reporting unit goodwill. During the year ended December 31, 2012, we recorded a goodwill impairment charge of $96.0 million related to our U.S. Spine reporting unit. We did not record a goodwill impairment charge during the years ended December 31, 2014 or 2013. See Notes 8 and 9 for more information regarding goodwill and goodwill impairment. Intangible Assets – Intangible assets are initially measured at their fair value. We have determined the fair value of our intangible assets either by the fair value of the consideration exchanged for the intangible asset or the estimated after-tax discounted cash flows expected to be generated from the intangible asset. Intangible assets with an indefinite life, including certain trademarks and trade names, are not amortized. Indefinite life intangible assets are assessed annually to determine whether events and circumstances continue to support an indefinite life. Intangible assets with a finite life, including core and developed technology, certain trademarks and trade names, customer-related intangibles, intellectual property rights and patents and licenses are amortized on a straight-line basis over their estimated useful life, ranging from less than one year to 40 years. Intangible assets with a finite life are tested for impairment whenever events or circumstances indicate that the carrying amount may not be recoverable. Intangible assets with an indefinite life are tested for impairment annually or whenever events or circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognized if the carrying amount exceeds the estimated fair value of the asset. The amount of the impairment loss to be recorded would be determined based upon the excess of the asset’s carrying value over its fair value. The fair values of indefinite lived intangible assets are determined based upon a discounted cash flow analysis using the relief from royalty method or a qualitative assessment may be performed for any changes to the asset’s fair value from the last quantitative assessment. The relief from royalty method estimates the cost savings associated with owning, rather than licensing, assets. Significant assumptions are incorporated into these discounted cash flow analyses such as estimated growth rates, royalty rates and risk-adjusted discount rates. We may do a qualitative assessment when the results of the previous quantitative test indicated that the asset’s fair value was significantly in excess of its carrying value. In determining the useful lives of intangible assets, we consider the expected use of the assets and the effects of obsolescence, demand, competition, anticipated technological advances, changes in surgical techniques, market influences and other economic factors. For technology-based intangible assets, we consider the expected life cycles of products, absent unforeseen technological advances, which incorporate the corresponding technology. Trademarks and trade names that do not have a wasting characteristic (i.e., there are no legal, regulatory, contractual, competitive, economic or other factors which limit the useful life) are assigned an indefinite life. Trademarks and trade names that are related to products expected to be phased out are assigned lives consistent with the period in which the products bearing each brand are expected to be sold. For customer relationship intangible assets, we assign useful lives based upon historical levels of customer attrition. Intellectual property rights are assigned useful lives that approximate the contractual life of any related patent or the period for which we maintain exclusivity over the intellectual property. 45 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Income Taxes – We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. We reduce our deferred tax assets by a valuation allowance if it is more likely than not that we will not realize some portion or all of the deferred tax assets. In making such determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations. In the event we were to determine that we would be able to realize our deferred income tax assets in the future in excess of their net recorded amount, we would make an adjustment to the valuation allowance which would reduce the provision for income taxes. Federal income taxes are provided on the portion of the income of foreign subsidiaries that is expected to be remitted to the U.S. We operate on a global basis and are subject to numerous and complex tax laws and regulations. Our income tax filings are regularly under audit in multiple federal, state and foreign jurisdictions. Income tax audits may require an extended period of time to reach resolution and may result in significant income tax adjustments when interpretation of tax laws or allocation of company profits is disputed. Because income tax adjustments in certain jurisdictions can be significant, we record accruals representing management’s best estimate of the probable resolution of these matters. To the extent additional information becomes available, such accruals are adjusted to reflect the revised estimated probable outcome. Derivative Financial Instruments – We measure all derivative instruments at fair value and report them on our consolidated balance sheet as assets or liabilities. We maintain written policies and procedures that permit, under appropriate circumstances and subject to proper authorization, the use of derivative financial instruments solely for hedging purposes. The use of derivative financial instruments for trading or speculative purposes is prohibited by our policy. See Note 13 for more information regarding our derivative and hedging activities. Other Comprehensive Income – Other comprehensive income (OCI) refers to revenues, expenses, gains and losses that under generally accepted accounting principles are included in comprehensive income but are excluded from net earnings as these amounts are recorded directly as an adjustment to stockholders’ equity. Our OCI is comprised of foreign currency translation adjustments, unrealized gains and losses on cash flow hedges, unrealized gains and losses on 46 available-for-sale securities and amortization of prior service costs and unrecognized gains and losses in actuarial assumptions. Treasury Stock – We account for repurchases of common stock under the cost method and present treasury stock as a reduction of stockholders’ equity. We reissue common stock held in treasury only for limited purposes. Noncontrolling Interest – In 2011, we made an investment in a company in which we acquired a controlling financial interest, but not 100 percent of the equity. In 2013, we purchased additional shares of the company from the minority shareholders. Further information related to the noncontrolling interests of that investment has not been provided as it is not significant to our consolidated financial statements. Accounting Pronouncements – In May 2014, the Financial Accounting Standards Board issued Accounting Standard Update (ASU) No. 2014-09 – Revenue from Contracts with Customers (Topic 606). The ASU provides a five-step model for revenue recognition that all industries will apply to recognize revenue when a customer obtains control of a good or service. The ASU will be effective for us beginning January 1, 2017. We are in the initial phases of our adoption plans and, accordingly, we are unable to estimate any effect this may have on our revenue recognition practices. There are no other recently issued accounting pronouncements that we have not yet adopted that are expected to have a material effect on our financial position, results of operations or cash flows. 3. Share-Based Compensation Our share-based payments primarily consist of stock options and restricted stock units (RSUs). Share-based compensation expense was as follows (in millions): For the Years Ended December 31, 2014 2013 2012 Stock options RSUs Total expense, pre-tax Tax benefit related to awards $ 24.2 $ 24.7 $ 32.4 25.2 23.8 22.6 49.4 48.5 55.0 (15.5) (15.6) (16.6) Total expense, net of tax $ 33.9 $ 32.9 $ 38.4 Stock Options We had two equity compensation plans in effect at December 31, 2014: the 2009 Stock Incentive Plan (2009 Plan) and the Stock Plan for Non-Employee Directors. The 2009 Plan succeeded the 2006 Stock Incentive Plan (2006 Plan) and the TeamShare Stock Option Plan (TeamShare Plan). No further awards have been granted under the 2006 Plan or under the TeamShare Plan since May 2009, and shares remaining available for grant under those plans have been merged into Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) the 2009 Plan. Vested stock options previously granted under the 2006 Plan, the TeamShare Plan and another prior plan, the 2001 Stock Incentive Plan, remained outstanding as of December 31, 2014. We have reserved the maximum number of shares of common stock available for award under the terms of each of these plans. We have registered 57.9 million shares of common stock under these plans. The 2009 Plan provides for the grant of nonqualified stock options and incentive stock options, long-term performance awards in the form of performance shares or units, restricted stock, RSUs and stock appreciation rights. The Compensation and Management Development Committee of the Board of Directors determines the grant date for annual grants under our equity compensation plans. The date for annual grants under the 2009 Plan to our executive officers is expected to occur in the first quarter of each year following the earnings announcements for the previous quarter and full year. The Stock Plan for Non-Employee Directors provides for awards of stock options, restricted stock and RSUs to non-employee directors. It has been our practice to issue shares of common stock upon exercise of stock options from previously unissued shares, except in limited circumstances where they are issued from treasury stock. The total number of awards which may be granted in a given year and/or over the life of the plan under each of our equity compensation plans is limited. At December 31, 2014, an aggregate of 8.7 million shares were available for future grants and awards under these plans. Stock options granted to date under our plans vest over four years and have a maximum contractual life of 10 years. As established under our equity compensation plans, vesting may accelerate upon retirement after the first anniversary date of the award if certain criteria are met. We recognize expense related to stock options on a straight-line basis over the requisite service period, less awards expected to be forfeited using estimated forfeiture rates. Due to the accelerated retirement provisions, the requisite service period of our stock options range from one to four years. Stock options are granted with an exercise price equal to the market price of our common stock on the date of grant, except in limited circumstances where local law may dictate otherwise. A summary of stock option activity for the year ended December 31, 2014 is as follows (options in thousands): Weighted Average Exercise Price Weighted Average Remaining Contractual Life Intrinsic Value (in millions) Stock Options 10,741 $70.06 1,193 (3,811) (235) (42) 94.58 73.55 75.84 71.25 7,846 $71.94 7,485 $71.47 4,927 $67.91 5.5 5.4 3.9 $325.5 $314.0 $224.2 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. Outstanding at January 1, 2014 Options granted Options exercised Options forfeited Options expired Outstanding at December 31, 2014 Vested or expected to vest as of December 31, 2014 Exercisable at December 31, 2014 We use a Black-Scholes option-pricing model to determine the fair value of our stock options. For stock options granted in 2012, expected volatility was derived from the implied volatility of traded options on our stock that were actively traded around the grant date of the stock options with exercise prices similar to the stock options and maturities of over one year. In 2013 and 2014, we used a combination of historical volatility and implied volatility because the traded options that were actively traded around the grant date of our stock options did not have maturities of over one year. The expected term of the stock options has been derived from 47 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The following table presents information regarding the We are required to estimate the number of RSUs that will vest and recognize share-based payment expense on a straight- line basis over the requisite service period. As of December 31, 2014, we estimate that approximately 866,000 outstanding RSUs will vest. If our estimate were to change in the future, the cumulative effect of the change in estimate will be recorded in that period. Based upon the number of RSUs that we expect to vest, the unrecognized share-based payment expense as of December 31, 2014 was $31.7 million and is expected to be recognized over a weighted-average period of 2.2 years. The fair value of RSUs vesting during the years ended December 31, 2014, 2013 and 2012 based upon our stock price on the date of vesting was $29.3 million, $32.5 million and $18.9 million, respectively. 