filings.toolsItem 8. Financial Statements and Supplementary Data
208K characters. Original on sec.gov ·
Item 8. Financial Statements and Supplementary Data
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Zimmer Biomet Holdings, Inc.
Index to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Zimmer Biomet Holdings, Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Zimmer Biomet Holdings, Inc. and its subsidiaries as of December 31, 2017 and 2016 and the related consolidated statements of earnings, comprehensive income (loss), stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2017, including the related notes and the financial statement schedule of valuation and qualifying accounts for each of the three years in the period ended December 31, 2017 appearing under Item 15(a)(2), (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, 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 Annual Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. 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.
Definition and Limitations of Internal Control over Financial Reporting
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.
/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
February 27, 2018
We have served as the Company’s auditor since 2000.
ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(in millions, except per share amounts)
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2017 | 2016 | 2015 | ||||||||||
| Net Sales | $ | 7,824.1 | $ | 7,683.9 | $ | 5,997.8 | ||||||
| Cost of products sold, excluding intangible asset amortization | 2,132.9 | 2,381.8 | 1,800.6 | |||||||||
| Intangible asset amortization | 603.9 | 565.9 | 337.4 | |||||||||
| Research and development | 367.4 | 365.6 | 268.8 | |||||||||
| Selling, general and administrative | 2,973.9 | 2,932.9 | 2,284.2 | |||||||||
| Goodwill impairment | 304.7 | - | - | |||||||||
| Special items (Note 2) | 633.1 | 611.8 | 839.5 | |||||||||
| Operating expenses | 7,015.9 | 6,858.0 | 5,530.5 | |||||||||
| Operating Profit | 808.2 | 825.9 | 467.3 | |||||||||
| Other expense, net | (18.3 | ) | (71.3 | ) | (36.9 | ) | ||||||
| Interest income | 2.2 | 2.9 | 9.4 | |||||||||
| Interest expense | (327.5 | ) | (357.9 | ) | (286.6 | ) | ||||||
| Earnings before income taxes | 464.6 | 399.6 | 153.2 | |||||||||
| (Benefit) provision for income taxes | (1,348.8 | ) | 95.0 | 7.0 | ||||||||
| Net earnings | 1,813.4 | 304.6 | 146.2 | |||||||||
| Less: Net loss attributable to noncontrolling interest | (0.4 | ) | (1.3 | ) | (0.8 | ) | ||||||
| Net Earnings of Zimmer Biomet Holdings, Inc. | $ | 1,813.8 | $ | 305.9 | $ | 147.0 | ||||||
| Earnings Per Common Share - Basic | $ | 8.98 | $ | 1.53 | $ | 0.78 | ||||||
| Earnings Per Common Share - Diluted | $ | 8.90 | $ | 1.51 | $ | 0.77 | ||||||
| Weighted Average Common Shares Outstanding | ||||||||||||
| Basic | 201.9 | 200.0 | 187.4 | |||||||||
| Diluted | 203.7 | 202.4 | 189.8 | |||||||||
| Cash Dividends Declared Per Common Share | $ | 0.96 | $ | 0.96 | $ | 0.88 |
The accompanying notes are an integral part of these consolidated financial statements.
ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in millions)
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2017 | 2016 | 2015 | ||||||||||
| Net Earnings | $ | 1,813.4 | $ | 304.6 | $ | 146.2 | ||||||
| Other Comprehensive Income (Loss): | ||||||||||||
| Foreign currency cumulative translation adjustments, net of tax | 445.0 | (130.0 | ) | (305.2 | ) | |||||||
| Unrealized cash flow hedge (losses)/gains, net of tax | (95.0 | ) | 28.3 | 52.7 | ||||||||
| Reclassification adjustments on cash flow hedges, net of tax | (3.8 | ) | (25.8 | ) | (93.0 | ) | ||||||
| Unrealized gains/(losses) on securities, net of tax | - | 0.5 | (0.2 | ) | ||||||||
| Adjustments to prior service cost and unrecognized actuarial assumptions, net of tax | 4.6 | 22.0 | (21.4 | ) | ||||||||
| Total Other Comprehensive Income (Loss) | 350.8 | (105.0 | ) | (367.1 | ) | |||||||
| Comprehensive Income (Loss) | 2,164.2 | 199.6 | (220.9 | ) | ||||||||
| Comprehensive Loss Attributable to Noncontrolling Interest | (1.3 | ) | (0.5 | ) | (0.3 | ) | ||||||
| Comprehensive Income (Loss) Attributable to Zimmer Biomet Holdings, Inc. | $ | 2,165.5 | $ | 200.1 | $ | (220.6 | ) |
The accompanying notes are an integral part of these consolidated financial statements.
ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in millions)
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2017 | 2016 | |||||||
| ASSETS | ||||||||
| Current Assets: | ||||||||
| Cash and cash equivalents | $ | 524.4 | $ | 634.1 | ||||
| Accounts receivable, less allowance for doubtful accounts | 1,494.6 | 1,604.4 | ||||||
| Inventories | 2,081.8 | 1,959.4 | ||||||
| Prepaid expenses and other current assets | 414.5 | 465.7 | ||||||
| Total Current Assets | 4,515.3 | 4,663.6 | ||||||
| Property, plant and equipment, net | 2,038.6 | 2,037.9 | ||||||
| Goodwill | 10,668.4 | 10,643.9 | ||||||
| Intangible assets, net | 8,353.4 | 8,785.4 | ||||||
| Other assets | 388.8 | 553.6 | ||||||
| Total Assets | $ | 25,964.5 | $ | 26,684.4 | ||||
| LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||
| Current Liabilities: | ||||||||
| Accounts payable | $ | 330.2 | $ | 364.5 | ||||
| Income taxes payable | 165.2 | 183.5 | ||||||
| Other current liabilities | 1,299.8 | 1,257.9 | ||||||
| Current portion of long-term debt | 1,225.0 | 575.6 | ||||||
| Total Current Liabilities | 3,020.2 | 2,381.5 | ||||||
| Deferred income taxes, net | 1,101.5 | 3,030.9 | ||||||
| Long-term income tax payable | 744.0 | 473.7 | ||||||
| Other long-term liabilities | 445.8 | 462.6 | ||||||
| Long-term debt | 8,917.5 | 10,665.8 | ||||||
| Total Liabilities | 14,229.0 | 17,014.5 | ||||||
| Commitments and Contingencies (Note 19) | ||||||||
| Stockholders' Equity: | ||||||||
| Common stock, $0.01 par value, one billion shares authorized, 306.5 million (304.7 million in 2016) issued | 3.1 | 3.1 | ||||||
| Paid-in capital | 8,514.9 | 8,368.5 | ||||||
| Retained earnings | 10,022.8 | 8,467.1 | ||||||
| Accumulated other comprehensive loss | (83.2 | ) | (434.0 | ) | ||||
| Treasury stock, 103.9 million shares (104.1 million shares in 2016) | (6,721.8 | ) | (6,735.8 | ) | ||||
| Total Zimmer Biomet Holdings, Inc. stockholders' equity | 11,735.8 | 9,668.9 | ||||||
| Noncontrolling interest | (0.3 | ) | 1.0 | |||||
| Total Stockholders' Equity | 11,735.5 | 9,669.9 | ||||||
| Total Liabilities and Stockholders' Equity | $ | 25,964.5 | $ | 26,684.4 |
The accompanying notes are an integral part of these consolidated financial statements.
ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in millions)
| Zimmer Biomet Holdings, Inc. Stockholders | ||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Accumulated | ||||||||||||||||||||||||||||||||||||
| Other | Total | |||||||||||||||||||||||||||||||||||
| Common Shares | Paid-in | Retained | Comprehensive | Treasury Shares | Noncontrolling | Stockholders' | ||||||||||||||||||||||||||||||
| Number | Amount | Capital | Earnings | Income (Loss) | Number | Amount | Interest | Equity | ||||||||||||||||||||||||||||
| Balance January 1,2015 | 268.4 | $ | 2.7 | $ | 4,330.7 | $ | 8,362.1 | $ | 38.1 | (98.7 | ) | $ | (6,183.7 | ) | $ | 1.8 | $ | 6,551.7 | ||||||||||||||||||
| Net earnings | - | - | - | 147.0 | - | - | - | (0.8 | ) | 146.2 | ||||||||||||||||||||||||||
| Other comprehensive loss | - | - | - | - | (367.1 | ) | - | - | 0.5 | (366.6 | ) | |||||||||||||||||||||||||
| Cash dividends declared | - | - | - | (164.4 | ) | - | - | - | - | (164.4 | ) | |||||||||||||||||||||||||
| Stock compensation plans | 1.6 | - | 142.2 | 3.0 | - | 0.1 | 4.6 | - | 149.8 | |||||||||||||||||||||||||||
| Share repurchases | - | - | - | - | - | (1.4 | ) | (150.0 | ) | - | (150.0 | ) | ||||||||||||||||||||||||
| Biomet merger consideration | 32.7 | 0.3 | 3,722.4 | - | - | - | - | - | 3,722.7 | |||||||||||||||||||||||||||
| Balance December 31, 2015 | 302.7 | 3.0 | 8,195.3 | 8,347.7 | (329.0 | ) | (100.0 | ) | (6,329.1 | ) | 1.5 | 9,889.4 | ||||||||||||||||||||||||
| Net earnings | - | - | - | 305.9 | - | - | - | (1.3 | ) | 304.6 | ||||||||||||||||||||||||||
| Other comprehensive loss | - | - | - | - | (105.0 | ) | - | - | 0.8 | (104.2 | ) | |||||||||||||||||||||||||
| Cash dividends declared | - | - | - | (191.9 | ) | - | - | - | - | (191.9 | ) | |||||||||||||||||||||||||
| Stock compensation plans | 2.0 | 0.1 | 173.2 | 5.4 | - | 0.1 | 8.8 | - | 187.5 | |||||||||||||||||||||||||||
| Share repurchases | - | - | - | - | - | (4.2 | ) | (415.5 | ) | - | (415.5 | ) | ||||||||||||||||||||||||
| Balance December 31, 2016 | 304.7 | 3.1 | 8,368.5 | 8,467.1 | (434.0 | ) | (104.1 | ) | (6,735.8 | ) | 1.0 | 9,669.9 | ||||||||||||||||||||||||
| Net earnings | - | - | - | 1,813.8 | - | - | - | (0.4 | ) | 1,813.4 | ||||||||||||||||||||||||||
| Other comprehensive income | - | - | - | - | 350.8 | - | - | (0.9 | ) | 349.9 | ||||||||||||||||||||||||||
| Cash dividends declared | - | - | - | (194.1 | ) | - | - | - | - | (194.1 | ) | |||||||||||||||||||||||||
| Retrospective adoption of new accounting standard | - | - | - | (77.8 | ) | - | - | - | - | (77.8 | ) | |||||||||||||||||||||||||
| Stock compensation plans | 1.8 | - | 146.4 | 13.8 | - | 0.2 | 14.0 | - | 174.2 | |||||||||||||||||||||||||||
| Balance December 31, 2017 | 306.5 | $ | 3.1 | $ | 8,514.9 | $ | 10,022.8 | $ | (83.2 | ) | (103.9 | ) | $ | (6,721.8 | ) | $ | (0.3 | ) | $ | 11,735.5 |
The accompanying notes are an integral part of these consolidated financial statements.
ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2017 | 2016 | 2015 | ||||||||||
| Cash flows provided by (used in) operating activities: | ||||||||||||
| Net earnings | $ | 1,813.4 | $ | 304.6 | $ | 146.2 | ||||||
| Adjustments to reconcile net earnings to net cash provided by operating activities: | ||||||||||||
| Depreciation and amortization | 1,062.7 | 1,039.3 | 712.4 | |||||||||
| Biomet merger consideration compensation expense | - | - | 90.4 | |||||||||
| Share-based compensation | 53.7 | 57.3 | 46.4 | |||||||||
| Goodwill and intangible asset impairment | 331.5 | 30.0 | - | |||||||||
| Excess income tax benefit from stock option exercises | - | - | (11.8 | ) | ||||||||
| Inventory step-up | 32.8 | 323.3 | 317.8 | |||||||||
| Gain on divestiture of assets | - | - | (19.0 | ) | ||||||||
| Debt extinguishment | - | 53.3 | 22.0 | |||||||||
| Deferred income tax provision | (1,776.0 | ) | (153.2 | ) | (164.0 | ) | ||||||
| Changes in operating assets and liabilities, net of | ||||||||||||
| acquired assets and liabilities | ||||||||||||
| Income taxes | 150.2 | (10.9 | ) | 244.7 | ||||||||
| Receivables | 176.5 | (137.8 | ) | (56.1 | ) | |||||||
| Inventories | (122.8 | ) | 76.4 | (205.4 | ) | |||||||
| Accounts payable and accrued liabilities | (148.2 | ) | 28.7 | (252.0 | ) | |||||||
| Other assets and liabilities | 8.5 | 21.2 | (21.8 | ) | ||||||||
| Net cash provided by operating activities | 1,582.3 | 1,632.2 | 849.8 | |||||||||
| Cash flows provided by (used in) investing activities: | ||||||||||||
| Additions to instruments | (337.0 | ) | (345.5 | ) | (266.4 | ) | ||||||
| Additions to other property, plant and equipment | (156.0 | ) | (184.7 | ) | (167.7 | ) | ||||||
| Purchases of investments | - | (1.5 | ) | (214.8 | ) | |||||||
| Sales of investments | - | 286.2 | 802.9 | |||||||||
| Proceeds from divestiture of assets | - | - | 69.9 | |||||||||
| Biomet acquisition, net of acquired cash | - | - | (7,760.1 | ) | ||||||||
| LDR acquisition, net of acquired cash | - | (1,021.1 | ) | - | ||||||||
| Business combination investments, net of acquired cash | (4.0 | ) | (421.9 | ) | - | |||||||
| Investments in other assets | (13.8 | ) | (3.0 | ) | (21.7 | ) | ||||||
| Net cash used in investing activities | (510.8 | ) | (1,691.5 | ) | (7,557.9 | ) | ||||||
| Cash flows provided by (used in) financing activities: | ||||||||||||
| Proceeds from senior notes | - | 1,073.5 | 7,628.2 | |||||||||
| Proceeds from multicurrency revolving facility | 400.0 | - | - | |||||||||
| Payments on multicurrency revolving facility | (400.0 | ) | - | - | ||||||||
| Redemption of senior notes | (500.0 | ) | (1,250.0 | ) | (2,762.0 | ) | ||||||
| Proceeds from term loan | 192.7 | 750.0 | 3,000.0 | |||||||||
| Payments on term loan | (940.0 | ) | (800.0 | ) | (500.0 | ) | ||||||
| Net (payments) proceeds on other debt | (0.9 | ) | (33.1 | ) | 0.1 | |||||||
| Dividends paid to stockholders | (193.6 | ) | (188.4 | ) | (157.1 | ) | ||||||
| Proceeds from employee stock compensation plans | 145.5 | 136.6 | 105.2 | |||||||||
| Unremitted collections from factoring programs | 103.5 | - | - | |||||||||
| Business combination contingent consideration payments | (9.1 | ) | - | - | ||||||||
| Restricted stock withholdings | (8.3 | ) | (6.3 | ) | (11.1 | ) | ||||||
| Excess income tax benefit from stock option exercises | - | - | 11.8 | |||||||||
| Debt issuance costs | (0.3 | ) | (10.0 | ) | (58.4 | ) | ||||||
| Repurchase of common stock | - | (415.5 | ) | (150.0 | ) | |||||||
| Net cash (used in) provided by financing activities | (1,210.5 | ) | (743.2 | ) | 7,106.7 | |||||||
| Effect of exchange rates on cash and cash equivalents | 29.3 | (22.7 | ) | (22.6 | ) | |||||||
| (Decrease) increase in cash and cash equivalents | (109.7 | ) | (825.2 | ) | 376.0 | |||||||
| Cash and cash equivalents, beginning of year | 634.1 | 1,459.3 | 1,083.3 | |||||||||
| Cash and cash equivalents, end of period | $ | 524.4 | $ | 634.1 | $ | 1,459.3 |
The accompanying notes are an integral part of these consolidated financial statements.
ZIMMER BIOMET HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| 1. | Business |
|---|
We design, manufacture and market orthopaedic reconstructive products; sports medicine, biologics, extremities and trauma products; office based technologies; spine, craniomaxillofacial and thoracic products; dental implants; and related surgical products. We collaborate with healthcare professionals around the globe to advance the pace of innovation. Our products and solutions help treat patients suffering from disorders of, or injuries to, bones, joints or supporting soft tissues. Together with healthcare professionals, we help millions of people live better lives.
The words “Zimmer Biomet,” “we,” “us,” “our,” “the Company” and similar words refer to Zimmer Biomet Holdings, Inc. and its subsidiaries. “Zimmer Biomet Holdings” refers to the parent company only. “Zimmer” used alone refers to the business or information of us and our subsidiaries on a stand-alone basis without inclusion of the business or information of LVB Acquisition, Inc. (“LVB”) or any of its subsidiaries, including Biomet, Inc. (“Biomet”), all of which we acquired in June 2015 (sometimes hereinafter referred to as the “Biomet merger” or the “merger”).
| 2. | Significant Accounting Policies |
|---|
Basis of Presentation - The consolidated financial statements include the accounts of Zimmer Biomet Holdings and its subsidiaries in which it holds a controlling financial interest. All significant intercompany accounts and transactions are eliminated. Certain amounts in the 2015 and 2016 consolidated financial statements have been reclassified to conform to the 2017 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, 2017, 2016 and 2015 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 2017. Through this channel, inventory is generally consigned to sales agents or customers so that products are available when needed for surgical procedures. No revenue is recognized upon the placement of inventory into consignment as we retain title and maintain the inventory on our balance sheet. Upon implantation, we issue an invoice and revenue is recognized. Pricing for products is generally predetermined by contracts with customers, agents acting on behalf of customer groups or by government regulatory bodies, depending on the market. Price discounts under group purchasing contracts are generally linked to volume of implant purchases by customer healthcare institutions within a specified group. At negotiated thresholds within a contract buying period, price discounts may increase.
Sales to stocking distributors, healthcare dealers, dental practices and dental laboratories accounted for approximately 25 percent of our net sales in 2017. 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, 2017, 2016 and 2015.
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 expenses and were $263.6 million, $231.7 million and $214.2 million for the years ended December 31, 2017, 2016 and 2015, respectively.
Research and Development - We expense all research and development (“R&D”) costs as incurred except when there is alternative future use for the R&D. R&D costs include salaries, prototypes, depreciation of equipment used in R&D, consultant fees and service fees paid to collaborative partners. Where contingent milestone payments are due to third parties under R&D 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, intangible asset impairment, consulting and professional fees and asset impairment or loss on disposal charges connected with global restructuring, quality enhancement and remediation efforts, operational excellence initiatives, and other items as “Special items” in our consolidated statement of earnings. “Special items” included (in millions):
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2017 | 2016 | 2015 | ||||||||||
| Biomet-related | ||||||||||||
| Merger consideration compensation expense | $ | - | $ | - | $ | 90.4 | ||||||
| Retention plans | - | - | 73.0 | |||||||||
| Consulting and professional fees | 81.5 | 220.4 | 167.4 | |||||||||
| Employee termination benefits | 12.1 | 50.8 | 101.0 | |||||||||
| Dedicated project personnel | 50.6 | 79.8 | 62.3 | |||||||||
| Relocated facilities | 7.7 | 19.1 | 5.6 | |||||||||
| Certain litigation matters | 15.5 | 2.5 | - | |||||||||
| Contract terminations | 5.2 | 39.9 | 95.0 | |||||||||
| Information technology integration | 5.9 | 14.3 | 5.2 | |||||||||
| Intangible asset impairment | 26.8 | 30.0 | - | |||||||||
| Loss/impairment on assets | 9.8 | 13.0 | - | |||||||||
| Other | 32.9 | 17.5 | 19.2 | |||||||||
| Total Biomet-related | 248.0 | 487.3 | 619.1 | |||||||||
| Other | ||||||||||||
| Consulting and professional fees | 218.1 | 33.0 | 114.8 | |||||||||
| Employee termination benefits | 3.5 | 7.0 | 1.9 | |||||||||
| Dedicated project personnel | 45.6 | 17.3 | 31.8 | |||||||||
| Relocated facilities | 6.3 | 0.2 | - | |||||||||
| Certain litigation matters | 78.2 | 30.8 | 31.2 | |||||||||
| Certain claims (Note 19) | 10.3 | - | 7.7 | |||||||||
| Contract terminations | 3.9 | 2.9 | - | |||||||||
| Information technology integration | 2.9 | 1.3 | 1.8 | |||||||||
| Intangible asset impairment | - | 1.1 | - | |||||||||
| Loss/impairment on assets | - | - | 3.8 | |||||||||
| LDR merger consideration compensation expense | - | 24.1 | - | |||||||||
| Contingent consideration adjustments | (4.5 | ) | - | 2.4 | ||||||||
| Certain R&D agreements | 2.5 | - | - | |||||||||
| Other | 18.3 | 6.8 | 25.0 | |||||||||
| Total Other | 385.1 | 124.5 | 220.4 | |||||||||
| Special items | $ | 633.1 | $ | 611.8 | $ | 839.5 |
Pursuant to the Biomet merger agreement, all outstanding LVB stock options and LVB stock-based awards vested immediately prior to the effective time of the merger, and holders of these options and awards received a portion of the aggregate merger consideration. Some of these options and awards were already vested under the terms of LVB’s equity incentive plans. We accounted for the fair value of the consideration we paid in exchange for previously vested options and awards as consideration to complete the merger. As part of the merger agreement terms, all previously unvested options and awards vested immediately prior to the effective time of the merger. Under LVB’s equity incentive plans, unvested options and awards would have otherwise been forfeited. We have concluded that the discretionary accelerated vesting of these unvested options and awards was for the economic benefit of the combined company, and, therefore, we classified the fair value of the merger consideration we paid to holders of such unvested options and awards of $90.4 million as compensation expense in 2015. Under similar terms, a portion of LDR Holding Corporation (“LDR”) stock options and LDR stock-based awards vested immediately before the LDR merger and we recognized compensation expense of $24.1 million in 2016.