4. Inventories Inventories consisted of the following (in millions): As of December 31, Finished goods Work in progress Raw materials Inventories 2014 2013 $ 899.9 $ 817.0 87.8 181.3 77.4 180.1 $1,169.0 $1,074.5 Amounts charged to the consolidated statement of earnings for excess and obsolete inventory in the years ended December 31, 2014, 2013 and 2012 were $51.8 million, $112.0 million and $55.1 million, respectively. The 2013 period was higher due to our decision to discontinue certain products. 5. Property, Plant and Equipment Property, plant and equipment consisted of the following (in millions): As of December 31, Land Building and equipment Capitalized software costs Construction in progress Accumulated depreciation $67.42 Instruments 2014 2013 $ 20.4 $ 21.7 1,283.4 1,353.1 294.7 272.6 1,696.3 1,610.6 115.8 58.2 3,410.6 3,316.2 (2,121.8) (2,091.5) Property, plant and equipment, net $ 1,288.8 $ 1,224.7 Depreciation expense was $268.6 million, $262.6 million and $266.0 million for the years ended December 31, 2014, 2013 and 2012, respectively. weighted average fair value for stock options granted, the assumptions used to determine fair value, and the intrinsic value of options exercised in the indicated year: For the Years Ended December 31, 2014 2013 2012 Dividend yield Volatility Risk-free interest rate Expected life (years) 0.9% 1.1% 1.1% 25.2% 24.5% 25.6% 1.8% 1.1% 1.5% 5.5 6.1 6.1 Weighted average fair value of options granted $22.59 $16.33 $15.40 Intrinsic value of options exercised (in millions) $ 99.6 $ 97.9 $ 17.1 As of December 31, 2014, there was $33.8 million of unrecognized share-based payment expense related to nonvested stock options granted under our plans. That expense is expected to be recognized over a weighted average period of 2.6 years. RSUs We have awarded RSUs to our employees. The terms of the awards have been three to four years. Some of the awards have only service conditions while some have performance and market conditions in addition to service conditions. The service condition-only awards vest ratably on the anniversary date of the award. The awards that have performance and market conditions vest all at once on the third anniversary date. Future service conditions may be waived if an employee retires after the first anniversary date of the award, but performance and market conditions continue to apply. Accordingly, the requisite service period used for share-based payment expense on our RSUs range from one to four years. A summary of nonvested RSU activity for the year ended December 31, 2014 is as follows (RSUs in thousands): Outstanding at January 1, 2014 Granted Vested Forfeited Outstanding at December 31, 2014 RSUs 1,454 455 (306) (128) 1,475 Weighted Average Grant Date Fair Value 94.48 61.46 72.54 76.60 For the RSUs with service conditions only, the fair value of the awards was determined based upon the fair market value of our common stock on the date of grant. For the RSUs with market conditions, a Monte Carlo valuation technique was used to simulate the market conditions of the awards. The outcome of the simulation was used to determine the fair value of the awards. 48 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 6. Acquisitions 7. Investments We made a number of business acquisitions during the We invest in short and long-term investments classified as years 2014, 2013 and 2012. In October 2014, we acquired ETEX Holdings, Inc. (Etex). The Etex acquisition enhanced our biologics portfolio through the addition of Etex’s bone void filler products. In May 2013, we acquired the business assets of Knee Creations, LLC (Knee Creations). The Knee Creations acquisition enhanced our product portfolio of joint preservation solutions. In June 2013, we acquired NORMED Medizin-Technik GmbH (Normed). The Normed acquisition strengthened our Extremities and Trauma product portfolios and brought new product development capabilities in the foot and ankle and hand and wrist markets. In January 2012, we acquired Synvasive Technology, Inc. (Synvasive). The Synvasive acquisition enhanced our product portfolio through the addition of the STABLECUT® surgical saw blades, as well as the eLIBRA® Dynamic Knee Balancing SystemTM for soft tissue balancing. In October 2012, we acquired Dornoch Medical Systems, Inc. (Dornoch). The Dornoch acquisition enhanced our product portfolio through the addition of a medical waste fluid management and disposal technology. The results of operations of the acquired companies have been included in our consolidated results of operations subsequent to the transaction dates, and the respective assets and liabilities of the acquired companies have been recorded at their estimated fair values in our consolidated statement of financial position as of the transaction dates, with any excess purchase price being recorded as goodwill. Pro forma financial information and other information required by GAAP have not been included as the acquisitions, individually and in the aggregate, did not have a material impact upon our financial position or results of operations. available-for-sale securities. Information regarding our investments is as follows (in millions): As of December 31, 2014 Corporate debt securities U.S. government and agency debt securities Commercial paper Certificates of deposit Total short and long-term investments As of December 31, 2013 Corporate debt securities U.S. government and agency debt securities Foreign government debt securities Commercial paper Certificates of deposit Total short and long-term investments Gross Unrealized Amortized Cost Gains Losses Fair value $516.9 $0.1 $(0.5) $516.5 194.3 57.8 100.3 – – – – – – 194.3 57.8 100.3 $869.3 $0.1 $(0.5) $868.9 $457.6 $0.4 $(0.1) $457.9 211.1 0.1 3.1 68.3 67.2 – – – – – – – 211.2 3.1 68.3 67.2 $807.3 $0.5 $(0.1) $807.7 The amortized cost and fair value of our available-for-sale fixed-maturity securities by contractual maturity are as follows (in millions): As of December 31, 2014 Amortized Cost Due in one year or less Due after one year through two years Total $612.6 256.7 $869.3 Fair Value $612.5 256.4 $868.9 49 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2013 Fair Value Measurements at Reporting Date Using: Quoted Prices in Active Markets for Identical Assets (Level 1) Recorded Balance Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Description Assets Available-for-sale securities Corporate debt securities $457.9 $– $457.9 $– U.S. government and agency debt securities 211.2 Foreign government debt securities Commercial paper Certificates of deposit 3.1 68.3 67.2 Total available-for-sale securities 807.7 Derivatives, current and long-term Foreign currency forward contracts and options Interest rate swaps Liabilities Derivatives, current and long-term Foreign currency forward contracts and options Interest rate swaps 68.7 16.3 $892.7 20.6 7.0 $ 27.6 – – – – – – – $– – – $– 211.2 3.1 68.3 67.2 807.7 68.7 16.3 $892.7 20.6 7.0 $ 27.6 – – – – – – – $– – – $– 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. 8. Fair Value Measurements of Assets and Liabilities The following financial assets and liabilities are recorded at fair value on a recurring basis (in millions): As of December 31, 2014 Fair Value Measurements at Reporting Date Using: Quoted Prices in Active Markets for Identical Assets (Level 1) Recorded Balance Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) $ 516.5 $– $ 516.5 $– 194.3 57.8 100.3 868.9 – – – – 194.3 57.8 100.3 868.9 125.5 24.0 $1,018.4 – – $– 125.5 24.0 $1,018.4 – – – – – – $– – – $– Description Assets Available-for-sale securities Corporate debt securities U.S. government and agency debt securities Commercial paper Certificates of deposit Total available-for- sale securities Derivatives, current and long-term Foreign currency forward contracts and options Interest rate swaps Liabilities Derivatives, current and long-term Foreign currency forward contracts and options Forward starting 1.7 – – 1.7 59.3 interest rate swaps 59.3 $ 61.0 $– $ 61.0 50 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The following nonfinancial assets were measured at fair value on a nonrecurring basis (in millions): Fair Value Measurements Using: Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Losses Description Total Year Ended December 31, 2014 Indefinite-lived intangible assets $34.2 $– $– $34.2 $14.2 Year Ended December 31, 2013 Indefinite-lived intangible assets $21.0 Year Ended December 31, 2012 Goodwill $41.0 $– $– Indefinite-lived intangible assets 24.2 – $– $– – $21.0 $ 2.8 $41.0 $96.0 24.2 11.6 We conduct our annual goodwill impairment testing in the fourth quarter of every year or whenever events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. In 2012, it was determined that our U.S. Spine reporting unit’s carrying value was in excess of its fair value. The goodwill for this reporting unit was written down to its implied fair value of $41.0 million, resulting in a $96.0 million non-cash impairment charge. The implied fair value of goodwill equals the estimated fair value of a reporting unit minus the fair value of the reporting unit’s net assets. In determining the implied fair value of the U.S. Spine reporting unit’s goodwill, we used unobservable inputs to estimate the fair value of the reporting unit and its assets and liabilities. Fair value was determined using a weighting of income and market approaches. Fair value under the income approach was determined by discounting to present value the estimated future cash flows of the reporting unit. Fair value under the market approach utilized the guideline public company methodology, which uses valuation indicators from publicly traded companies that are similar to our U.S. Spine reporting unit and considers control premiums that would result from a sale of the reporting unit and the level of assets in the reporting unit versus the comparable companies. In estimating the future cash flows of the reporting unit, we utilized a combination of market and company specific inputs that a market participant would use in assessing the fair value of the reporting unit. The primary market input was revenue growth rates. These rates were based upon historical trends and estimated future growth drivers such as an aging global population, obesity and more active lifestyles. Significant company specific inputs included assumptions regarding how the reporting unit could leverage operating expenses as revenue grows and the impact any new products will have on revenues. Under the guideline public company methodology, we took into consideration specific risk differences between our reporting unit and the comparable companies, such as recent financial performance, size risks and product portfolios, among other considerations. Based upon our reporting unit’s recent financial performance, market share and product portfolio, we valued the reporting unit near the bottom of the valuation indicators of the comparable companies. The fair value of the reporting unit’s assets and liabilities were determined by using the same methods that are used in business combination purchase accounting. Factors that contributed to the 2012 impairment of the U.S. Spine reporting unit included broader market issues as well as company specific issues. The U.S. spine market was under pressure due to a constrained economic environment leading to continuing high unemployment and payer pushback on the necessity of certain procedures. Additionally, pricing was declining across the industry. Company specific issues included turnover with our independent sales agents and lack of execution in developing new, competitive products which resulted in a less than optimal product portfolio in our U.S. Spine reporting unit. Before the economic downturn in 2008, we estimated the U.S. spine market was growing in the low double digits, but declined to flat or in the low single digits in 2012. Previous goodwill impairment tests forecasted some recovery in the market which did not occur. As we completed our annual operating plan in the fourth quarter of 2012, it became clearer that the U.S. spine market recovery would take longer than we planned, including the persistence of significant negative pricing pressures. Additionally, we concluded that new product introductions made in 2012 would not have as significant of a positive effect as we had previously forecasted. As a result, we tempered our expectations of recovery in the U.S. market and for our U.S. Spine reporting unit and recognized an impairment charge. In our 2013 and 2014 annual goodwill impairment tests of our U.S. Spine reporting unit, we concluded no impairment charge was necessary. In our 2014 annual impairment test, the U.S. Spine reporting unit’s estimated fair value was in excess of its carrying value of net assets by 24 percent. We have four other reporting units with goodwill assigned to them. We estimate the fair value of those reporting