Pursuant to the Biomet merger agreement, retention plans were established for certain Biomet employees and third-party sales agents. Retention payments were earned by employees and third-party sales agents who remained with Biomet through the Closing Date. We recognized $73.0 million of expense resulting from these retention plans in 2015.
Consulting and professional fees include expenditures related to third-party integration consulting performed in a variety of areas such as tax, compliance, logistics and human resources for our business combinations including our merger with Biomet; legal fees related to the consummation of mergers and acquisitions and certain litigation and compliance matters; other consulting and professional fees and contract labor related to our quality enhancement and remediation efforts and operational excellence initiatives; third-party fees related to severance and termination benefits matters; costs of complying with our deferred prosecution agreement with the U.S. Department of Justice; and consulting fees related to certain information system integrations.
After the closing date of the Biomet merger, we started to implement our integration plans to drive operational synergies. Part of these integration plans included termination of employees and certain contracts with independent agents, distributors, suppliers and lessors. Our integration plans are expected to last through mid-2018 and we expect to incur approximately a total of $170 million for employee termination benefits and $140 million for contract termination expense in that time period. As of December 31, 2017, we had incurred a cumulative total of $163.9 million for employee termination benefits and $140.1 million for contract termination expense. Accordingly, our integration plans with respect to employee termination benefits and contract termination expenses are substantially complete. The following table summarizes the liabilities related to these integration plans (in millions):
| Employee | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Termination | Contract | |||||||||||
| Benefits | Terminations | Total | ||||||||||
| Balance, December 31, 2016 | $ | 38.1 | $ | 35.1 | $ | 73.2 | ||||||
| Additions | 12.1 | 5.2 | 17.3 | |||||||||
| Cash payments | (36.7 | ) | (10.4 | ) | (47.1 | ) | ||||||
| Foreign currency exchange rate changes | 1.3 | 0.4 | 1.7 | |||||||||
| Balance, December 31, 2017 | $ | 14.8 | $ | 30.3 | $ | 45.1 |
We have also recognized other employee termination benefits related to LDR, other acquisitions and our operational excellence initiatives.
Dedicated project personnel expenses include the salary, benefits, travel expenses and other costs directly associated with employees who are 100 percent dedicated to our integration of acquired businesses, employees who have been notified of termination, but are continuing to work on transferring their responsibilities and employees working on our quality enhancement and remediation efforts and operational excellence initiatives.
Relocated facilities expenses are the moving costs, lease expenses and other facility costs incurred during the relocation period in connection with relocating certain facilities.
Certain litigation matters relate to net expenses recognized during the year for the estimated or actual settlement of certain pending litigation and similar claims, including matters where we recognized income from a settlement on more favorable terms than our previous estimate, or we reduced our estimate of a previously recorded contingent liability. These litigation matters have included royalty disputes, patent litigation matters, product liability litigation matters and commercial litigation matters.
Contract termination costs relate to terminated agreements in connection with the integration of acquired companies and changes to our distribution model as part of business restructuring and operational excellence initiatives. The terminated contracts primarily relate to sales agents and distribution agreements.
Information technology integration costs are non-capitalizable costs incurred related to integrating information technology platforms of acquired companies or other significant software implementations as part of our quality and operational excellence initiatives.
As part of the Biomet merger, we recognized $209.0 million of intangible assets for in-process research and development (“IPR&D”) projects. During 2017 and 2016, we recorded impairment losses of $18.8 million and $30.0 million, respectively, related to these IPR&D intangible assets. The impairments were primarily due to the termination of certain IPR&D projects. We also recognized $479.0 million of intangible assets for trademarks that we designated as having an indefinite life. During 2017, we reclassified one of these trademarks to a finite life asset which resulted in an impairment of $8.0 million.
Loss/impairment on disposal of assets relates to assets that we have sold or intend to sell, or for which the economic useful life of the asset has been significantly reduced due to integration or our quality and operational excellence initiatives.
Contingent consideration adjustments represent the changes in the fair value of contingent consideration obligations to be paid to the prior owners of acquired businesses.
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.
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.
Accounts Receivable - Accounts receivable consists of trade and other miscellaneous receivables. We grant credit to customers in the normal course of business and maintain an allowance for doubtful accounts for potential credit losses. We determine the allowance for doubtful accounts by geographic market and take into consideration historical credit experience, creditworthiness of the customer and other pertinent information. We make concerted efforts to collect all accounts receivable, but sometimes we have to write-off the account against the allowance when we determine the account is uncollectible. The allowance for doubtful accounts was $60.2 million and $51.6 million as of December 31, 2017 and 2016, respectively.
Inventories - Inventories are stated at the lower of cost or market, with cost determined on a first-in first-out basis.
Property, Plant and Equipment - Property, plant and equipment is carried at cost less accumulated depreciation. Depreciation is computed using the straight-line method based on estimated useful lives of ten to forty years for buildings and improvements and three to eight years for machinery and equipment. Maintenance and repairs are expensed as incurred. We review property, plant and equipment for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. An impairment loss would be recognized when estimated future undiscounted cash flows relating to the asset are less than its carrying amount. An impairment loss is measured as the amount by which the carrying amount of an asset exceeds its fair value.
Software Costs - We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use when both the preliminary project stage is completed and it is probable that the software will be used as intended. Capitalized software costs generally include external direct costs of materials and services utilized in developing or obtaining computer software and compensation and related benefits for employees who are directly associated with the software project. Capitalized software costs are included in property, plant and equipment on our balance sheet and amortized on a straight-line or weighted average estimated user basis when the software is ready for its intended use over the estimated useful lives of the software, which approximate three to 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 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 in the amount that the carrying value of the business unit exceeds the fair value. See Note 9 for more information regarding goodwill.
Intangible Assets - Intangible assets are initially measured at their fair value. We have determined the fair value of our intangible assets either by the fair value of the consideration exchanged for the intangible asset or the estimated after-tax discounted cash flows expected to be generated from the intangible asset. Intangible assets with an indefinite life, including certain trademarks and trade names and IPR&D projects, 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 twenty years. Intangible assets with a finite life are tested for impairment whenever events or circumstances indicate that the carrying amount may not be recoverable.
Intangible assets with an indefinite life are tested for impairment annually or whenever events or circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognized if the carrying amount exceeds the estimated fair value of the asset. The amount of the impairment loss to be recorded would be determined based upon the excess of the asset’s carrying value over its fair value. The fair values of indefinite lived intangible assets are determined based upon a discounted cash flow analysis using the relief from royalty method or a qualitative assessment may be performed for any changes to the asset’s fair value from the last quantitative assessment. The relief from royalty method estimates the cost savings associated with owning, rather than licensing, assets. Significant assumptions are incorporated into these discounted cash flow analyses such as estimated growth rates, royalty rates and risk-adjusted discount rates. We may do a qualitative assessment when the results of the previous quantitative test indicated that the asset’s fair value was significantly in excess of its carrying value.
In determining the useful lives of intangible assets, we consider the expected use of the assets and the effects of obsolescence, demand, competition, anticipated technological advances, changes in surgical techniques, market influences and other economic factors. For technology-based intangible assets, we consider the expected life cycles of products, absent unforeseen technological advances, which incorporate the corresponding technology. Trademarks and trade names that do not have a wasting characteristic (i.e., there are no legal, regulatory, contractual, competitive, economic or other factors which limit the useful life) are assigned an indefinite life. Trademarks and trade names that are related to products expected to be phased out are assigned lives consistent with the period in which the products bearing each brand are expected to be sold. For customer relationship intangible assets, we assign useful lives based upon historical levels of customer attrition. Intellectual property rights are assigned useful lives that approximate the contractual life of any related patent or the period for which we maintain exclusivity over the intellectual property.
Income Taxes - We account for income taxes under the asset and liability method, which requires the recognition of 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 the new tax rate is enacted.
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.
We operate on a global basis and are subject to numerous and complex tax laws and regulations. Our income tax filings are regularly under audit in multiple federal, state and foreign jurisdictions. Income tax audits may require an extended period of time to reach resolution and may result in significant income tax adjustments when interpretation of tax laws or allocation of company profits is disputed. Because income tax adjustments in certain jurisdictions can be significant, we record accruals representing management's best estimate of the probable resolution of these
matters. To the extent additional information becomes available, such accruals are adjusted to reflect the revised estimated probable outcome.
Derivative Financial Instruments - We measure all derivative instruments at fair value and report them on our consolidated balance sheet as assets or liabilities. We maintain written policies and procedures that permit, under appropriate circumstances and subject to proper authorization, the use of derivative financial instruments solely for risk management purposes. The use of derivative financial instruments for trading or speculative purposes is prohibited by our policy. See Note 13 for more information regarding our derivative and hedging activities.
Other Comprehensive Income (Loss) - Other comprehensive income (loss) (“OCI”) refers to revenues, expenses, gains and losses that under generally accepted accounting principles are included in comprehensive income but are excluded from net earnings as these amounts are recorded directly as an adjustment to stockholders’ equity. Our OCI is comprised of foreign currency translation adjustments, unrealized gains and losses on cash flow hedges, unrealized gains and losses on available-for-sale securities and amortization of prior service costs and unrecognized gains and losses in actuarial assumptions.
Treasury Stock - We account for repurchases of common stock under the cost method and present treasury stock as a reduction of stockholders’ equity. We reissue common stock held in treasury only for limited purposes.
Noncontrolling Interest - We have an investment in another company in which we have a controlling financial interest, but not 100 percent of the equity. Further information related to the noncontrolling interests of that investment has not been provided as it is not significant to our consolidated financial statements.
Accounting Pronouncements – In January 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-04 – Simplifying the Test for Goodwill Impairment. This ASU requires goodwill impairment to be measured as the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. Under previous guidance, if the carrying amount of a reporting unit’s net assets were greater than its fair value, impairment was measured as the excess of the carrying amount of the reporting unit’s goodwill over its implied fair value. The determination of a reporting unit’s implied goodwill generally required significant estimates to fair value its net assets. Therefore, this ASU simplifies goodwill impairment testing by eliminating the need to estimate the fair value of a reporting unit’s net assets. The impact of this ASU is dependent on the specific facts and circumstances of future impairments and is applied prospectively on testing that occurs subsequent to adoption. We elected to early adopt this ASU in 2017. As a result, the new ASU was used to determine the goodwill impairment charge on our Office Based Technologies and Spine, less Asia Pacific reporting units that were recognized in 2017. See Note 9 for additional details regarding this goodwill impairment charge.
In October 2016, the FASB issued ASU 2016-16 – Intra-Entity Asset Transfers of Assets Other than Inventory. This ASU changes the accounting for the tax effects of intra-entity asset transfers/sales. Under current GAAP, the tax effects of intra-entity asset transfers/sales are deferred until the transferred asset is sold to a third party or otherwise recovered through use. Under the new guidance, the tax expense from the sale of the asset in the seller’s tax jurisdiction is recognized when the transfer occurs, even though the pre-tax effects of that transaction are eliminated in consolidation. Any deferred tax asset that arises in the buyer’s jurisdiction would also be recognized at the time of the transfer. The new guidance does not apply to intra-entity transfers/sales of inventory. We early adopted this standard effective January 1, 2017. The modified retrospective approach is required for transition, which resulted in us recognizing a cumulative-effect adjustment in Retained earnings as of January 1, 2017 for intra-entity transfers/sales we had executed prior to that date. The January 1, 2017 cumulative effect adjustment resulted in a $77.8 million decrease to Retained earnings, a $3.9 million decrease to Prepaid expenses and other current assets, a $22.4 million decrease in Other assets, a $2.0 million decrease to Income taxes payable, and a $53.5 million increase to Deferred income taxes, net. The adoption of this ASU resulted in additional tax benefit of $5.9 million to our provision for income taxes in the year ended December 31, 2017 compared to what it would have been under the previous accounting rules.
In May 2014, the FASB issued ASU 2014-09 – Revenue from Contracts with Customers (Topic 606). This ASU provides a five-step model for revenue recognition that all industries will apply to recognize revenue when a customer obtains control of a good or service. This ASU will be effective for us beginning January 1, 2018. Entities are permitted to apply the standard and related amendments either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the ASU recognized at the date of initial application.
We have completed our assessment of this ASU. Based upon our assessment, there will not be a material change to the timing of our revenue recognition. However, we will be required to reclassify certain immaterial costs from selling, general and administrative (“SG&A”) expense to net sales, which will result in a reduction of net sales, but have no impact on operating profit. We will adopt this new standard using the retrospective method, which will result in us restating prior reporting periods presented.
In March 2017, the FASB issued ASU 2017-07 – Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. This ASU requires us to report the service cost component of pensions in the same location as other compensation costs arising from services rendered by the pertinent employees during the period. We will be required to report the other components of net benefit costs in Other Income (Expense) in the statement of earnings. This ASU will be effective for us beginning January 1, 2018. The ASU must be applied retrospectively for the presentation of the service cost component and the other components of net periodic pension cost in the statement of earnings and prospectively, on and after the effective date, for the capitalization of the service cost component of net periodic pension cost in assets. See Note 14 for further information on the components of our net benefit cost.
In February 2016, the FASB issued ASU 2016-02 – Leases. This ASU requires lessees to recognize right-of-use assets and lease liabilities on the balance sheet. This ASU will be effective for us beginning January 1, 2019. Early adoption is permitted. Based on current guidance, this ASU must be adopted using a modified retrospective transition approach at the beginning of the earliest comparative period in the consolidated financial statements. We own most of our manufacturing facilities, but lease various office space and other less significant assets throughout the world. We have formed our project team and have begun a process to collect the necessary information to implement this ASU. We will continue evaluating our leases and the related impact this ASU will have on our consolidated financial statements throughout 2018.
In August 2017, the FASB issued ASU 2017-12 – Targeted Improvements to Accounting for Hedging Activities. This ASU amends the hedge accounting guidance to simplify the application of hedge accounting, makes more financial and nonfinancial hedging strategies eligible for hedge accounting treatment, changes how companies assess effectiveness and updates presentation and disclosure requirements. We are currently evaluating the impact this ASU will have on our consolidated financial statements; however, based on our current hedging portfolio, we do not anticipate that this ASU will have a significant impact on our financial position, results of operations or cash flows. This ASU will be effective for us January 1, 2019, with early adoption permitted. After adoption, we may explore new hedging opportunities that are eligible for hedge accounting treatment under the new standard.
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. | Business Combinations |
|---|
Biomet Merger
We completed our merger with LVB, the parent company of Biomet, on June 24, 2015. We paid $12,030.3 million in cash and stock and assumed Biomet’s senior notes. The total amount of merger consideration utilized for the acquisition method of accounting, as reduced by the merger consideration paid to holders of unvested LVB stock options and LVB stock-based awards of $90.4 million, was $11,939.9 million.
The following table sets forth unaudited pro forma financial information derived from (i) the audited financial statements of Zimmer for the year ended December 31, 2015; and (ii) the unaudited financial statements of LVB for the period January 1, 2015 to June 23, 2015. The pro forma financial information has been adjusted to give effect to the merger as if it had occurred on January 1, 2014.
Pro Forma Financial Information
(Unaudited)
| Year Ended December 31, 2015 | ||||
|---|---|---|---|---|
| (in millions) | ||||
| Net Sales | $ | 7,517.8 | ||
| Net Earnings | $ | 330.2 |
These unaudited pro forma results have been prepared for comparative purposes only and include adjustments such as inventory step-up, amortization of acquired intangible assets and interest expense on debt incurred to finance the merger. Material, nonrecurring pro forma adjustments directly attributable to the Biomet merger include:
| • | The $90.4 million of merger compensation expense for unvested LVB stock options and LVB stock-based awards was removed from net earnings for the year ended December 31, 2015 and recognized as an expense in the year ended December 31, 2014. |
|---|
| • | The $73.0 million of retention plan expense was removed from net earnings for the year ended December 31, 2015 and recognized as an expense in the year ended December 31, 2014. |
|---|
| • | Transaction costs of $17.7 million were removed from net earnings for the year ended December 31, 2015 and recognized as an expense in the year ended December 31, 2014. |
|---|
LDR Acquisition
On July 13, 2016, we completed our merger with LDR. We paid cash of $1,138.0 million. The total amount of merger consideration utilized for the acquisition method of accounting, as reduced by the merger consideration paid to holders of unvested LDR stock options and LDR stock-based awards of $24.1 million, was $1,113.9 million.
The addition of LDR provided us with an immediate position in the growing cervical disc replacement (“CDR”) market. The combination positioned us to accelerate the growth of our Spine business through the incremental revenues associated with entry into the CDR market and cross-portfolio selling opportunities to both Zimmer Biomet and LDR customer bases. The goodwill was generated from the operational synergies and cross-selling opportunities we expected to achieve from our combined operations. None of the goodwill is deductible for tax purposes.
The following table summarizes the final estimated fair value of the assets acquired and liabilities assumed at the closing date of the LDR merger (in millions):
| Final Values | ||||
| Cash | $ | 92.8 | ||
| Accounts receivable, net | 30.5 | |||
| Inventory | 97.0 | |||
| Other current assets | 5.6 | |||
| Property, plant and equipment | 24.7 | |||
| Intangible assets not subject to amortization: | ||||
| In-process research and development (IPR&D) | 2.0 | |||
| Intangible assets subject to amortization: | ||||
| Technology | 447.0 | |||
| Customer relationships | 122.0 | |||
| Trademarks and trade names | 74.0 | |||
| Other assets | 73.8 | |||
| Goodwill | 507.2 | |||
| Total assets acquired | 1,476.6 | |||
| Current liabilities | 122.5 | |||
| Long-term debt | 0.5 | |||
| Deferred taxes | 236.7 | |||
| Other long-term liabilities | 3.0 | |||
| Total liabilities assumed | 362.7 | |||
| Net assets acquired | $ | 1,113.9 |
We have not included pro forma information and certain other information under GAAP for the LDR acquisition because it did not have a material impact on our financial position or results of operations.
Other Acquisitions
During the year ended December 31, 2016, we completed individually immaterial acquisitions of companies including Cayenne Medical, Inc. (“Cayenne Medical”), a sports medicine company, Compression Therapy Concepts, Inc. (“CTC”), a provider of non-invasive products for the prevention of deep vein thrombosis, CD Diagnostics, Inc. (“CD Diagnostics”), a medical diagnostic testing company, and MedTech SA (“MedTech”), a designer and manufacturer of robotic equipment for brain and spine surgeries. The total aggregate cash consideration was $441.7 million. These acquisitions were completed primarily to expand our product offerings. We have assigned a fair value of $58.0 million for settlement of preexisting relationships and additional payments related to these acquisitions that are contingent on the respective acquired companies’ product sales, commercial milestones and certain cost savings. The fair value of the aggregate contingent payment liabilities was calculated based on the probability of achieving the specified sales growth, cost savings and commercial milestones and discounting to present value the payments. The goodwill was generated from the operational synergies and cross-selling opportunities we expected to achieve from the technologies acquired. None of the goodwill related to these acquisitions is deductible for tax purposes.
The following table summarizes the aggregate final estimated fair value as of the respective closing dates of the assets acquired and liabilities assumed related to the Cayenne Medical, CTC, CD Diagnostics, MedTech, and other immaterial acquisitions that occurred during the year ended December 31, 2016 (in millions):
| Current assets | $ | 66.4 | ||
|---|---|---|---|---|
| Property, plant and equipment | 4.5 | |||
| Intangible assets | 172.9 | |||
| Goodwill | 337.1 | |||
| Other assets | 38.2 | |||
| Total assets acquired | 619.1 | |||
| Current liabilities | 20.0 | |||
| Long-term liabilities | 99.4 | |||
| Total liabilities assumed | 119.4 | |||
| Net assets acquired | $ | 499.7 |
We have not included pro forma information and certain other information under GAAP for the Cayenne Medical, CTC, CD Diagnostics, or MedTech acquisitions because, individually and in aggregate, they did not have a material impact on our financial position or results of operations.
| 4. | 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, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2017 | 2016 | 2015 | ||||||||||
| Total expense, pre-tax | $ | 53.7 | $ | 57.3 | $ | 46.4 | ||||||
| Tax benefit related to awards | 12.5 | 31.5 | 14.5 | |||||||||
| Total expense, net of tax | $ | 41.2 | $ | 25.8 | $ | 31.9 |
Stock Options
We had two equity compensation plans in effect at December 31, 2017: the 2009 Stock Incentive Plan (“2009 Plan”) and the Stock Plan for Non-Employee Directors. The 2009 Plan succeeded the 2006 Stock Incentive Plan (“2006 Plan”) and the TeamShare Stock Option Plan (“TeamShare Plan”). No further awards have been granted under the 2006 Plan or under the TeamShare Plan since May 2009, and shares remaining available for grant under those plans have been merged into the 2009 Plan. Vested stock options previously granted under the 2006 Plan and the TeamShare Plan remained outstanding as of December 31, 2017. 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 71.6 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, 2017, an aggregate of 11.8 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, 2017 is as follows (options in thousands):
| Stock Options | Weighted Average Exercise Price | Weighted Average Remaining Contractual Life | Intrinsic Value (in millions) | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Outstanding at January 1, 2017 | 7,901 | $ | 86.21 | |||||||||||||
| Options granted | 1,663 | 121.52 | ||||||||||||||
| Options exercised | (1,730 | ) | 79.41 | |||||||||||||
| Options forfeited | (532 | ) | 113.54 | |||||||||||||
| Options expired | (45 | ) | 96.27 | |||||||||||||
| Outstanding at December 31, 2017 | 7,257 | $ | 93.83 | 6.3 | $ | 197.0 | ||||||||||
| Vested or expected to vest as of December 31, 2017 | 6,742 | $ | 92.36 | 6.2 | $ | 192.8 | ||||||||||
| Exercisable at December 31, 2017 | 4,107 | $ | 79.67 | 4.6 | $ | 168.6 |
We use a Black-Scholes option-pricing model to determine the fair value of our stock options. Expected volatility was derived from a combination of historical volatility and implied volatility because the traded options that were actively traded around the grant date of our stock options did not have maturities of over one year. The expected term of the stock options has been derived from historical employee exercise behavior. The risk-free interest rate was determined using the implied yield currently available for zero-coupon U.S. government issues with a remaining term approximating the expected life of the options. The dividend yield was determined by using an estimated annual dividend and dividing it by the market price of our stock on the grant date.