units using the income approach by discounting to present value the estimated future cash flows of the reporting unit or a combination of the income approach and market approach utilizing the guideline public company methodology. Due to challenging market conditions associated with our U.S. Dental reporting unit, our 2013 annual impairment test indicated the estimated fair value of the U.S. Dental reporting unit was in excess of its carrying value of net assets by only 11 percent. For the annual impairment test in 2014, the goodwill balance of 51 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) the U.S. Dental reporting unit was $169.1 million. In our 2014 annual impairment test, due to improved operating performance and improving macroenomic conditions, including higher valuation indicators used in our market approach, the U.S. Dental reporting unit’s estimated fair value was in excess of its carrying value of net assets by 24 percent. In 2014, for our three other reporting units’ annual impairment test, we performed a qualitative assessment of changes in fair value from the 2013 income approach. A qualitative assessment was performed because the estimated fair value of each of the reporting units was significantly in excess of the carrying value of its net assets in the 2013 impairment test. We will continue to monitor the fair value of our U.S. Spine and U.S. Dental reporting units as well as our other three reporting units in our interim and annual reporting periods. If estimated cash flows for these reporting units decrease, we may be required to record further impairment charges in the future. Factors that could result in our cash flows being lower than our current estimates include: 1) decreased revenues caused by unforeseen changes in the healthcare market, or our inability to generate new product 9. Goodwill and Other Intangible Assets revenue from our research and development activities, and 2) our inability to achieve the estimated operating margins in our forecasts due to unforeseen factors. Additionally, changes in the broader economic environment could cause changes to our estimated discount rates or comparable company valuation indicators, which may impact our estimated fair values. In 2014, 2013 and 2012, we also recorded $14.2 million, $2.8 million and $11.6 million, respectively, of impairment charges in “Special items” related to certain indefinite lived intangible assets. The impairment was a result of lower future estimated revenues from products using certain trademarks. The lower future estimated revenues resulted from new competitive products in the marketplace, a trend towards newer, less invasive products, a decrease in projected revenues in U.S. Dollar terms due to the strengthening of the U.S. Dollar versus foreign currencies, negative publicity in the marketplace related to certain hip devices and our challenges in the global spine market. Effective in the fourth quarter of 2014 the intangible assets that were impaired have been reclassified as a finite lived intangible asset and will be amortized. The following table summarizes the changes in the carrying amount of goodwill (in millions): Americas Europe Asia Pacific Total $1,623.9 $1,128.6 $192.3 $2,944.8 (373.0) – – (373.0) 1,250.9 1,128.6 192.3 2,571.8 11.0 (5.0) 24.0 34.5 – (25.1) 35.0 4.4 1,629.9 1,187.1 167.2 2,984.2 (373.0) – – (373.0) 1,256.9 1,187.1 167.2 2,611.2 40.6 – – 40.6 (4.3) (119.4) (13.9) (137.6) 1,666.2 1,067.7 153.3 2,887.2 (373.0) – – (373.0) $1,293.2 $1,067.7 $153.3 $2,514.2 Balance at January 1, 2013 Goodwill Accumulated impairment losses Acquisitions Currency translation Balance at December 31, 2013 Goodwill Accumulated impairment losses Acquisitions Currency translation Balance at December 31, 2014 Goodwill Accumulated impairment losses 52 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The components of identifiable intangible assets were as follows (in millions): As of December 31, 2014: Intangible assets subject to amortization: Gross carrying amount Accumulated amortization Intangible assets not subject to amortization: Gross carrying amount Total identifiable intangible assets As of December 31, 2013: Intangible assets subject to amortization: Gross carrying amount Accumulated amortization Intangible assets not subject to amortization: Gross carrying amount Total identifiable intangible assets Intellectual Property Rights Trademarks and Trade Names Customer Relationships Technology Other Total $ 727.2 $ 173.4 $ 74.2 $213.8 $ 93.9 $1,282.5 (458.3) (157.7) (34.1) (99.6) (58.3) (808.0) – – 129.0 – – 129.0 $ 268.9 $ 15.7 $169.1 $114.2 $ 35.6 $ 603.5 $ 700.4 $ 173.4 $ 43.3 $216.2 $ 95.1 $1,228.4 (401.4) (142.5) (33.9) (76.4) (43.9) (698.1) – – 177.4 – – 177.4 $ 299.0 $ 30.9 $186.8 $139.8 $ 51.2 $ 707.7 Intangible amortization expense was recorded as follows 10. Other Current and Long-term Liabilities (in millions): For the Years Ended December 31, 2014 2013 2012 Other current and long-term liabilities consisted of the following (in millions): Cost of products sold $ 15.2 $18.3 $24.0 Selling, general and administrative 92.0 77.6 73.1 As of December 31, Total intangible amortization $107.2 $95.9 $97.1 Estimated annual amortization expense based upon intangible assets recognized as of December 31, 2014 for the years ending December 31, 2015 through 2019 is (in millions): For the Years Ending December 31, Other current liabilities: License and service agreements Certain claims accrual (Note 19) Litigation settlement accrual (Note 19) Forward starting interest rate swaps Salaries, wages and benefits Accrued liabilities 2014 2013 $100.2 $109.2 50.0 70.0 59.3 167.7 351.3 50.0 – – 153.9 351.0 2015 2016 2017 2018 2019 $88.5 81.6 66.2 50.9 36.3 Total other current liabilities $798.5 $664.1 Other long-term liabilities: Long-term income tax payable Certain claims accrual (Note 19) Other long-term liabilities Total other long-term liabilities $181.7 $115.0 307.2 159.7 329.0 132.6 $648.6 $576.6 53 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 11. Debt Our debt consisted of the following (in millions): As of December 31, Long-term debt Senior Notes due 2014 Senior Notes due 2019 Senior Notes due 2021 Senior Notes due 2039 Term Loan Other long-term debt Debt discount Adjustment related to interest rate swaps 2014 2013 $ – $ 250.0 500.0 300.0 500.0 98.0 4.9 (1.4) 24.0 500.0 300.0 500.0 112.4 2.1 (1.5) 9.3 Total long-term debt $1,425.5 $1,672.3 In May 2014, we entered into a new credit agreement (Senior Credit Facility). The Senior Credit Facility contains: (i) a 5-year unsecured term loan facility in the principal amount of $3.0 billion (Term Loan), and (ii) a 5-year unsecured multicurrency revolving facility in the principal amount of $1.35 billion (Multicurrency Revolving Facility). The Senior Credit Facility replaced a previous agreement that provided for a $1.35 billion revolving credit facility that would have matured in May 2017. The Multicurrency Revolving Facility will mature in May 2019, with two one-year extensions available at our option. Borrowings under the Multicurrency Revolving Facility may be used for general corporate purposes. The availability of the Term Loan is conditioned on, among other things, the consummation of the Biomet merger. The Term Loan requires us to reduce unused commitments and prepay the borrowings under the Term Loan with any net cash proceeds received from specified asset sales, issuances or sales of equity and incurrences of borrowed money indebtedness, subject to certain exceptions. Commitments under the Term Loan automatically terminate on the earliest to occur of: (i) the funding and disbursement of the Term Loan funds to us, (ii) April 24, 2015, as such date may be extended pursuant to the merger agreement, or (iii) termination of the merger agreement. The Term Loan will mature five years after the initial borrowing. Borrowings under the Term Loan may only be used by us to fund, in part, the Biomet merger, including the payment of any indebtedness of LVB and its subsidiaries, and to pay all or a portion of the costs incurred by us in connection with the Biomet merger. There were no borrowings outstanding under the Senior Credit Facility at December 31, 2014. In May 2014, we also entered into a 364-Day Credit Agreement (Bridge Credit Agreement). The Bridge Credit Agreement is a 364-day unsecured committed bridge facility in the principal amount of $7.66 billion. Funding of loans under the Bridge Credit Agreement is conditioned on, among other things, the consummation of the Biomet merger. Any loans under the Bridge Credit Agreement will mature 364 days after the funding date of the loans. The Bridge Credit Agreement 54 requires us to reduce unused commitments and prepay the loans with any net cash proceeds received from specified asset sales, issuances or sales of equity and incurrences of borrowed money indebtedness, such as new senior notes we intend to issue, subject to certain exceptions. Commitments under the Bridge Credit Agreement automatically terminate on the earliest to occur of: (i) the funding and disbursement of the loans, (ii) April 24, 2015, as such date may be extended pursuant to the merger agreement, or (iii) termination of the merger agreement. Proceeds of loans under the Bridge Credit Agreement may only be used to fund, in part, the Biomet merger, including the payment of any indebtedness of LVB and its subsidiaries, and to pay all or a portion of the costs incurred by us in connection with the Biomet merger. We have a term loan agreement (Japan Term Loan) with one of the lenders under the Senior Credit Facility 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. The estimated fair value of the Japan Term Loan as of December 31, 2014, based upon publicly available market yield curves and the terms of the debt (Level 2), was $97.6 million. We and certain of our wholly owned foreign subsidiaries are the borrowers under the Senior Credit Facility. Borrowings under the Senior Credit Facility bear interest at floating rates based upon indices determined by the currency of the borrowings plus an applicable margin determined by reference to our senior unsecured long-term credit rating, or at an alternate base rate, or, in the case of borrowings under the Multicurrency Revolving Facility only, at a fixed-rate determined through a competitive bid process. The Senior Credit Facility contains customary affirmative and negative covenants and events of default for an unsecured financing arrangement, including, among other things, limitations on consolidations, mergers and sales of assets. Financial covenants include a consolidated indebtedness to consolidated EBITDA ratio of no greater than 3.0 to 1.0 in periods prior to any Term Loan funding and no greater than 5.0 to 1.0 in periods after the Term Loan is funded. If our credit rating falls below investment grade, additional restrictions would result, including restrictions on investments and payment of dividends. We were in compliance with all covenants under the Senior Credit Facility as of December 31, 2014. Commitments under the Senior Credit Facility are subject to certain fees. On the Multicurrency Revolving Facility, we pay a facility fee at a rate determined by reference to our senior unsecured long-term credit rating. On the Term Loan, we pay a fee on the daily actual unused commitment for the period from and including July 23, 2014 through the day the commitments under the Term Loan terminate. Zimmer Holdings is the borrower under the Bridge Credit Agreement. Borrowings under the Bridge Credit Agreement bear interest at floating rates based upon LIBOR plus an applicable margin determined by reference to our senior Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) unsecured long-term credit rating, or at an alternate base rate. The Bridge Credit Agreement contains customary affirmative and negative covenants and events of default for an unsecured financing arrangement, including, among other things, limitations on consolidations, mergers and sales of assets. Financial covenants include a consolidated indebtedness to consolidated EBITDA ratio of no greater than 5.0 to 1.0. We were in compliance with all covenants under the Bridge Credit Agreement as of December 31, 2014. If our credit rating falls below investment grade, additional restrictions would result, including restrictions on investments and payment of dividends. We will pay a funding fee if we borrow under the Bridge Credit Agreement as well as duration fees based on the outstanding principal amount of the loans in the amount and on the dates specified in the Bridge Credit Agreement. In addition, we pay a fee on the daily actual unused commitment for the period from and including July 23, 2014 through the day the commitments under the Bridge Credit Agreement terminate. In association with the Senior Credit Facility and Bridge Credit Agreement, we incurred debt issuance costs paid to the lenders. These debt issuance costs, to the extent paid, were recognized as financing cash flows