The following table presents information regarding the weighted average fair value of stock options granted, the assumptions used to determine fair value, the intrinsic value of options exercised and the tax benefit of options exercised in the indicated year:
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2017 | 2016 | 2015 | ||||||||||
| Dividend yield | 0.8 | % | 0.9 | % | 0.8 | % | ||||||
| Volatility | 21.6 | % | 21.9 | % | 22.2 | % | ||||||
| Risk-free interest rate | 2.0 | % | 1.4 | % | 1.7 | % | ||||||
| Expected life (years) | 5.3 | 5.3 | 5.3 | |||||||||
| Weighted average fair value of options granted | $ | 26.09 | $ | 21.30 | $ | 22.30 | ||||||
| Intrinsic value of options exercised (in millions) | $ | 67.6 | $ | 73.0 | $ | 49.4 | ||||||
| Tax benefit of options exercised (in millions) | $ | 27.7 | $ | 30.1 | $ | 81.4 |
As of December 31, 2017, there was $56.9 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 2.7 years.
RSUs
We have awarded RSUs to certain of our employees. The terms of the awards have been two to four years. Some of the awards have only service conditions while some have performance and market conditions in addition to service conditions. The service condition-only awards vest ratably on the anniversary date of the award. The awards that have performance and market conditions vest all at once on the third anniversary date. Future service conditions may be waived if an employee retires after the first anniversary date of the award, but performance and market conditions continue to apply. Accordingly, the requisite service period used for share-based payment expense on our RSUs range from one to four years.
A summary of nonvested RSU activity for the year ended December 31, 2017 is as follows (RSUs in thousands):
| Weighted Average | ||||||||
|---|---|---|---|---|---|---|---|---|
| Grant Date | ||||||||
| RSUs | Fair Value | |||||||
| Outstanding at January 1, 2017 | 1,394 | $ | 102.04 | |||||
| Granted | 586 | 115.77 | ||||||
| Vested | (256 | ) | 97.12 | |||||
| Forfeited | (363 | ) | 107.02 | |||||
| Outstanding at December 31, 2017 | 1,361 | 107.56 |
For the RSUs with service conditions only, the fair value of the awards was determined based upon the fair market value of our common stock on the date of grant. For the RSUs with market conditions, a Monte Carlo valuation technique was used to simulate the market conditions of the awards. The outcome of the simulation was used to determine the fair value of the awards.
We are required to estimate the number of RSUs that will vest and recognize share-based payment expense on a straight-line basis over the requisite service period. As of December 31, 2017, we estimate that approximately 776,600 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, 2017 was $54.2 million and is expected to be recognized over a weighted-average period of 2.6 years. The fair value of RSUs vesting during the years ended December 31, 2017, 2016 and 2015 based upon our stock price on the date of vesting was $31.2 million, $25.5 million, and $40.6 million, respectively.
| 5. | Inventories |
|---|
Inventories consisted of the following (in millions):
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2017 | 2016 | |||||||
| Finished goods | $ | 1,632.2 | $ | 1,556.9 | ||||
| Work in progress | 200.0 | 141.7 | ||||||
| Raw materials | 249.6 | 260.8 | ||||||
| Inventories | $ | 2,081.8 | $ | 1,959.4 |
Amounts charged to the consolidated statements of earnings for excess and obsolete inventory, including certain product lines we intend to discontinue, in the years ended December 31, 2017, 2016 and 2015 were $128.4 million, $195.4 million and $118.4 million, respectively. The increase in the 2016 period primarily resulted from our decision to discontinue certain products.
| 6. | Property, Plant and Equipment |
|---|
Property, plant and equipment consisted of the following (in millions):
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2017 | 2016 | |||||||
| Land | $ | 29.0 | $ | 37.0 | ||||
| Building and equipment | 1,838.5 | 1,789.9 | ||||||
| Capitalized software costs | 421.6 | 397.2 | ||||||
| Instruments | 2,683.9 | 2,347.6 | ||||||
| Construction in progress | 110.7 | 99.8 | ||||||
| 5,083.7 | 4,671.5 | |||||||
| Accumulated depreciation | (3,045.1 | ) | (2,633.6 | ) | ||||
| Property, plant and equipment, net | $ | 2,038.6 | $ | 2,037.9 |
Depreciation expense was $454.1 million, $466.7 million and $375.0 million for the years ended December 31, 2017, 2016 and 2015, respectively.
| 7. | Transfers of Financial Assets |
|---|
In the fourth quarter of 2016, we executed receivables purchase arrangements to liquidate portions of our trade accounts receivable balance with unrelated third parties. The receivables relate to products sold to customers and are short-term in nature. The factorings were treated as sales of our accounts receivable. Proceeds from the transfers reflect either the face value of the accounts receivable or the face value less factoring fees.
In the U.S. and Japan, our programs are executed on a revolving basis with a maximum funding limit as of December 31, 2017 of $350 million. We act as the collection agent on behalf of the third party, but have no significant retained interests or servicing liabilities related to the accounts receivable sold. In order to mitigate credit risk, we purchased credit insurance for the factored accounts receivable. The result is our risk of loss being limited to the factored accounts receivable not covered by the insurance. Additionally, we have provided guarantees for the factored accounts receivable. The maximum exposures to loss associated with these arrangements were $22.9 million and $5.2 million as of December 31, 2017 and 2016, respectively.
In Europe, we sell to a third party and have no continuing involvement or significant risk with the factored accounts receivable.
Funds received from the transfers are recorded as an increase to cash and a reduction to accounts receivable outstanding in the consolidated balance sheets. We report the cash flows attributable to the sale of receivables to third parties in cash flows from operating activities in our consolidated statements of cash flows. Net expenses resulting from the sales of receivables are recognized in selling, general and administrative expense. Net expenses include any resulting gains or losses from the sales of receivables, credit insurance and factoring fees.
For the years ended December 31, 2017 and 2016, we sold receivables having an aggregate face value of $1,456.9 million and $103.1 million to third parties in exchange for cash proceeds of $1,455.6 million and $103.1 million, respectively. Expenses recognized on these sales during the years ended December 31, 2017 and 2016, were not significant. For the year ended December 31, 2017, under the U.S. and Japan programs, we collected $1,031.2 million from our customers and remitted that amount to the third party, and we effectively repurchased $96.3 million of previously sold accounts receivable from the third party due to the programs’ revolving nature. At December 31, 2017, we collected $103.5 million that was unremitted to the third party, which is reflected in our balance sheet under other current liabilities. We estimate the incremental operating cash inflows related to all of our programs were approximately $174 million and $103 million for the years ended December 31, 2017 and 2016.
At December 31, 2017, the outstanding principal amount of receivables that has been derecognized under the U.S. and Japan revolving arrangements amounted to $197.0 million and $64.2 million, respectively.
| 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, 2017 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fair Value Measurements at Reporting Date Using: | ||||||||||||||||
| Description | Recorded Balance | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Assets | ||||||||||||||||
| Derivatives, current and long-term | ||||||||||||||||
| Foreign currency forward contracts | $ | 1.6 | $ | - | $ | 1.6 | $ | - | ||||||||
| Interest rate swaps | 4.5 | - | 4.5 | - | ||||||||||||
| $ | 6.1 | $ | - | $ | 6.1 | $ | - | |||||||||
| Liabilities | ||||||||||||||||
| Derivatives, current and long-term | ||||||||||||||||
| Foreign currency forward contracts | $ | 50.9 | $ | - | $ | 50.9 | $ | - | ||||||||
| Contingent payments related to acquisitions | 41.0 | - | - | 41.0 | ||||||||||||
| $ | 91.9 | $ | - | $ | 50.9 | $ | 41.0 |
| As of December 31, 2016 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fair Value Measurements at Reporting Date Using: | ||||||||||||||||
| Description | Recorded Balance | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Assets | ||||||||||||||||
| Derivatives, current and long-term | ||||||||||||||||
| Foreign currency forward contracts | $ | 65.3 | $ | - | $ | 65.3 | $ | - | ||||||||
| Interest rate swaps | 4.0 | - | 4.0 | - | ||||||||||||
| $ | 69.3 | $ | - | $ | 69.3 | $ | - | |||||||||
| Liabilities | ||||||||||||||||
| Derivatives, current and long-term | ||||||||||||||||
| Foreign currency forward contracts | $ | 0.3 | $ | - | $ | 0.3 | $ | - | ||||||||
| Contingent payments related to acquisitions | 62.8 | - | - | 62.8 | ||||||||||||
| $ | 63.1 | $ | - | $ | 0.3 | $ | 62.8 |
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.
Contingent payments related to acquisitions consist of commercial milestone, cost savings and sales-based payments, and are valued using discounted cash flow techniques. The fair value of commercial milestone payments reflects management’s expectations of probability of payment, and increases as the probability of payment increases or expectation of timing of payments is accelerated. The fair value of cost savings and sales-based payments is based upon probability-weighted future cost savings and revenue estimates, and increases as cost savings and revenue estimates increase, probability weighting of higher cost savings and revenue scenarios increase or expectation of timing of payment is accelerated. The majority of these contingent payments are related to acquisitions that occurred in 2016. We recognized $4.5 million of income related to contingent payments due to changes in estimates for the year ended December 31, 2017. We also paid $13.7 million in contingent payments and made a fair value adjustment of $3.6 million to the preliminary estimate of contingent consideration that reduced the contingent payment liability for the year ended December 31, 2017.
| 9. | Goodwill and Other Intangible Assets |
|---|
The following table summarizes the changes in the carrying amount of goodwill (in millions):
| Americas | EMEA | Asia Pacific | Immaterial Product Category Operating Segments | Total | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Balance at January 1, 2016 | ||||||||||||||||||||
| Goodwill | $ | 7,328.0 | $ | 1,291.0 | $ | 548.9 | $ | 1,139.3 | $ | 10,307.2 | ||||||||||
| Accumulated impairment losses | - | - | - | (373.0 | ) | (373.0 | ) | |||||||||||||
| 7,328.0 | 1,291.0 | 548.9 | 766.3 | 9,934.2 | ||||||||||||||||
| Biomet purchase accounting adjustments | 31.9 | (8.0 | ) | (61.3 | ) | (8.3 | ) | (45.7 | ) | |||||||||||
| LDR purchase accounting | - | - | - | 482.4 | 482.4 | |||||||||||||||
| Other acquisitions | 284.8 | 34.3 | - | 20.9 | 340.0 | |||||||||||||||
| Currency translation | (10.2 | ) | (53.6 | ) | (0.3 | ) | (2.9 | ) | (67.0 | ) | ||||||||||
| Balance at December 31, 2016 | ||||||||||||||||||||
| Goodwill | 7,634.5 | 1,263.7 | 487.3 | 1,631.4 | 11,016.9 | |||||||||||||||
| Accumulated impairment losses | - | - | - | (373.0 | ) | (373.0 | ) | |||||||||||||
| 7,634.5 | 1,263.7 | 487.3 | 1,258.4 | 10,643.9 | ||||||||||||||||
| LDR purchase accounting | - | - | - | 24.5 | 24.5 | |||||||||||||||
| Other acquisitions | (0.5 | ) | (33.2 | ) | - | 27.6 | (6.1 | ) | ||||||||||||
| Currency translation | 90.8 | 149.3 | 13.2 | 57.5 | 310.8 | |||||||||||||||
| Impairment | - | - | - | (304.7 | ) | (304.7 | ) | |||||||||||||
| Balance at December 31, 2017 | ||||||||||||||||||||
| Goodwill | 7,724.8 | 1,379.8 | 500.5 | 1,741.0 | 11,346.1 | |||||||||||||||
| Accumulated impairment losses | - | - | - | (677.7 | ) | (677.7 | ) | |||||||||||||
| $ | 7,724.8 | $ | 1,379.8 | $ | 500.5 | $ | 1,063.3 | $ | 10,668.4 |
During the year ended December 31, 2017, we recorded goodwill impairment charges related to our Office Based Technologies and Spine, less Asia Pacific (“Spine”) reporting units of $32.7 million and $272.0 million, respectively.
In the third quarter of 2017, we performed a goodwill impairment test on our Office Based Technologies reporting unit due to continued revenue declines. As a result, we recognized a $32.7 million impairment charge. The $32.7 million impairment represented the entire goodwill balance of the reporting unit and therefore no goodwill remains. This reporting unit was acquired as part of the Biomet merger in 2015 and therefore its assets and liabilities were recognized at their estimated fair values at the merger date. Since the merger date valuation, operating performance has been lower than expected due to integration issues, management turnover and poor execution of its operating plans.
We estimated the fair value of the Office Based Technologies reporting unit using a market approach. GAAP defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” We used market indicators based upon the reporting unit’s operating performance to estimate what price would be paid for the assets in an orderly transaction.
We performed our annual goodwill impairment test in the fourth quarter of 2017. In our annual impairment test, we determined our Spine reporting unit’s carrying value was in excess of its estimated fair value. As discussed in Note 2, we elected to early adopt ASU 2017-04 in the third quarter of 2017. This resulted in an impairment charge of $272.0 million, representing the amount by which the reporting unit’s carrying value exceeded its estimated fair value. This reporting unit includes goodwill from Zimmer as well as additional goodwill from both the Biomet and LDR mergers. The forecasts used to recognize the goodwill related to the spine product categories of Biomet and LDR assumed cross sale opportunities of the combined businesses, including the proprietary Mobi-C Cervical Disc acquired with LDR, would enable the reporting unit to grow faster than the overall spine market. The primary drivers of impairment were lower than expected sales due to sales force integration issues and additional complexities of combining the Zimmer, Biomet and LDR spine product supply chains. As a result, it will take longer than originally anticipated to realize the benefits of the mergers of the Biomet and LDR spine product categories.
We estimated the fair value of the Spine reporting unit based on 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 Spine reporting unit and considers differences between our reporting unit and 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 of our differentiated products or 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.
We have five other reporting units with goodwill assigned to them. The estimated fair values of these reporting units exceeded their carrying value by more than 10 percent. We estimated the fair value of those reporting units using the income and market approaches.
We will continue to monitor the fair value of our Spine reporting unit as well as our other five reporting units in our interim and annual reporting periods. If our estimated cash flows for these reporting units decrease, we may have 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 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.
The components of identifiable intangible assets were as follows (in millions):
| Technology | Intellectual Property Rights | Trademarks and Trade Names | Customer Relationships | IPR&D | Other | Total | ||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of December 31, 2017: | ||||||||||||||||||||||||||||
| Intangible assets subject to amortization: | ||||||||||||||||||||||||||||
| Gross carrying amount | $ | 3,669.8 | $ | 180.7 | $ | 671.1 | $ | 5,409.5 | $ | - | $ | 160.0 | $ | 10,091.1 | ||||||||||||||
| Accumulated amortization | (1,061.4 | ) | (176.1 | ) | (132.1 | ) | (890.4 | ) | - | (84.1 | ) | (2,344.1 | ) | |||||||||||||||
| Intangible assets not subject to amortization: | ||||||||||||||||||||||||||||
| Gross carrying amount | - | - | 460.0 | - | 146.4 | 606.4 | ||||||||||||||||||||||
| Total identifiable intangible assets | $ | 2,608.4 | $ | 4.6 | $ | 999.0 | $ | 4,519.1 | $ | 146.4 | $ | 75.9 | $ | 8,353.4 | ||||||||||||||
| As of December 31, 2016: | ||||||||||||||||||||||||||||
| Intangible assets subject to amortization: | ||||||||||||||||||||||||||||
| Gross carrying amount | $ | 3,599.4 | $ | 181.6 | $ | 626.1 | $ | 5,303.5 | $ | - | $ | 135.7 | $ | 9,846.3 | ||||||||||||||
| Accumulated amortization | (806.8 | ) | (172.3 | ) | (80.8 | ) | (566.0 | ) | - | (70.4 | ) | (1,696.3 | ) | |||||||||||||||
| Intangible assets not subject to amortization: | ||||||||||||||||||||||||||||
| Gross carrying amount | - | - | 475.1 | - | 160.3 | - | 635.4 | |||||||||||||||||||||
| Total identifiable intangible assets | $ | 2,792.6 | $ | 9.3 | $ | 1,020.4 | $ | 4,737.5 | $ | 160.3 | $ | 65.3 | $ | 8,785.4 |
Estimated annual amortization expense based upon intangible assets recognized as of December 31, 2017 for the years ending December 31, 2018 through 2022 is (in millions):
| For the Years Ending December 31, | ||||
|---|---|---|---|---|
| 2018 | $ | 595.0 | ||
| 2019 | 575.4 | |||
| 2020 | 572.2 | |||
| 2021 | 563.9 | |||
| 2022 | 557.4 |
| 10. | Other Current and Long-term Liabilities |
|---|
Other current and long-term liabilities consisted of the following (in millions):
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2017 | 2016 | |||||||
| Other current liabilities: | ||||||||
| License and service agreements | $ | 171.4 | $ | 168.0 | ||||
| Certain claims accrual (Note 19) | 78.0 | 75.0 | ||||||
| Salaries, wages and benefits | 255.2 | 225.8 | ||||||
| Accrued liabilities | 795.2 | 789.1 | ||||||
| Total other current liabilities | $ | 1,299.8 | $ | 1,257.9 | ||||
| Other long-term liabilities: | ||||||||
| Certain claims accrual (Note 19) | 121.4 | 218.6 | ||||||
| Other long-term liabilities | 324.4 | 244.0 | ||||||
| Total other long-term liabilities | $ | 445.8 | $ | 462.6 |
| 11. | Debt |
|---|
Our debt consisted of the following (in millions):
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2017 | 2016 | |||||||
| Current portion of long-term debt | ||||||||
| 1.450% Senior Notes due 2017 | $ | - | $ | 500.0 | ||||
| U.S. Term Loan B | 75.0 | 75.0 | ||||||
| 2.000% Senior Notes due 2018 | 1,150.0 | - | ||||||
| Other short-term debt | - | 0.6 | ||||||
| Total short-term debt | $ | 1,225.0 | $ | 575.6 | ||||
| Long-term debt | ||||||||
| 2.000% Senior Notes due 2018 | $ | - | $ | 1,150.0 | ||||
| 4.625% Senior Notes due 2019 | 500.0 | 500.0 | ||||||
| 2.700% Senior Notes due 2020 | 1,500.0 | 1,500.0 | ||||||
| 3.375% Senior Notes due 2021 | 300.0 | 300.0 | ||||||
| 3.150% Senior Notes due 2022 | 750.0 | 750.0 | ||||||
| 3.550% Senior Notes due 2025 | 2,000.0 | 2,000.0 | ||||||
| 4.250% Senior Notes due 2035 | 253.4 | 253.4 | ||||||
| 5.750% Senior Notes due 2039 | 317.8 | 317.8 | ||||||
| 4.450% Senior Notes due 2045 | 395.4 | 395.4 | ||||||
| 1.414% Euro Notes due 2022 | 600.4 | 527.4 | ||||||
| 2.425% Euro Notes due 2026 | 600.4 | 527.4 | ||||||
| U.S. Term Loan A | 835.0 | 1,700.0 | ||||||
| U.S. Term Loan B | 600.0 | 675.0 | ||||||
| Japan Term Loan A | 103.2 | 99.6 | ||||||
| Japan Term Loan B | 187.9 | - | ||||||
| Other long-term debt | 4.1 | 4.2 | ||||||
| Debt discount and issuance costs | (53.2 | ) | (65.8 | ) | ||||
| Adjustment related to interest rate swaps | 23.1 | 31.4 | ||||||
| Total long-term debt | $ | 8,917.5 | $ | 10,665.8 |
At December 31, 2017, our total debt consisted of $8.4 billion aggregate principal amount of senior notes, which included $1.2 billion of Euro-denominated senior notes (“Euro notes”), $835.0 million outstanding under a U.S. term loan (“U.S. Term Loan A”) that will mature on June 24, 2020, $675.0 million outstanding under a U.S. term loan (“U.S. Term Loan B”) that will mature on September 30, 2019, an 11.7 billion Japanese Yen term loan agreement (“Japan Term Loan A”) and a 21.3 billion Japanese Yen term loan agreement (“Japan Term Loan B”) that each will mature on September 27, 2022, and other debt and fair value adjustments totaling $27.2 million, partially offset by debt discount and issuance costs of $53.2 million.
On September 22, 2017, we entered into a term loan agreement for the Japan Term Loan B, and an amended and restated term loan agreement, which amended and restated the Japan Term Loan A loan agreement dated as of May 24, 2012, as amended as of October 31, 2014. As described above, the term loans under both of these agreements will mature on September 27, 2022. Each of these term loans bears interest at a fixed rate of 0.635 percent per annum.
On December 13, 2016, we completed the offering of €500 million aggregate principal amount of our 1.414% Euro notes due December 13, 2022 and €500 million aggregate principal amount of our 2.425% Euro notes due December 13, 2026. Interest is payable on each series of Euro notes on December 13 of each year until maturity.
In 2016, we also entered into U.S. Term Loan B and borrowed $750.0 million thereunder to repay outstanding borrowings under a previous multicurrency revolving facility incurred in connection with the acquisition of LDR.
In 2015, we issued senior notes and borrowed $3.0 billion under U.S. Term Loan A to finance a portion of the cash consideration payable in the Biomet merger, pay merger related fees and expenses and pay a portion of Biomet’s funded debt.
In 2016 and 2015, we used a portion of the funds received from the above-described note issuances and borrowings to repay other outstanding debt. The repayments resulted in debt extinguishment charges of $53.3 million and $22.0 million in 2016 and 2015, respectively, recorded as part of other expense, net.