on our consolidated statement of cash flows. For the debt issuance costs related to the Bridge Credit Agreement, we are recognizing expense on a straight-line basis over the estimated commitment period, which is one year. If we borrow under the Bridge Credit Agreement in the future, any remaining unamortized debt issuance costs will be recognized as interest expense over the period debt is outstanding under the Bridge Credit Agreement. The related expense for the Bridge Credit Agreement debt issuance costs and the Bridge Credit Agreement and Term Loan unused commitment fees has been presented as “Other expense” on our consolidated statement of earnings since we have not borrowed against these agreements. The debt issuance costs related to the Term Loan portion of the Senior Credit Facility will be recognized as interest expense under the effective interest rate method once we borrow on the Term Loan. The debt issuance costs related to the Multicurrency Revolving Facility are being recognized as expense on a straight-line basis over the 5-year commitment period of the facility. We have three tranches of senior notes outstanding: $500 million aggregate principal amount of 4.625 percent notes due November 30, 2019, $300 million aggregate principal amount of 3.375 percent notes due November 30, 2021 and $500 million aggregate principal amount of 5.75 percent notes due November 30, 2039. Interest on each series is payable on May 30 and November 30 of each year until maturity. The estimated fair value of our senior notes as of December 31, 2014, based on quoted prices for the specific securities from transactions in over-the-counter markets (Level 2), was $1,460.2 million. We may redeem the senior notes at our election in whole or in part at any time prior to maturity at a redemption price equal to the greater of 1) 100 percent of the principal amount of the notes being redeemed; or 2) the sum of the present values of the remaining scheduled payments of principal and interest (not including any portion of such payments of interest accrued as of the date of redemption), discounted to the date of redemption on a semi-annual basis at the Treasury Rate (as defined in the debt agreement), plus 20 basis points in the case of the 2019 notes and 2021 notes, and 25 basis points in the case of the 2039 notes. We would also pay the accrued and unpaid interest on the Senior Notes to the redemption date. 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 13 for additional information regarding the interest rate swap agreements. We also have available uncommitted credit facilities totaling $31.9 million. At December 31, 2014 and 2013, the weighted average interest rate for our long-term borrowings was 3.5 percent and 3.3 percent, respectively. We paid $67.5 million, $68.1 million and $67.8 million in interest during 2014, 2013 and 2012, respectively. 12. Accumulated Other Comprehensive 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 14 for more information on our defined benefit plans. 55 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The following table shows the changes in the components of OCI, net of tax (in millions): Balance December 31, 2013 OCI before reclassifications Reclassifications Balance December 31, 2014 The following table shows the reclassification adjustments from OCI (in millions): Foreign Currency Translation Cash Flow Hedges Unrealized Gains on Securities Defined Benefit Plan Items $ 401.1 (241.5) – $ 33.1 55.9 (18.9) $ 0.5 (0.5) (0.4) $ (67.6) (80.0) 4.2 $ 159.6 $ 70.1 $(0.4) $(143.4) Component of OCI Cash flow hedges Foreign exchange forward contracts Foreign exchange options Cross-currency interest rate swaps Investments Realized gains on securities Defined benefit plans Prior service cost Unrecognized actuarial (loss) Total reclassifications Amount of Gain / (Loss) Reclassified from OCI For the Years Ended December 31, 2014 2013 2012 Location on Statement of Earnings $ 33.3 – – 33.3 14.4 $ 8.0 (0.2) – 7.8 3.4 $(12.0) (0.4) 0.2 (12.2) (8.9) $ 18.9 $ 4.4 $ (3.3) $ 0.4 – $ 0.4 $ $ – – – $ $ – – – $ 3.9 (11.1) $ 3.9 (16.6) $ 2.9 (13.3) (7.2) (3.0) (12.7) (4.8) (10.4) (3.9) $ (4.2) $ (7.9) $ (6.5) $ 15.1 $ (3.5) $ (9.8) Cost of products sold Cost of products sold Interest expense Total before tax Provision for income taxes Net of tax Interest income Provision for income taxes Net of tax * * Total before tax Provision for income taxes Net of tax Net of tax * These OCI components are included in the computation of net periodic pension expense (see Note 14). The following table shows the tax effects on each component of OCI recognized in our consolidated statements of comprehensive income (in millions): For the Years Ended December 31, 2014 2013 2012 2014 2013 2012 2014 2013 2012 Before Tax Tax Net of Tax Foreign currency cumulative translation adjustments Unrealized cash flow hedge gains Reclassification adjustments on foreign currency hedges Reclassification adjustments on securities Unrealized gains/(losses) on securities Adjustments to prior service cost and unrecognized actuarial $(241.5) $(44.4) $46.1 15.2 12.2 – 0.4 60.5 (33.3) (0.4) (0.5) 63.6 (7.8) – 0.1 $ $ – 4.6 (14.4) – – $ – 30.2 (3.4) – – assumptions (104.8) 50.3 20.3 (29.0) 11.8 – 4.3 8.9 – – 8.5 $(241.5) $(44.4) $46.1 10.9 3.3 – 0.4 55.9 (18.9) (0.4) (0.5) 33.4 (4.4) – 0.1 (75.8) 38.5 11.8 Total Other Comprehensive Gain/(Loss) $(320.0) $ 61.8 $94.2 $(38.8) $38.6 $21.7 $(281.2) $ 23.2 $72.5 56 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 13. Derivative Instruments and Hedging Activities Foreign Currency Exchange Rate Risk 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 senior notes due 2019 and 2021. The total notional amounts are $250 million and $300 million for the senior notes due 2019 and 2021, respectively. On the interest rate swap agreements for the senior notes due 2019, we receive a fixed interest rate of 4.625 percent and pay variable interest equal to the three-month LIBOR plus an average of 133 basis points. On the interest rate swap agreements for the senior notes due 2021, we receive a fixed interest rate of 3.375 percent and pay variable interest equal to the three-month LIBOR plus an average of 99 basis points. Derivatives Designated as Cash Flow Hedges In 2014, we entered into forward starting interest rate swaps that we have designated as cash flow hedges of our anticipated issuance of senior notes related to the pending Biomet merger that we anticipate will mature in March 2045. The forward starting interest rate swaps mitigate the risk of changes in interest rates prior to completion of the senior notes offering. The total notional amounts of the forward starting interest rate swaps are $1 billion and will settle in March 2015. On the forward starting interest rate swaps, we receive variable interest equal to three-month LIBOR and pay a fixed interest weighted average rate of 3.01 percent. We will defer the effective portion of the forward starting interest rate swaps over the maturity period of the hedged senior notes, which is thirty years, and recognize any ineffective portion immediately in earnings. 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. For foreign currency exchange forward contracts and options outstanding at December 31, 2014, we had obligations to purchase U.S. Dollars and sell Euros, Japanese Yen, British Pounds, Canadian Dollars, Australian Dollars, Korean Won, Swedish Krona, Czech Koruna, Thai Baht, Taiwan Dollars, South African Rand, Russian Rubles and Indian Rupees and obligations to purchase Swiss Francs and sell U.S. Dollars. These derivatives mature at dates ranging from January 2015 through June 2017. As of December 31, 2014, the notional amounts of outstanding forward contracts and options entered into with third parties to purchase U.S. Dollars were $1,289.8 million. As of December 31, 2014, the notional amounts of outstanding forward contracts and options entered into with third parties to purchase Swiss Francs were $306.3 million. 57 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Derivatives Not Designated as Hedging Instruments Foreign Currency Exchange and Interest Rate Risk 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 remeasurement gains/losses recognized in earnings are generally offset with gains/losses on the foreign currency forward exchange contracts in the same reporting period. These offsetting gains/losses are recorded in cost of products sold as the underlying assets and liabilities exposed to remeasurement include inventory-related transactions. 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 $1.2 billion to $1.7 billion per quarter. Derivatives Designated as Cash Flow Hedges In 2011, our subsidiary in Japan, with a functional currency of Japanese Yen, borrowed variable-rate debt of $143.0 million denominated in U.S. Dollars under our previous credit facility. To manage the foreign currency exchange risk associated with remeasuring the debt to Japanese Yen and the interest rate risk associated with the variable-rate debt, we entered into multiple cross-currency interest rate swap agreements with a total notional amount of 11,798 million Japanese Yen. We designated these swaps as cash flow hedges of the foreign currency exchange and interest rate risks. The effective portion of changes in fair value of the cross-currency interest rate swaps was temporarily recorded in other comprehensive income and then recognized in interest expense when the hedged item affected net earnings. The cross-currency interest rate swap agreements matured in 2012 and we paid off the subsidiary’s U.S. Dollar debt with Japanese Yen debt borrowed under our previous credit facility. 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): Derivative Instrument Interest rate swaps Gain /(Loss) on Instrument Gain /(Loss) on Hedged Item Year Ended December 31, Year Ended December 31, Location on Statement of Earnings 2014 2013 2012 2014 2013 2012 Interest expense $14.7 $(24.6) $6.1 $(14.7) $24.6 $(6.1) We had no ineffective fair value hedging instruments nor any amounts excluded from the assessment of hedge effectiveness during the years ended December 31, 2014, 2013 and 2012. 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): Amount of Gain / (Loss) Recognized in OCI Year Ended December 31, Amount of Gain / (Loss) Reclassified from OCI Year Ended December 31, Derivative Instrument 2014 2013 2012 Location on Statement of Earnings 2014 2013 2012 Foreign exchange forward contracts $119.8 $63.9 $16.3 Cost of products sold $33.3 $ 8.0 $(12.0) Foreign exchange options Forward starting interest rate swaps Cross-currency interest rate swaps – (0.3) (1.1) (59.3) – – – – – $ 60.5 $63.6 $15.2 Cost of products sold Interest expense Interest expense – – – (0.2) (0.4) – – – 0.2 $33.3 $ 7.8 $(12.2) The net amount recognized in earnings during the years ended December 31, 2014, 2013 and 2012 due to ineffectiveness and amounts excluded from the assessment of hedge effectiveness were not significant. 58 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The fair value of outstanding derivative instruments designated as cash flow hedges and recorded on the balance sheet at December 31, 2014, together with settled derivatives where the hedged item has not yet affected earnings, was a net unrealized gain of $87.9 million, or $70.0 million after taxes, which is deferred in accumulated other comprehensive income. Of the net unrealized gain, $89.5 million, or $66.0 million after taxes, is expected to be reclassified to earnings in cost of products sold and a loss of $0.7 million, or $0.5 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/(losses) from these derivative instruments were recognized on our consolidated statements of earnings (in millions): Derivative Instrument Foreign exchange forward contracts Year Ended December 31, Location on Statement of Earnings 2014 2013 2012 Cost of products sold $15.3 $– $(2.0) 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. Balance Sheet Presentation As of December 31, 2014 and December 31, 2013, 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): Asset Derivatives Foreign exchange forward contracts Foreign exchange forward contracts Interest rate swaps Total asset derivatives Liability Derivatives As of December 31, 2014 As of December 31, 2013 Balance Sheet Location Fair Value Balance Sheet Location Fair Value Other current assets $ 98.7 Other current assets $ 60.2 Other assets Other assets 53.1 24.0 $175.8 Other assets Other assets 30.2 16.3 $106.7 Foreign exchange forward contracts Other current liabilities $ 16.4 Other current liabilities $ 26.4 Forward starting interest rate swaps Foreign exchange forward contracts Interest rate swaps Total liability derivatives Other current liabilities Other long-term liabilities Other long-term liabilities 59.3 11.6 – $ 87.3 Other current liabilities Other current liabilities Other long-term liabilities – 15.9 7.0 $ 49.3 The table below presents the effects of our master netting agreements on our consolidated balance sheets (in millions): Description Asset Derivatives Cash flow hedges Cash flow hedges Liability Derivatives Cash flow hedges Cash flow hedges As of December 31, 2014 As of December 31, 2013 Location Gross Amount Offset Net Amount in Balance Sheet Gross Amount Offset Net Amount in Balance Sheet Other current assets $98.7 $15.9 Other assets 53.1 10.4 $82.8 42.7 $60.2 $13.5 30.2 8.2 $46.7 22.0 Other current liabilities Other long-term liabilities 16.4 11.6 15.9 10.4 0.5 1.2 26.4 15.9 13.5 8.2 12.9 7.7 59 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 14. 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. Defined Benefit Plans The components of net pension expense for our defined benefit retirement plans were as follows (in millions): For the Years Ended December 31, Service cost Interest cost Expected return on plan assets Settlement Amortization of prior service cost Amortization of unrecognized actuarial loss Net periodic benefit cost U.S. and Puerto Rico Foreign 2014 2013 2012 2014 2013 2012 $ 10.9 $ 11.9 $ 11.4 $ 14.7 $16.1 $15.0 15.5 13.2 13.3 9.2 5.6 6.1 (30.8) (28.7) (25.5) (11.0) (6.7) (7.6) – (2.6) 10.6 – (2.6) 14.8 0.7 (2.0) 11.4 – – – (1.3) (1.3) (0.9) 0.5 1.8 1.9 $ 3.6 $ 8.6 $ 9.3 $ 12.1 $15.5 $14.5 The weighted average actuarial assumptions used to determine net pension expense for our defined benefit retirement plans were as follows: For the Years Ended December 31, Discount rate Rate of compensation increase Expected long-term rate of return on plan assets U.S. and Puerto Rico Foreign 2014 2013 2012 2014 2013 2012 4.98% 3.29% 7.75% 4.32% 3.29% 7.75% 4.97% 3.81% 7.75% 2.46% 1.48% 2.88% 2.13% 2.29% 2.74% 2.58% 2.77% 3.51% 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. 60 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Changes in projected benefit obligations and plan assets were (in millions): For the Years Ended December 31, Projected benefit obligation – beginning of year Service cost Interest cost Plan amendments Employee contributions Benefits paid Actuarial (gain) loss Expenses paid Translation (gain) loss Projected benefit obligation – end of year Plan assets at fair market value – beginning of year Actual return on plan assets Employer contributions Employee contributions Plan amendments Benefits paid Expenses paid Translation gain (loss) Plan assets at fair market value – end of year Funded status Amounts recognized in consolidated balance sheet: Prepaid pension Short-term accrued benefit liability Long-term accrued benefit liability Net amount recognized Amounts recognized in accumulated other comprehensive income: Unrecognized prior service cost Unrecognized actuarial loss Total amount recognized U.S. and Puerto Rico Foreign 2014 2013 2014 2013 $316.7 $314.3 $371.5 $259.4 10.9 15.5 – – 11.9 13.2 – – 14.7 9.2 16.1 5.6 (7.0) 118.9 18.5 15.9 (10.0) (10.4) (22.6) (29.4) 53.5 (12.3) 77.9 (17.7) – – – – (0.2) (0.2) (38.3) 2.9 $386.6 $316.7 $423.7 $371.5 $398.6 $363.0 $372.3 $231.6 10.9 2.7 – – 25.2 20.8 – – 38.0 14.7 18.5 9.7 15.0 15.9 – 126.7 (10.0) (10.4) (22.6) (29.4) – – – – (0.2) (0.2) (35.3) 3.0 $402.2 $398.6 $385.4 $372.3 $ 15.6 $ 81.9 $(38.3) $ 0.8 $ 29.4 $ 92.7 $ 12.4 $ 12.1 (0.7) (0.7) (0.5) – (13.1) (10.1) (50.2) (11.3) $ 15.6 $ 81.9 $(38.3) $ 0.8 $ (9.4) $(12.0) $(12.8) $ (8.3) 176.1 113.3 68.7 15.5 $166.7 $101.3 $ 55.9 $ 7.2 61 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) We estimate the following amounts recorded as part of accumulated other comprehensive income will be recognized as part of our net pension expense during 2015 (in millions): Unrecognized prior service cost Unrecognized actuarial loss U.S. and Puerto Rico Foreign $(2.6) $(1.9) 18.3 $15.7 2.7 $ 0.8 The weighted average actuarial assumptions used to determine the projected benefit obligation for our defined benefit retirement plans were as follows: For the Years Ended December 31, Discount rate Rate of compensation increase U.S. and Puerto Rico Foreign 2014 2013 2012 2014 2013 2012 4.10% 4.98% 4.32% 1.38% 2.45% 2.15% 3.29% 3.29% 3.29% 1.43% 1.52% 2.75% Plans with projected benefit obligations in excess of plan assets were as follows (in millions): As of December 31, Projected benefit obligation Plan assets at fair market value U.S. and Puerto Rico Foreign 2014 2013 2014 2013 $54.6 40.8 $10.8 $365.2 $318.1 – 315.0 307.4 Total accumulated benefit obligations and plans with accumulated benefit obligations in excess of plan assets were as follows (in millions): As of December 31, Total accumulated benefit obligations Plans with accumulated benefit obligations in excess of plan assets: Accumulated benefit obligation Plan assets at fair market value 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): For the Years Ending December 31, 2015 2016 2017 2018 2019 2020-2024 U.S. and Puerto Rico Foreign $ 12.3 $17.0 13.3 15.0 16.5 18.4 113.2 16.5 16.9 17.0 17.9 89.1 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 U.S. and Puerto Rico Foreign 2014 2013 2014 2013 $337.5 $273.8 $413.1 $362.1 32.8 22.0 8.8 – 358.6 315.0 308.9 303.7 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. 62 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 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. The fair value of our U.S. and Puerto Rico pension plan assets by asset category was as follows (in millions): As of December 31, 2014 Fair Value Measurements at Reporting Date Using: Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) $1.4 $ – $– – – – – – – 83.7 23.0 83.0 49.1 36.0 126.0 – – – – – – $1.4 $400.8 $– As of December 31, 2013 Fair Value Measurements at Reporting Date Using: Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) $0.8 $ – $– – – – – – – 79.6 22.3 87.7 43.4 42.1 122.7 – – – – – – $0.8 $397.8 $– Asset Category Cash and cash equivalents Equity securities: U.S. large-cap U.S. small-cap International Real estate Commodity-linked mutual funds Intermediate fixed income securities Total Total $ 1.4 83.7 23.0 83.0 49.1 36.0 126.0 $402.2 Asset Category Cash and cash equivalents Equity securities: U.S. large-cap U.S. small-cap International Real estate Commodity-linked mutual funds Intermediate fixed income securities Total Total $ 0.8 79.6 22.3 87.7 43.4 42.1 122.7 $398.6 The fair value of our foreign pension plan assets was as follows (in millions): As of December 31, 2014 Fair Value Measurements at Reporting Date Using: Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) $ 31.0 $ – $ Asset Category Cash and cash equivalents Equity securities: Total $ 31.0 Energy Materials Industrials Consumer discretionary Consumer staples Healthcare Financials Information technology Telecommunication services Utilities Other Fixed income securities: Government bonds Corporate bonds Asset-backed securities Other debt Other types of investments: Mortgage loans Insurance contracts Other investments Real estate Total 4.7 7.1 7.5 6.5 7.5 6.8 16.3 4.9 2.0 3.4 36.7 72.5 58.9 22.0 1.7 9.2 6.1 12.0 68.6 4.7 7.1 7.5 6.5 7.5 6.8 16.3 4.9 2.0 3.4 34.5 – – – – – – – – – – – – – – – – – – 2.2 72.5 58.9 22.0 1.7 9.2 6.1 12.0 – $385.4 $132.2 $184.6 $68.6 As of December 31, 2013 Fair Value Measurements at Reporting Date Using: Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) $ 13.9 $ – $ Asset Category Cash and cash equivalents Equity securities: Total $ 13.9 Energy Materials Industrials Consumer discretionary Consumer staples Healthcare Financials Information technology Telecommunication services Utilities Other Fixed income securities: Government bonds Corporate bonds Asset-backed securities Other debt Other types of investments: Mortgage loans Insurance contracts Other investments Real estate Total 4.7 5.7 7.6 5.2 6.8 9.7 15.8 5.8 2.6 3.4 35.7 64.4 65.9 24.0 2.8 9.0 6.4 14.7 68.2 4.7 5.7 7.6 5.2 6.8 9.7 15.8 5.8 2.6 3.4 33.2 – – – – – – – – – – – – – – – – – – 2.5 64.4 65.9 24.0 2.8 9.0 6.4 14.7 – – – – – – – – – – – – – – – – – – – – 68.6 – – – – – – – – – – – – – – – – – – – 68.2 $372.3 $114.4 $189.7 $68.2 63 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2014 and 2013, our defined benefit 15. Income Taxes pension plans’ assets did not hold any direct investment in Zimmer Holdings common stock. The components of earnings before income taxes and the Equity securities are valued using a market approach, income taxes paid consisted of the following (in millions): 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): Beginning Balance Gains on assets sold Change in fair value of assets Net purchases and sales Translation loss Ending Balance December 31, 2014 $68.2 0.3 1.7 4.8 (6.4) $68.6 We expect that we will have no legally required minimum funding requirements in 2015 for the qualified U.S. and Puerto Rico defined benefit retirement plans, nor do we expect to voluntarily contribute to these plans during 2015. Contributions to foreign defined benefit plans are estimated to be approximately $14.0 million in 2015. 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 $32.8 million, $29.6 million and $26.5 million related to these plans for the years ended December 31, 2014, 2013 and 2012, respectively. For the Years Ended December 31, 2014 2013 2012 United States operations $395.6 $400.7 $409.9 Foreign operations 548.3 580.4 580.2 Total $943.9 $981.1 $990.1 The provision for income taxes consisted of (in millions): Current: Federal State Foreign Deferred: Federal State Foreign $177.6 $ 199.0 $179.8 16.3 115.2 309.1 (56.9) (6.6) (20.7) 20.6 128.5 348.1 13.8 108.4 302.0 (87.7) (58.8) (8.5) (30.0) 0.7 (6.7) (84.2) (126.2) (64.8) Provision for income taxes $224.9 $ 221.9 $237.2 Income taxes paid $340.1 $ 272.3 $227.6 A reconciliation of the U.S. statutory income tax rate to our effective tax rate is as follows: For the Years Ended December 31, 2014 2013 2012 U.S. statutory income tax rate 35.0% 35.0% 35.0% State taxes, net of federal deduction 0.7 0.8 1.0 Tax impact of foreign operations, including foreign tax credits Tax impact of certain significant (11.3) (12.2) (10.4) transactions 1.4 1.6 (3.5) Tax benefit relating to U.S. manufacturer’s deduction and export sales R&D credit Goodwill impairment Other (1.9) (0.2) – 0.1 (1.8) (0.6) – (0.2) (1.9) – 3.4 0.4 Effective income tax rate 23.8% 22.6% 24.0% Our operations in Puerto Rico, Switzerland and the State of Indiana benefit from various tax incentive grants. Unless these grants are extended, they will expire between fiscal years 2015 and 2026. 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 64 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 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): As of December, 31 Deferred tax assets: Inventory Net operating loss carryover Tax credit carryover Capital loss carryover Accrued liabilities Share-based compensation Unremitted earnings of foreign subsidiaries Other Total deferred tax assets Less: Valuation allowances Deferred tax liabilities: Fixed assets Intangible assets Other Total deferred tax liabilities Total net deferred tax assets December 31, 2014 and 2013, respectively. The remaining valuation allowances of $4.9 million and $2.7 million at December 31, 2014 and 2013, respectively, relate primarily to potential capital losses. At December 31, 2014, we had an aggregate of approximately $3,204.0 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): 2014 2013 $ 275.1 $ 271.1 116.9 185.5 7.4 106.7 59.9 32.3 50.3 26.4 187.1 7.8 72.0 74.6 25.6 11.2 834.1 675.8 For the Years Ended December 31, 2014 2013 2012 (122.8) (42.7) Balance at January 1 $304.3 $285.5 $158.4 $(104.3) $ (97.7) (95.9) (106.4) – (1.2) Decreases related to prior periods Increases related to current period Decreases related to settlements with taxing authorities Decreases related to lapse of statute of 0.9 16.5 118.7 (3.8) (17.3) 17.3 22.5 (8.9) 19.1 (3.0) (2.9) (0.6) (200.2) (205.3) limitations (1.7) – (1.2) $ 511.1 $ 427.8 Balance at December 31 $314.0 $304.3 $285.5 Total deferred tax assets after valuation 711.3 633.1 Increases related to prior periods During the first quarter of 2014, we established a $70.5 million deferred tax asset (and offsetting valuation allowance) for indefinite lived net operating loss carryforwards in a Luxembourg domiciled holding company. These losses primarily relate to interest deductions on intercompany debt and were generated in periods prior to 2014. Previously, we were unable to realize a tax benefit for the losses due to the absence of current and future operating income within the Luxembourg subsidiary. The net operating loss carryovers are available to reduce future federal, state and foreign taxable earnings. At December 31, 2014, $47.8 million of these net operating loss carryovers generally expire within a period of 1 to 20 years and $69.1 million have an indefinite life. Valuation allowances for net operating loss carryovers have been established in the amount of $99.0 million and $17.3 million at December 31, 2014 and 2013, respectively. The tax credit carryovers are available to offset future federal, state and foreign tax liabilities. At December 31, 2014, these tax credit carryovers generally expire within a period of 1 to 10 years. We have established valuation allowances for certain tax credit carryovers in the amount of $11.5 million and $14.9 million at December 31, 2014 and 2013, respectively. The capital loss carryover is also available to reduce future federal capital gains. At December 31, 2014, these capital loss carryovers generally expire within a period of 2 to 4 years. We have established valuation allowances for certain capital loss carryovers in the amount of $7.4 million and $7.8 million at Amounts impacting effective tax rate, if recognized balance at December 31 $203.0 $186.3 $159.0 We recognize accrued interest and penalties, related to unrecognized tax benefits, as income tax expense. During 2014, we accrued interest and penalties of $5.7 million, and as of December 31, 2014, had recognized a liability for interest and penalties of $47.8 million. During 2013, we accrued interest and penalties of $8.2 million, and as of December 31, 2013, had recognized a liability for interest and penalties of $42.1 million. During 2012, we accrued interest and penalties of $23.2 million, and as of December 31, 2012, had recognized a liability for interest and penalties of $33.9 million. 