We have a revolving credit and term loan agreement (the “2016 Credit Agreement”) and a first amendment to our credit agreement executed in 2014 (the “2014 Credit Agreement”). The 2016 Credit Agreement contains the U.S. Term Loan B and a five-year unsecured multicurrency revolving facility of $1.5 billion (the “Multicurrency Revolving Facility”). The Multicurrency Revolving Facility replaced the previous multicurrency revolving facility under the 2014 Credit Agreement and will mature on September 30, 2021, with two available one-year extensions at our discretion. The 2014 Credit Agreement also provided for the U.S. Term Loan A, which remains in effect.
Borrowings under the 2014 and 2016 Credit Agreements generally bear interest at floating rates based upon indices determined by the currency of the borrowing, or at an alternate base rate, in each case, plus an applicable margin determined by reference to our senior unsecured long-term credit rating, or, in the case of borrowings under the Multicurrency Revolving Facility only, at a fixed rate determined through a competitive bid process. We pay a facility fee on the aggregate amount of the Multicurrency Revolving Facility at a rate determined by reference to our senior unsecured long-term credit rating.
The 2016 Credit Agreement and 2014 Credit Agreement, as amended, contain customary affirmative and negative covenants and events of default for unsecured financing arrangements, including, among other things, limitations on consolidations, mergers and sales of assets. Financial covenants under the 2016 and 2014 Credit Agreements include a consolidated indebtedness to consolidated EBITDA ratio of no greater than 5.0 to 1.0 through June 30, 2017, and no greater than 4.5 to 1.0 thereafter. If our credit rating falls below investment grade, additional restrictions would result, including restrictions on investments and payment of dividends. We were in compliance with all covenants under the 2016 and 2014 Credit Agreements as of December 31, 2017. As of December 31, 2017, there were no borrowings outstanding under the Multicurrency Revolving Facility.
Under the terms of U.S. Term Loan A, starting September 30, 2015, principal payments are due as follows: $75.0 million on a quarterly basis during the first three years, $112.5 million on a quarterly basis during the fourth year, and $412.5 million on a quarterly basis during the fifth year. We have paid $2.165 billion in principal under U.S. Term Loan A, resulting in $835.0 million in outstanding borrowings as of December 31, 2017. The interest rate at December 31, 2017 was 2.9 percent on U.S. Term Loan A.
Under the terms of U.S. Term Loan B, future principal payments are due as follows: $75.0 million on September 30, 2018, with the remaining balance due on the U.S. Term Loan B maturity date of September 30, 2019. We have paid $75.0 million in principal under U.S. Term Loan B, resulting in $675.0 million outstanding on the U.S. Term Loan B as of December 31, 2017. The interest rate at December 31, 2017 was 2.6 percent on U.S. Term Loan B.
We may, at our option, redeem our senior notes, in whole or in part, at any time upon payment of the principal, any applicable make-whole premium, and accrued and unpaid interest to the date of redemption. In addition, we may redeem, at our option, the 2.700% Senior Notes due 2020, the 3.375% Senior Notes due 2021, the 3.150% Senior Notes due 2022, the 3.550% Senior Notes due 2025, the 4.250% Senior Notes due 2035 and the 4.450% Senior Notes due 2045 without any make-whole premium at specified dates ranging from one month to six months in advance of the scheduled maturity date.
The estimated fair value of our senior notes as of December 31, 2017, based on quoted prices for the specific securities from transactions in over-the-counter markets (Level 2), was $8,489.8 million. The estimated fair value of Japan Term Loan A and Japan Term Loan B, in the aggregate, as of December 31, 2017, based upon publicly available market yield curves and the terms of the debt (Level 2), was $290.0 million. The carrying values of U.S. Term Loan A and U.S. Term Loan B approximate fair value as they bear interest at short-term variable market rates.
We 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. These fair value hedges were settled in 2016. In 2016, we entered into various variable-to-fixed interest rate swap agreements that were accounted for as cash flow hedges of U.S. Term Loan B. See Note 13 for additional information regarding the interest rate swap agreements.
We also have available uncommitted credit facilities totaling $58.4 million.
At December 31, 2017 and 2016, the weighted average interest rate for our borrowings was 2.9 percent and 2.8 percent, respectively. We paid $317.5 million, $363.1 million, and $207.1 million in interest during 2017, 2016, and 2015, respectively.
| 12. | Accumulated Other Comprehensive (Loss) Income |
|---|
OCI refers to certain gains and losses that under GAAP are included in comprehensive income but are excluded from net earnings as these amounts are initially recorded as an adjustment to stockholders’ equity. Amounts in OCI may be reclassified to net earnings upon the occurrence of certain events.
Our OCI is comprised of foreign currency translation adjustments, unrealized gains and losses on cash flow hedges, unrealized gains and losses on available-for-sale securities, and amortization of prior service costs and unrecognized gains and losses in actuarial assumptions on our defined benefit plans. Foreign currency translation adjustments are reclassified to net earnings upon sale or upon a complete or substantially complete liquidation of an investment in a foreign entity. Unrealized gains and losses on cash flow hedges are reclassified to net earnings when the hedged item affects net earnings. Unrealized gains and losses on available-for-sale securities are reclassified to net earnings if we sell the security before maturity or if the unrealized loss is considered to be other-than-temporary. Amounts related to defined benefit plans that are in OCI are reclassified over the service periods of employees in the plan. The reclassification amounts are allocated to all employees in the plans and, therefore, the reclassified amounts may become part of inventory to the extent they are considered direct labor costs. See Note 14 for more information on our defined benefit plans.
The following table shows the changes in the components of OCI, net of tax (in millions):
| Foreign | Cash | Defined | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Currency | Flow | Benefit | ||||||||||
| Translation | Hedges | Plan Items | ||||||||||
| Balance December 31, 2016 | $ | (323.5 | ) | $ | 32.3 | $ | (142.8 | ) | ||||
| OCI before reclassifications | 445.0 | (95.0 | ) | (2.7 | ) | |||||||
| Reclassifications | - | (3.8 | ) | 7.3 | ||||||||
| Balance December 31, 2017 | $ | 121.5 | $ | (66.5 | ) | $ | (138.2 | ) |
The following table shows the reclassification adjustments from OCI (in millions):
| Amount of Gain / (Loss) | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Reclassified from OCI | ||||||||||||||
| For the Years Ended December 31, | Location on | |||||||||||||
| Component of OCI | 2017 | 2016 | 2015 | Statement of Earnings | ||||||||||
| Cash flow hedges | ||||||||||||||
| Foreign exchange forward contracts | $ | 5.1 | $ | 87.7 | $ | 122.3 | Cost of products sold | |||||||
| Forward starting interest rate swaps | - | (66.4 | ) | - | Other expense | |||||||||
| Forward starting interest rate swaps | (0.5 | ) | (1.7 | ) | (1.3 | ) | Interest expense | |||||||
| 4.6 | 19.6 | 121.0 | Total before tax | |||||||||||
| 0.8 | (6.2 | ) | 28.0 | Provision (benefit) for income taxes | ||||||||||
| $ | 3.8 | $ | 25.8 | $ | 93.0 | Net of tax | ||||||||
| Defined benefit plans | ||||||||||||||
| Prior service cost | $ | 10.3 | $ | 7.8 | $ | 5.6 | * | |||||||
| Unrecognized actuarial (loss) | (22.1 | ) | (22.9 | ) | (20.1 | ) | * | |||||||
| (11.8 | ) | (15.1 | ) | (14.5 | ) | Total before tax | ||||||||
| (4.5 | ) | (5.2 | ) | (5.3 | ) | Benefit for income taxes | ||||||||
| $ | (7.3 | ) | $ | (9.9 | ) | $ | (9.2 | ) | Net of tax | |||||
| Total reclassifications | $ | (3.5 | ) | $ | 15.9 | $ | 83.8 | 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 (loss) (in millions):
| For the Years Ended December 31, | ||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Before Tax | Tax | Net of Tax | ||||||||||||||||||||||||||||||||||
| 2017 | 2016 | 2015 | 2017 | 2016 | 2015 | 2017 | 2016 | 2015 | ||||||||||||||||||||||||||||
| Foreign currency cumulative translation adjustments | $ | 396.8 | $ | (128.2 | ) | $ | (305.2 | ) | $ | (48.2 | ) | $ | 1.8 | $ | - | $ | 445.0 | $ | (130.0 | ) | $ | (305.2 | ) | |||||||||||||
| Unrealized cash flow hedge gains | (116.0 | ) | 29.7 | 59.1 | (21.0 | ) | 1.4 | 6.4 | (95.0 | ) | 28.3 | 52.7 | ||||||||||||||||||||||||
| Reclassification adjustments on foreign currency hedges | (4.6 | ) | (19.6 | ) | (121.0 | ) | (0.8 | ) | 6.2 | (28.0 | ) | (3.8 | ) | (25.8 | ) | (93.0 | ) | |||||||||||||||||||
| Unrealized gains/(losses) on securities | - | 0.5 | (0.2 | ) | - | - | - | - | 0.5 | (0.2 | ) | |||||||||||||||||||||||||
| Adjustments to prior service cost and unrecognized actuarial assumptions | 6.6 | 27.3 | (25.0 | ) | 2.0 | 5.3 | (3.6 | ) | 4.6 | 22.0 | (21.4 | ) | ||||||||||||||||||||||||
| Total Other Comprehensive Income (Loss) | $ | 282.8 | $ | (90.3 | ) | $ | (392.3 | ) | $ | (68.0 | ) | $ | 14.7 | $ | (25.2 | ) | $ | 350.8 | $ | (105.0 | ) | $ | (367.1 | ) |
| 13. | Derivative Instruments and Hedging Activities |
|---|
We are exposed to certain market risks relating to our ongoing business operations, including foreign currency exchange rate risk, commodity price risk, interest rate risk and credit risk. We manage our exposure to these and other market risks through regular operating and financing activities. Currently, the only risks that we manage through the use of derivative instruments are interest rate risk and foreign currency exchange rate risk.
Interest Rate Risk
Derivatives Designated as Fair Value Hedges
In prior years, we entered into various fixed-to-variable interest rate swap agreements that were accounted for as fair value hedges of a portion of the Senior Notes due 2019 and all of the Senior Notes due 2021. In August 2016, we received cash for these interest rate swap assets by terminating the hedging instruments with the counterparties. The remaining unamortized balance as of December 31, 2017 was $23.1 million, which will be recognized using the effective interest rate method over the remaining maturity period of the hedged notes.
Derivatives Designated as Cash Flow Hedges
In 2014, we entered into forward starting interest rate swaps that were designated as cash flow hedges of the thirty year tranche of senior notes (the 4.450% Senior Notes due 2045) we expected to issue in 2015. The forward starting interest rate swaps mitigated the risk of changes in interest rates prior to the completion of the notes offering. The interest rate swaps were settled at a loss of $97.6 million in 2015. This loss will be recognized using the effective interest rate method over the remaining maturity period of the hedged notes. With the issuance of the Euro notes in December 2016, we extinguished a portion of the 4.450% Senior Notes due 2045 and recognized $66.4 million of the previously settled loss as part of our debt extinguishment cost. The remaining loss to be recognized at December 31, 2017 was $27.7 million.
In September 2016, we entered into various variable-to-fixed interest rate swap agreements with a notional amount of $375 million that were accounted for as cash flow hedges of Term Loan B. The interest rate swaps minimize the exposure to changes in the LIBOR interest rates while the variable-rate debt is outstanding. The weighted average fixed interest rate for all of the outstanding interest rate swap agreements is approximately 0.82 percent through September 30, 2019.