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. 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. 65 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) During the second quarter of 2014, the IRS began the audit of our U.S. federal returns for the years 2010 through 2012. During the second quarter of 2011, the IRS concluded its examination of our U.S. federal returns for years 2005 through 2007 and during the fourth quarter of 2013, the IRS concluded its examination of our U.S. federal returns for years 2008 through 2009. For years 2006 through 2009, the IRS has proposed adjustments reallocating profits between certain of our U.S. and foreign subsidiaries. During the second quarter of 2014, the IRS issued a corrected Revenue Agent Report for years 2008 through 2009, assessing a penalty with respect to a 2008 uncertain tax position. We have disputed these proposed adjustments and continue to pursue resolution with the IRS. During the second quarter of 2014, the IRS issued a statutory notice of deficiency for the years 2005 through 2007. We are contesting this deficiency notice and we filed a petition with the U.S. Tax Court during the third quarter of 2014. Although the ultimate timing for resolution of the disputed tax issues is uncertain, we may resolve certain tax matters with the IRS within the next twelve months and pay amounts for other unresolved tax matters in order to limit the potential impact of IRS interest charges. Final resolution of these matters could have a material impact on our income tax expense, results of operations and cash flows for future periods. 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 returns in the process of examination, administrative appeals or litigation. Our tax returns are currently under examination in various foreign jurisdictions. Foreign jurisdictions have statutes of limitations generally ranging from 3 to 5 years. Years still open to examination by foreign tax authorities in major jurisdictions include: Australia (2010 onward), Canada (2008 onward), France (2011 onward), Germany (2009 onward), Ireland (2010 onward), Italy (2010 onward), Japan (2010 onward), Korea (2010 onward), Puerto Rico (2008 onward), Switzerland (2013 onward), and the United Kingdom (2013 onward). 16. Capital Stock and Earnings per Share We are authorized to issue 250 million shares of preferred stock, none of which were issued or outstanding as of December 31, 2014. 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 66 a reconciliation of weighted average shares for the basic and diluted share computations (in millions): For the Years Ended December 31, 2014 2013 2012 Weighted average shares outstanding for basic net earnings per share Effect of dilutive stock options and other equity awards Weighted average shares outstanding for diluted net earnings per share 169.0 169.6 174.9 2.7 2.2 1.1 171.7 171.8 176.0 For 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. For the years ended December 31, 2013 and 2012, an average of 3.1 million and 11.9 million options, respectively, were not included. During 2014, we repurchased 4.2 million shares of our common stock at an average price of $94.57 per share for a total cash outlay of $400.5 million, including commissions. 17. Segment Data We design, develop, manufacture and market orthopaedic reconstructive implants, biologics, dental implants, spinal implants, trauma products and related surgical products which include surgical supplies and instruments designed to aid in surgical procedures and post-operation rehabilitation. We also provide other healthcare-related services. We manage operations through three major geographic segments – the Americas, which is comprised principally of the U.S. and includes other North, Central and South American markets; Europe, which is comprised principally of Europe and includes the Middle East and African markets; and Asia Pacific, which is comprised primarily of Japan and includes other Asian and Pacific markets. This structure is the basis for our reportable segment information discussed below. Management evaluates reportable segment 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, “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, U.S., Puerto Rico and Ireland-based manufacturing operations and logistics and intangible asset amortization resulting from business combination accounting and share- based payment expense. Intercompany transactions have been eliminated from segment operating profit. Management reviews accounts receivable, inventory, property, plant and equipment, goodwill and intangible assets by reportable segment exclusive of U.S., Puerto Rico and Ireland-based manufacturing operations and logistics and corporate assets. Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Net sales and other information by segment is as follows (in millions): As of and for the Year Ended December 31, 2014 Net sales Depreciation and amortization Segment operating profit Inventory step-up and certain other inventory and manufacturing related charges Certain claims Special items Operating profit Long-lived assets Total assets Additions to instruments Additions to other property, plant and equipment As of and for the Year Ended December 31, 2013 Net sales Depreciation and amortization Segment operating profit Inventory step-up and certain other inventory and manufacturing related charges Certain claims Special items Operating profit Long-lived assets Total assets Additions to instruments Additions to other property, plant and equipment As of and for the Year Ended December 31, 2012 Net sales Depreciation and amortization Segment operating profit Americas Europe Asia Pacific Global Operations and Corporate Functions Total $2,594.2 79.6 1,288.4 $1,269.5 72.0 398.6 $809.6 31.7 351.0 $ – 192.5 (604.1) $4,673.3 375.8 1,433.9 877.6 2,856.9 0.2 9.8 301.4 2,113.1 17.0 14.1 109.8 530.3 6.0 9.1 – 4,134.4 174.2 111.9 (21.2) (21.5) (356.5) 1,034.7 1,288.8 9,634.7 197.4 144.9 $2,619.8 70.9 1,302.6 $1,212.6 72.6 359.7 $791.0 30.7 342.3 $ – 184.3 (634.8) $4,623.4 358.5 1,369.8 810.8 2,814.9 0.2 9.0 306.3 2,343.8 14.8 10.3 107.6 541.9 6.5 7.6 – 3,880.0 171.4 73.1 (70.5) (47.0) (216.7) 1,035.6 1,224.7 9,580.6 192.9 100.0 $2,476.3 73.7 1,256.3 $1,177.4 73.6 369.1 $818.0 36.3 311.1 $ – 179.5 (617.9) $4,471.7 363.1 1,318.6 Inventory step-up and certain other inventory and manufacturing related charges Certain claims Goodwill impairment Special items Operating profit Long-lived assets Total assets Additions to instruments Additions to other property, plant and equipment 776.0 2,690.6 – 0.7 326.1 2,308.0 14.0 21.9 108.6 578.3 7.1 6.4 – 3,435.5 127.8 85.7 (4.8) (15.0) (96.0) (155.4) 1,047.4 1,210.7 9,012.4 148.9 114.7 67 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The Americas long-lived tangible assets are located primarily in the U.S. $198.7 million of Europe long-lived tangible assets as of December 31, 2014 are located in Switzerland. For segment reporting purposes, deployed instruments are included in the measurement of reportable segment assets while undeployed instruments at U.S., Puerto Rico and Ireland- based manufacturing operations and logistics are included in global operations and corporate functions. The majority of instruments are purchased by U.S., Puerto Rico and Ireland- based 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. U.S. sales were $2,397.9 million, $2,418.2 million and $2,280.7 million for the years ended December 31, 2014, 2013 and 2012, respectively. Sales within any other individual country were less than 10 percent of our consolidated sales. Sales are attributable to a country based upon the customer’s country of domicile. Net sales by product category are as follows (in millions): For the Years Ended December 31, 2014 2013 2012 Reconstructive Knees Hips Extremities Dental Trauma Spine Surgical and other Total $1,965.8 $1,909.9 $1,833.8 1,326.4 1,330.5 1,342.0 204.3 193.8 173.8 3,496.5 3,434.2 3,349.6 242.8 316.7 207.2 410.1 239.3 315.6 202.3 432.0 237.7 307.9 208.9 367.6 $4,673.3 $4,623.4 $4,471.7 68 18. Leases Total rent expense for the years ended December 31, 2014, 2013 and 2012 aggregated $48.4 million, $49.2 million and $46.3 million, respectively. Future minimum rental commitments under non- cancelable operating leases in effect as of December 31, 2014 were (in millions): For the Years Ending December 31, 2015 2016 2017 2018 2019 Thereafter $46.5 36.1 27.0 21.4 19.6 32.3 19. Commitments and Contingencies Product Liability-Related Claims We are subject to product liability claims arising in the ordinary course of our business. We establish standard accruals for product liability claims in conjunction with outside counsel based on current information and historical settlement information for open claims, related legal fees and claims incurred but not reported. These standard product liability accruals are recognized in selling, general and administrative expense. We may also establish provisions for certain product liability claims outside of the standard accruals that are recorded separately on our statement of earnings, such as the provision for claims related to the Durom Cup discussed below. We maintain insurance, subject to self-insured retention requirements, for losses from these and other 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, 2014, case specific discovery in these lawsuits was on-going. The initial trial in Santas took place in November 2014 and initial trials in McAllister and the MDL are expected to commence in the second quarter of 2015. Other lawsuits are pending in various jurisdictions, and additional claims may be asserted in the future. Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Since 2008, we have recognized expense of $471.7 million for Durom Cup-related claims, including $21.5 million, $47.0 million and $15.0 million during the years ended December 31, 2014, 2013 and 2012, respectively. We maintain insurance for product liability claims, subject to self-insurance retention requirements. In 2008, we notified our insurance carriers of potential claims related to the Durom Cup. As of December 31, 2014, 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 an initial amount of the insurance proceeds we estimate to recover and expect to receive more in the near future. We have a $170.3 million receivable in “Other assets” remaining on our consolidated balance sheet as of December 31, 2014 for estimated insurance recoveries. As is customary in this process, 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, 2014 of the remaining liability for all Durom Cup-related claims is $357.2 million, of which $50.0 million is classified as short-term in “Other current liabilities” and $307.2 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. 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. Although we are defending this lawsuit vigorously, its ultimate resolution is uncertain. 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 Multidistrict Litigation 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, 2014, discovery in these lawsuits was on-going. Bellwether trials are expected to commence in the third quarter of 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. Intellectual Property-Related Claims 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 69 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 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 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 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 year ended December 31, 2014. On January 20, 2015, Stryker filed a motion with the Federal Circuit for a rehearing en banc. Although we are defending this lawsuit vigorously, its ultimate resolution is uncertain. Shareholder Derivative Action On June 16, 2014, a shareholder derivative action, Hays v. Dvorak et al., was filed in the Court of Chancery of the State of Delaware. The plaintiff sought to maintain the action purportedly on our behalf against certain of our current and former directors and two non-director executive officers. The plaintiff alleged, among other things, breaches of fiduciary duties, abuse of control, unjust enrichment and gross mismanagement by the named defendants based on the trial court’s ruling in the patent infringement lawsuit brought by Stryker described above relating to certain of our Pulsavac Plus Wound Debridement Products. The plaintiff did not seek damages from us, but instead requested damages of an unspecified amount on our behalf. The plaintiff also sought 20. Quarterly Financial Information (Unaudited) (in millions, except per share data) equitable relief to remedy the individual defendants’ alleged misconduct, attorneys’ fees, costs and other relief. On August 18, 2014, we filed a motion to stay or dismiss the complaint, and the individual defendants filed a joinder motion. On December 15, 2014, the Delaware Court of Chancery granted our motion to stay pending a ruling from the Federal Circuit on the appeal in the Stryker patent infringement case. The Federal Circuit issued a ruling on December 19, 2014, as described above. On February 6, 2015, all claims pending in this shareholder derivative action were dismissed without prejudice pursuant to a stipulation of dismissal. Regulatory Matters In September 2012, we received a warning letter from the FDA citing concerns relating to certain manufacturing and validation processes pertaining to Trilogy Acetabular System products manufactured at our Ponce, Puerto Rico manufacturing facility. 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. As of December 31, 2014, the warning letter remains 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 facility may not be granted and premarket approval applications for Class III devices to which the quality system regulation deviations are reasonably related will not be approved until the violations have been corrected. In addition to responding to the warning letter 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. 2014 Quarter Ended 2013 Quarter Ended Mar Jun Sep Dec Mar Jun Sep Dec $1,161.5 $1,182.9 $1,106.0 $1,222.9 $1,138.9 $1,169.5 $1,074.3 $1,240.7 856.1 221.5 849.7 176.5 807.7 165.5 910.0 156.6 846.0 218.6 845.9 152.1 745.5 154.4 899.9 235.9 1.31 1.29 1.05 1.03 0.98 0.96 0.92 0.91 1.30 1.28 0.90 0.89 0.91 0.90 1.38 1.36 Net sales Gross profit Net earnings of Zimmer Holdings, Inc. Earnings per common share Basic Diluted 70 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. Item 9A. 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 Item 9B. Other Information During the fourth quarter of 2014, 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. 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 the end of the period covered by this report, our disclosure controls and procedures are effective at a reasonable assurance level. 71 Z I M M E R HOL D I NG S , I NC . PART III 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T 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 5, 2015 (the “2015 Proxy Statement”). We have adopted the Zimmer 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.zimmer.com or directly at http:// investor.zimmer.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. Executive Compensation Information required by this item is incorporated by reference from our 2015 Proxy Statement. 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 2015 Proxy Statement. Item 13. Certain Relationships and Related Transactions and Director Independence Information required by this item is incorporated by reference from our 2015 Proxy Statement. Item 14. Principal Accounting Fees and Services Information required by this item is incorporated by reference from of our 2015 Proxy Statement. 72 Z I M M E R HOL D I NG S , I NC . PART IV Item 15. Exhibits, Financial Statement Schedules (a) 1. Financial Statements 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T The following consolidated financial statements of Zimmer 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, 2014, 2013 and 2012 Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2014, 2013 and 2012 Consolidated Balance Sheets as of December 31, 2014 and 2013 Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2014, 2013 and 2012 Consolidated Statements of Cash Flows for the Years Ended December 31, 2014, 2013 and 2012 Notes to Consolidated Financial Statements 2. Financial Statement Schedules 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. 73 Z I M M E R HOL D I NG S , I NC . SIGNATURES 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T 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 HOLDINGS, INC. By: /S/ DAVID C. DVORAK David C. Dvorak President and Chief Executive Officer Dated: February 23, 2015 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. SIGNATURE TITLE DATE /S/ DAVID C. DVORAK David C. Dvorak /S/ JAMES T. CRINES James T. Crines /S/ DEREK M. DAVIS Derek M. Davis President, Chief Executive Officer and Director (Principal Executive Officer) February 23, 2015 Executive Vice President, Finance and Chief Financial Officer (Principal Financial Officer) February 23, 2015 Vice President, Finance, and Corporate Controller and Chief Accounting Officer (Principal Accounting Officer) February 23, 2015 /S/ CHRISTOPHER B. BEGLEY Director February 23, 2015 Christopher B. Begley /S/ BETSY J. BERNARD Betsy J. Bernard /S/ PAUL M. BISARO Paul M. Bisaro Gail K. Boudreaux Michael J. Farrell /S/ LARRY C. GLASSCOCK Larry C. Glasscock /S/ ROBERT A. HAGEMANN Robert A. Hagemann /S/ ARTHUR J. HIGGINS Arthur J. Higgins Director Director Director Director Director Director Director February 23, 2015 February 23, 2015 February 23, 2015 February 23, 2015 February 23, 2015 February 23, 2015 February 23, 2015 /S/ CECIL B. PICKETT, PH.D. Director February 23, 2015 Cecil B. Pickett, Ph.D. 74 Z I M M E R HOL D I NG S , I NC . INDEX TO EXHIBITS Exhibit No Description 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T 2.1 3.1 3.2 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 10.1* 10.2* 10.3* 10.4* 10.5* 10.6* 10.7* 10.8* 10.9* 10.10* 10.11* 10.12* Agreement and Plan of Merger, dated as of April 24, 2014, by and among Zimmer Holdings, Inc., Owl Merger Sub, Inc. and LVB Acquisition, Inc. (incorporated by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed April 30, 2014) Restated Certificate of Incorporation of Zimmer Holdings, Inc. dated May 13, 2008 (incorporated by reference to Exhibit 3.1 to the Registrant’s Quarterly Report on Form 10-Q filed August 5, 2008) Restated By-Laws of Zimmer Holdings, Inc. effective December 13, 2013 (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed December 19, 2013) Specimen Common Stock certificate (incorporated by reference to Exhibit 4.1 to the Registrant’s Quarterly Report on Form 10-Q filed November 6, 2012) Indenture dated as of November 17, 2009 between Zimmer Holdings, Inc. and Wells Fargo Bank, National Association, as Trustee (incorporated by reference to the form filed as Exhibit 4.8 to the Registrant’s Registration Statement on Form S-3 filed November 12, 2009) First Supplemental Indenture to the Indenture dated as of November 17, 2009 between Zimmer Holdings, Inc. and Wells Fargo Bank, National Association, as Trustee (incorporated by reference to Exhibit 4.2 to the Registrant’s Current Report on Form 8-K filed November 17, 2009) Form of 4.625% Note due 2019 (incorporated by reference to Exhibit 4.3 above) Form of 5.750% Note due 2039 (incorporated by reference to Exhibit 4.3 above) Second Supplemental Indenture dated as of November 10, 2011, to the Indenture dated as of November 17, 2009 between Zimmer Holdings, Inc. and Wells Fargo Bank, National Association, as Trustee (incorporated by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed November 10, 2011) Form of 1.400% Note due 2014 (incorporated by reference to Exhibit 4.6 above) Form of 3.375% Note due 2021 (incorporated by reference to Exhibit 4.6 above) Stockholders Agreement, dated as of April 24, 2014, by and among Zimmer Holdings, Inc., LVB Acquisition Holding, LLC, and the other signatories thereto (incorporated by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed April 30, 2014) Zimmer Holdings, Inc. 2001 Stock Incentive Plan (incorporated by reference to Appendix B to the Registrant’s definitive Proxy Statement on Schedule 14A filed March 24, 2003) First Amendment to the Zimmer Holdings, Inc. 2001 Stock Incentive Plan (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed December 15, 2005) Zimmer Holdings, Inc. 2006 Stock Incentive Plan, as amended (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed December 13, 2006) Zimmer Holdings, Inc. Executive Performance Incentive Plan, as amended May 7, 2013 (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed May 13, 2013) Restated Zimmer, Inc. Long-Term Disability Income Plan for Highly Compensated Employees (incorporated by reference to Exhibit 10.9 to the Registrant’s Annual Report on Form 10-K filed February 28, 2007) Change in Control Severance Agreement with David C. Dvorak (incorporated by reference to Exhibit 10.10 to the Registrant’s Annual Report on Form 10-K filed February 28, 2009) Change in Control Severance Agreement with Katarzyna Mazur-Hofsaess (incorporated by reference to Exhibit 10.3 to the Registrant’s Quarterly Report on Form 10-Q filed August 7, 2013) Form of Change in Control Severance Agreement with James T. Crines (incorporated by reference to Exhibit 10.12 to the Registrant’s Annual Report on Form 10-K filed February 28, 2009) Form of Change in Control Severance Agreement with Chad F. Phipps (incorporated by reference to Exhibit 10.13 to the Registrant’s Annual Report on Form 10-K filed February 28, 2009) Form of Change in Control Severance Agreement with Joseph A. Cucolo (incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q filed May 5, 2010) Change in Control Severance Agreement with Stephen Hong Liang, Ooi (incorporated by reference to Exhibit 10.21 to the Registrant’s Annual Report on Form 10-K filed March 12, 2003) Change in Control Severance Agreement with Derek M. Davis (incorporated by reference to Exhibit 10.14 to the Registrant’s Annual Report on Form 10-K filed February 28, 2009) 75 Z I M M E R HOL D I NG S , I NC . Exhibit No Description 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T Restated Benefit Equalization Plan of Zimmer Holdings, Inc. and Its Subsidiary or Affiliated Corporations Participating in the Zimmer Holdings, Inc. Savings and Investment Program (incorporated by reference to Exhibit 10.16 to the Registrant’s Annual Report on Form 10-K filed February 28, 2009) Restated Benefit Equalization Plan of Zimmer Holdings, Inc. and Its Subsidiary or Affiliated Corporations Participating in the Zimmer Holdings, Inc. Retirement Income Plan or the Zimmer Puerto Rico Retirement Income Plan (incorporated by reference to Exhibit 10.17 to the Registrant’s Annual Report on Form 10-K filed February 28, 2009) Form of Confidentiality, Non-Competition and Non-Solicitation Agreement with U.S.-Based Executive Officers (incorporated by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q filed November 6, 2012) Non-Disclosure, Non-Competition and Non-Solicitation Employment Agreement with Stephen Hong Liang, Ooi (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed March 27, 2006) Confidentiality, Non-Competition and Non-Solicitation Agreement with Katarzyna Mazur-Hofsaess (incorporated by reference to Exhibit 10.4 to the Registrant’s Quarterly Report on Form 10-Q filed August 7, 2013) Form of Nonqualified Stock Option Award Letter under the Zimmer Holdings, Inc. 2001 Stock Incentive Plan (incorporated by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K filed January 11, 2006) Zimmer Holdings, Inc. Stock Plan for Non-Employee Directors, as amended (incorporated by reference to Appendix C to the Registrant’s Definitive Proxy Statement filed March 20, 2009) Form of Nonqualified Stock Option Award Letter under the Zimmer Holdings, Inc. Stock Plan for Non-Employee Directors (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed April 5, 2005) Form of Restricted Stock Unit Award Letter under the Zimmer Holdings, Inc. Stock Plan for Non-Employee Directors (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed February 21, 2006) Form of Nonqualified Stock Option Award Letter under the Zimmer Holdings, Inc. 2006 Stock Incentive Plan (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed December 13, 2006) Form of Nonqualified Stock Option Award Letter for Non-U.S. Employees under the Zimmer Holdings, Inc. 2006 Stock Incentive Plan (incorporated by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K filed December 13, 2006) Restated Zimmer Holdings, Inc. Deferred Compensation Plan for Non-Employee Directors (incorporated by reference to Appendix D to the Registrant’s Definitive Proxy Statement filed March 20, 2009) Zimmer Holdings, Inc. 2009 Stock Incentive Plan, as amended May 7, 2013 (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed May 13, 2013) Form of Nonqualified Stock Option Award Letter under the Zimmer Holdings, Inc. 2009 Stock Incentive Plan (incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q filed May 5, 2011) Form of Nonqualified Stock Option Award Letter for Non-U.S. Employees under the Zimmer Holdings, Inc. 2009 Stock Incentive Plan (incorporated by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q filed May 5, 2011) Form of Performance-Based Restricted Stock Unit Award Letter (one-year performance period) under the Zimmer Holdings, Inc. 2009 Stock Incentive Plan (incorporated by reference to Exhibit 10.3 to the Registrant’s Quarterly Report on Form 10-Q filed May 5, 2011) Form of Performance-Based Restricted Stock Unit Award Letter for Non-U.S. Employees (one-year performance period) under the Zimmer Holdings, Inc. 2009 Stock Incentive Plan (incorporated by reference to Exhibit 10.4 to the Registrant’s Quarterly Report on Form 10-Q filed May 5, 2011) Form of Restricted Stock Unit Award Letter (two-year vesting) under the Zimmer Holdings, Inc. 2009 Stock Incentive Plan Form of Performance-Based Restricted Stock Unit Award Letter (three-year performance period) under the Zimmer Holdings, Inc. 2009 Stock Incentive Plan Form of Indemnification Agreement with Non-Employee Directors and Officers (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed July 31, 2008) $1,350,000,000 Credit Agreement dated as of May 9, 2012 (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed May 15, 2012) Amendment No. 1 dated as of December 13, 2013 to the Credit Agreement dated as of May 9, 2012 (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on December 19, 2013) 10.13* 10.14* 10.15* 10.16* 10.17* 10.18* 10.19* 10.20* 10.21* 10.22* 10.23* 10.24* 10.25* 10.26* 10.27* 10.28* 10.29* 10.30* 10.31* 10.32* 10.33 10.34 76 Z I M M E R HOL D I NG S , I NC . Exhibit No Description 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T 10.35 10.36 10.37 10.38 10.39 10.40 10.41 21 23 31.1 31.2 32 Term Loan Agreement ¥11,700,000,000 dated as of May 24, 2012 (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed May 31, 2012) Letter of Guarantee dated as of May 24, 2012 (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed May 31, 2012) First Amendment, dated October 31, 2014, to the ¥11,700,000,000 Term Loan Agreement dated as of May 24, 2012 (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed November 5, 2014) Voting Agreement, dated as of April 24, 2014, by and among Zimmer Holdings, Inc., LVB Acquisition Holding, LLC and the other signatories thereto (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed April 30, 2014) Commitment Letter, dated as of April 24, 2014, by and among Credit Suisse Securities (USA) LLC, Credit Suisse AG and Zimmer Holdings, Inc. (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed April 30, 2014) 364-Day Credit Agreement, dated as of May 29, 2014, among Zimmer Holdings, Inc., Credit Suisse AG, Cayman Islands Branch, as Administrative Agent, and the lenders named therein (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed June 4, 2014) Credit Agreement, dated as of May 29, 2014, among Zimmer Holdings, Inc., Zimmer K.K., Zimmer Investment Luxembourg SARL, the borrowing subsidiaries referred to therein, JPMorgan Chase Bank, N.A., as General Administrative Agent, JPMorgan Chase Bank, N.A., Tokyo Branch, as Japanese Administrative Agent, J. P. Morgan Europe Limited, as European Administrative Agent, and the lenders named therein (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed June 4, 2014) List of Subsidiaries of Zimmer Holdings, Inc. Consent of PricewaterhouseCoopers LLP Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934 of the Chief Executive Officer, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934 of the Chief Financial Officer, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 101.INS XBRL Instance Document 101.SCH XBRL Taxonomy Extension Schema Document 101.CAL XBRL Taxonomy Extension Calculation Linkbase Document 101.LAB XBRL Taxonomy Extension Label Linkbase Document 101.PRE XBRL Taxonomy Extension Presentation Linkbase Document 101.DEF XBRL Taxonomy Extension Definition Linkbase Document * Management contract or compensatory plan or arrangement 77 Z I M M E R HOL D I NG S , I NC . 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T SCHEDULE II ZIMMER HOLDINGS, INC. VALUATION AND QUALIFYING ACCOUNTS Balance at Beginning of Period Additions Charged (Credited) to Expense Deductions to Reserve Effects of Foreign Currency Acquired Allowances Balance at End of Period (in millions) – 0.3 17.2 22.8 22.7 40.3 41.3 42.7 7.1 1.9 2.0 (0.9) 1.5 74.7 (1.8) (1.5) (1.4) (0.3) (0.1) (9.2) (0.5) (1.0) – – – 22.8 22.7 22.3 41.3 42.7 – – 2.2 – 14.6 122.8 Description Allowance for Doubtful Accounts: Year Ended December 31, 2012 Year Ended December 31, 2013 Year Ended December 31, 2014 Deferred Tax Asset Valuation Allowances: Year End December 31, 2012 Year End December 31, 2013 Year End December 31, 2014 78 Z I M M E R HOL D I NG S , I NC . Reconciliations 2 0 1 4 F O R M 1 0 - K AN N U A L R E P O R T Reconciliation of Operating Profit to Adjusted Operating Profit for the Years Ended December 31, 2014, 2013, 2012, 2011 and 2010 (in millions, unaudited) For the Years Ended December 31, 2014 2013 2012 2011 2010 Operating Profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,034.7 $1,035.6 $1,047.4 $1,024.1 $ 916.7 Inventory step-up and other inventory and manufacturing related charges . . . . . . . . . . . . . Certain claims . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Goodwill impairment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21.2 21.5 — 70.5 47.0 — 4.8 15.0 96.0 Special items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 356.5 216.7 155.4 11.4 157.8 — 75.2 1.4 75.0 204.0 34.7 Adjusted Operating Profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,433.9 $1,369.8 $1,318.6 $1,268.5 $1,231.8 Reconciliation of Diluted EPS to Adjusted Diluted EPS for the Years Ended December 31, 2014, 2013, 2012, 2011 and 2010 (unaudited) For the Years Ended December 31, 2014 2013 2012 2011 2010 Diluted EPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4.19 $ 4.43 $ 4.29 $ 4.03 $ 2.97 Inventory step-up and other inventory and manufacturing related charges . . . . . . . . . . . Certain claims . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Goodwill impairment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Special items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other expense on Biomet merger financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.12 0.13 — 2.08 0.23 0.41 0.27 — 1.26 — 0.03 0.09 0.54 0.88 — 0.06 0.84 — 0.40 — 0.01 0.37 1.01 0.17 — Taxes on above items and other certain tax adjustments* . . . . . . . . . . . . . . . . . . . . . . . . . . (0.69) (0.62) (0.53) (0.53) (0.20) Adjusted Diluted EPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6.06 $ 5.75 $ 5.30 $ 4.80 $ 4.33 * The tax effect is calculated based upon the statutory rates for the jurisdictions where the items were incurred. Reconciliation of Sales Growth Rate to Constant Currency Sales Growth Rate for the Year Ended December 31, 2014 (unaudited) Geographic Segment Americas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1)% —% (1)% For the Year Ended December 31, 2014 Reported % Growth Foreign Exchange Impact Constant Currency % Growth Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Asia Pacific . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consolidated . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Product Category Reconstructive . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Knees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Hips . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Extremities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dental . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Trauma . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Spine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Surgical and other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consolidated . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 2 1 2 3 — 5 1 — 2 (5) 1 — (6) (1) (1) (1) (1) (1) (1) (2) (1) (2) (1) 5 8 2 3 4 1 6 2 2 3 (3) 2 79 [THIS PAGE INTENTIONALLY LEFT BLANK] Corporate Information (As of March 1, 2015) Board of Directors Larry C. Glasscock Chairman of the Board, Zimmer Holdings, Inc. Retired Chairman, President and Chief Executive Ofﬁcer, Anthem, Inc. Betsy J. Bernard Retired President, AT&T Corp. Paul M. Bisaro Executive Chairman, Actavis plc Christopher B. Begley Retired Executive Chairman and Chief Executive Ofﬁcer, Hospira, Inc. Gail K. Boudreaux Former Chief Executive Ofﬁcer, UnitedHealthcare Management Team David C. Dvorak President and Chief Executive Ofﬁcer Audrey M. Beckman Senior Vice President, Strategic Quality Initiatives James T. Crines Executive Vice President, Finance and Chief Financial Ofﬁcer Joseph A. Cucolo President, Americas Derek M. Davis Vice President, Finance and Corporate Controller and Chief Accounting Ofﬁcer William P. Fisher Senior Vice President, Global Human Resources David C. Dvorak President and Chief Executive Ofﬁcer, Zimmer Holdings, Inc. Michael J. Farrell Chief Executive Ofﬁcer, ResMed Inc. Robert A. Hagemann Retired Senior Vice President and Chief Financial Ofﬁcer, Quest Diagnostics Incorporated Arthur J. Higgins Consultant, Blackstone Healthcare Partners Cecil B. Pickett, Ph.D. Retired President, Research and Development, Biogen Idec Inc. Katarzyna Mazur-Hofsaess, M.D., Ph.D. President, Europe, Middle East and Africa Stephen H. L. Ooi President, Asia Paciﬁc Matt E. Monaghan Senior Vice President, Global Hips and Reconstructive Research Chad F. Phipps Senior Vice President, General Counsel and Secretary David J. Kunz Vice President, Global Quality, Clinical and Regulatory Affairs Richard C. Stair Senior Vice President, Global Operations and Logistics Stephen E. White Senior Vice President and General Manager, Knees Stockholder Information Headquarters Zimmer Holdings, Inc. 345 East Main Street Warsaw, IN 46580, U.S.A. +1-574-267-6131 www.zimmer.com Stock Listing Zimmer is listed on the New York Stock Exchange and the SIX Swiss Exchange under the symbol ZMH. Transfer Agent Communications concerning stock transfer requirements, loss of certiﬁcates and change of address should be directed to Zimmer’s Transfer Agent: American Stock Transfer & Trust Company, LLC 6201 15th Avenue Brooklyn, NY 11219 +1-888-552-8493 (domestic) +1-718-921-8124 (international) Email: zimmer@amstock.com Website: http://www.amstock.com Investor Relations Zimmer invites stockholders, security analysts, portfolio managers and other interested parties to contact: Robert J. Marshall Jr. Vice President, Investor Relations and Treasurer +1-574-371-8042 robert.marshall@zimmer.com James T. Crines Executive Vice President, Finance and Chief Financial Ofﬁcer +1-574-372-4264 james.crines@zimmer.com To obtain a free copy of Zimmer’s annual report on form 10-K, quarterly reports on form 10-Q, news releases, earnings releases, proxy statements, or to obtain Zimmer’s ﬁnancial calendar, access SEC ﬁlings, listen to earnings calls, or to look up Zimmer stock quotes, please visit http://investor.zimmer.com or call +1-866-688-7656. Independent Auditors PricewaterhouseCoopers LLP Chicago, IL, U.S.A. Dividend Reinvestment and Stock Purchase Plan American Stock Transfer & Trust Company, LLC administers the Investors Choice Dividend Reinvestment and Stock Purchase Plan, which allows registered stockholders to purchase additional shares of Zimmer common stock through the automatic investment of dividends. The plan also allows registered stockholders to purchase shares with optional cash investments of at least $25, either by check or by automatic deductions from checking or savings accounts. The maximum optional cash investment is $10,000 per transaction. Please direct inquiries concerning the plan to: Zimmer Holdings, Inc., c/o American Stock Transfer & Trust Company, LLC, P.O. Box 922, Wall Street Station, New York, NY 10269-0560, +1-888-552-8493 (domestic), +1-718-921-8124 (international) Stock Performance Graph Comparison of Cumulative Total Return for years ended December 31 Assumes $100 was invested on December 31, 2009 in Zimmer common stock and each index and that dividends were reinvested. Returns over the indicated period should not be considered indicative of future returns. $250 $200 $150 $100 $0 This annual report is printed on paper that contains 10% post-consumer waste. baseline Zimmer Holdings, Inc. S&P 500 Stock Index S&P 500 Health Care Equipment Index $100 $100 $100 2010 $100 $115 $104 2011 $90 $118 $96 2012 $114 $136 $112 2013 $160 $180 $144 2014 $197 $205 $181 Zimmer Holdings, Inc., 345 East Main Street, P.O. Box 708, Warsaw, IN 46580, U.S.A.

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