Foreign Currency Exchange Rate Risk
We operate on a global basis and are exposed to the risk that our financial condition, results of operations and cash flows could be adversely affected by changes in foreign currency exchange rates. To reduce the potential effects of
foreign currency exchange rate movements on net earnings, we enter into derivative financial instruments in the form of foreign currency exchange forward contracts with major financial institutions. We also designated our Euro notes and other foreign currency exchange forward contracts as net investment hedges of investments in foreign subsidiaries. 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, Indian Rupees, Turkish Lira, Polish Zloty, Danish Krone, and Norwegian Krone. We do not use derivative financial instruments for trading or speculative purposes.
Derivatives Designated as Net Investment Hedges
We are exposed to the impact of foreign exchange rate fluctuations in the investments in our wholly-owned foreign subsidiaries that are denominated in currencies other than the U.S. dollar. In order to mitigate the volatility in foreign exchange rates, we issued Euro notes in December 2016, as discussed in Note 11, and designated 100 percent of the Euro notes to hedge our net investment in certain wholly-owned foreign subsidiaries that have a functional currency of Euro. All changes in the fair value of the hedging instrument designated as a net investment hedge are recorded as a component of accumulated other comprehensive loss in the consolidated balance sheet.
We also entered into a foreign currency exchange forward contract in anticipation of the Euro notes issuance and designated it as a net investment hedge.
In the years ended December 31, 2017 and 2016, we recognized a foreign exchange loss of $146.0 million and a foreign exchange gain of $18.8 million, respectively, in OCI on our net investment hedges. We recognized no ineffectiveness from our net investment hedges for the years ended December 31, 2017 and 2016.
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. We designate these derivative instruments as cash flow hedges.
We perform quarterly assessments of hedge effectiveness by verifying and documenting the critical terms of the hedge instrument and that forecasted transactions have not changed significantly. We also assess on a quarterly basis whether there have been adverse developments regarding the risk of a counterparty default. For derivatives which qualify as hedges of future cash flows, the effective portion of changes in fair value is temporarily recorded in other comprehensive income and then recognized in cost of products sold when the hedged item affects net earnings. The ineffective portion of a derivative’s change in fair value, if any, is immediately reported in cost of products sold. On our consolidated statement of cash flows, the settlements of these cash flow hedges are recognized in operating cash flows.
For foreign currency exchange forward contracts outstanding at December 31, 2017, 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, Indian Rupees, Turkish Lira, Polish Zloty, Danish Krone, and Norwegian Krone and obligations to purchase Swiss Francs and sell U.S. Dollars. These derivatives mature at dates ranging from January 2018 through June 2020. As of December 31, 2017, the notional amounts of outstanding forward contracts entered into with third parties to purchase U.S. Dollars were $1,735.9 million. As of December 31, 2017, the notional amounts of outstanding forward contracts entered into with third parties to purchase Swiss Francs were $291.3 million.
Derivatives Not Designated as Hedging Instruments
We enter into foreign currency forward exchange contracts with terms of one month to manage currency exposures for monetary assets and liabilities denominated in a currency other than an entity’s functional currency. As a result, any foreign currency re-measurement gains/losses recognized in earnings are generally offset with gains/losses on the foreign currency forward exchange contracts in the same reporting period. These contracts are settled on the last day of each reporting period. Therefore, there is no outstanding balance related to these contracts recorded on the
balance sheet as of the end of the reporting period. The notional amounts of these contracts are typically in a range of $1.5 billion to $2.0 billion per quarter.
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):
| Gain / (Loss) on Instrument | Gain / (Loss) on Hedged Item | |||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Location on Statement of | Years Ended December 31, | Years Ended December 31, | ||||||||||||||||||||||||
| Derivative Instrument | Earnings | 2017 | 2016 | 2015 | 2017 | 2016 | 2015 | |||||||||||||||||||
| Interest rate swaps | Interest expense | $ | - | $ | 7.5 | $ | 2.8 | $ | - | $ | (7.5 | ) | $ | (2.8 | ) |
We had no ineffective fair value hedging instruments nor any amounts excluded from the assessment of hedge effectiveness during the years ended December 31, 2017, 2016 and 2015.
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 (loss) and consolidated balance sheets (in millions):
| Amount of Gain / (Loss) | Amount of Gain / (Loss) | |||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Recognized in OCI | Location on | Reclassified from OCI | ||||||||||||||||||||||||
| Years Ended December 31, | Statement of | Years Ended December 31, | ||||||||||||||||||||||||
| Derivative Instrument | 2017 | 2016 | 2015 | Earnings | 2017 | 2016 | 2015 | |||||||||||||||||||
| Foreign exchange forward contracts | $ | (116.5 | ) | $ | 25.7 | $ | 97.4 | Cost of products sold | $ | 5.1 | $ | 87.7 | $ | 122.3 | ||||||||||||
| Interest rate swaps | 0.5 | 4.0 | - | Interest expense | - | - | - | |||||||||||||||||||
| Forward starting interest rate swaps | - | - | (38.3 | ) | Interest expense | (0.5 | ) | (1.7 | ) | (1.3 | ) | |||||||||||||||
| Forward starting interest rate swaps | - | - | - | Other expense, net | - | (66.4 | ) | - | ||||||||||||||||||
| $ | (116.0 | ) | $ | 29.7 | $ | 59.1 | $ | 4.6 | $ | 19.6 | $ | 121.0 |
The net amount recognized in earnings during the years ended December 31, 2017, 2016 and 2015 due to ineffectiveness and amounts excluded from the assessment of hedge effectiveness were not significant.
The fair value of outstanding derivative instruments designated as cash flow hedges and recorded on the balance sheet at December 31, 2017, together with settled derivatives where the hedged item has not yet affected earnings, was a net unrealized loss of $84.4 million, or $66.5 million after taxes, which is deferred in accumulated other comprehensive income. Of the net unrealized loss, $37.2 million, or $31.5 million after taxes, is expected to be reclassified to earnings in cost of products sold and a loss of $0.6 million, or $0.4 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):
| Location on | Years Ended December 31, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Derivative Instrument | Statement of Earnings | 2017 | 2016 | 2015 | ||||||||||
| Foreign exchange forward contracts | Other expense, net | $ | (62.3 | ) | $ | 2.5 | $ | 28.8 |
These gains/(losses) do not reflect offsetting gains of $45.5 million in 2017 and offsetting losses of $15.5 million and $42.2 million in 2016 and 2015, respectively, recognized in Other expense, net as a result of foreign currency
re-measurement of monetary assets and liabilities denominated in a currency other than an entity’s functional currency.
Balance Sheet Presentation
As of December 31, 2017 and December 31, 2016, 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 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):
| As of December 31, 2017 | As of December 31, 2016 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Balance Sheet | Fair | Balance Sheet | Fair | |||||||||
| Location | Value | Location | Value | |||||||||
| Asset Derivatives | ||||||||||||
| Foreign exchange forward contracts | Other current assets | $ | 14.5 | Other current assets | $ | 57.9 | ||||||
| Foreign exchange forward contracts | Other assets | 4.8 | Other assets | 34.9 | ||||||||
| Interest rate swaps | Other assets | 4.5 | Other assets | 4.0 | ||||||||
| Total asset derivatives | $ | 23.8 | $ | 96.8 | ||||||||
| Liability Derivatives | ||||||||||||
| Foreign exchange forward contracts | Other current liabilities | $ | 45.8 | Other current liabilities | $ | 20.9 | ||||||
| Forward starting interest rate swaps | Other current liabilities | - | Other current liabilities | - | ||||||||
| Foreign exchange forward contracts | Other long-term liabilities | 22.8 | Other long-term liabilities | 6.9 | ||||||||
| Total liability derivatives | $ | 68.6 | $ | 27.8 |
The table below presents the effects of our master netting agreements on our consolidated balance sheets (in millions):
| As of December 31, 2017 | As of December 31, 2016 | |||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Description | Location | Gross Amount | Offset | Net Amount in Balance Sheet | Gross Amount | Offset | Net Amount in Balance Sheet | |||||||||||||||||||
| Asset Derivatives | ||||||||||||||||||||||||||
| Cash flow hedges | Other current assets | $ | 14.5 | $ | 13.4 | $ | 1.1 | $ | 57.9 | $ | 20.6 | $ | 37.3 | |||||||||||||
| Cash flow hedges | Other assets | 4.8 | 4.3 | 0.5 | 34.9 | 6.8 | 28.1 | |||||||||||||||||||
| Liability Derivatives | ||||||||||||||||||||||||||
| Cash flow hedges | Other current liabilities | 45.8 | 13.4 | 32.4 | 20.9 | 20.6 | 0.3 | |||||||||||||||||||
| Cash flow hedges | Other long-term liabilities | 22.8 | 4.3 | 18.5 | 6.9 | 6.8 | 0.1 |
The following net investment hedge gains were recognized on our consolidated statements of comprehensive income (loss) (in millions):
| Amount of Gain / (Loss) | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Recognized in OCI | ||||||||||||
| Years Ended December 31, | ||||||||||||
| Derivative Instrument | 2017 | 2016 | 2015 | |||||||||
| Euro Notes | $ | (146.0 | ) | $ | 9.4 | $ | - | |||||
| Foreign exchange forward contracts | - | 9.4 | - | |||||||||
| $ | (146.0 | ) | $ | 18.8 | $ | - |
| 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, | ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| U.S. and Puerto Rico | Foreign | |||||||||||||||||||||||
| 2017 | 2016 | 2015 | 2017 | 2016 | 2015 | |||||||||||||||||||
| Service cost | $ | 8.7 | $ | 9.6 | $ | 11.8 | $ | 17.7 | $ | 19.0 | $ | 18.9 | ||||||||||||
| Interest cost | 14.0 | 13.8 | 15.8 | 8.4 | 10.0 | 8.8 | ||||||||||||||||||
| Expected return on plan assets | (32.4 | ) | (32.2 | ) | (31.8 | ) | (12.2 | ) | (13.7 | ) | (13.9 | ) | ||||||||||||
| Curtailment gain | - | - | - | - | (0.5 | ) | - | |||||||||||||||||
| Settlements | 0.4 | 2.6 | - | 1.1 | - | - | ||||||||||||||||||
| Amortization of prior service cost | (5.9 | ) | (5.9 | ) | (3.7 | ) | (4.4 | ) | (1.9 | ) | (1.9 | ) | ||||||||||||
| Amortization of unrecognized actuarial loss | 17.9 | 16.5 | 17.4 | 4.2 | 6.4 | 2.7 | ||||||||||||||||||
| Net periodic benefit cost | $ | 2.7 | $ | 4.4 | $ | 9.5 | $ | 14.8 | $ | 19.3 | $ | 14.6 |
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, | ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| U.S. and Puerto Rico | Foreign | |||||||||||||||||||||||
| 2017 | 2016 | 2015 | 2017 | 2016 | 2015 | |||||||||||||||||||
| Discount rate | 4.33 | % | 4.32 | % | 4.56 | % | 1.38 | % | 1.41 | % | 1.94 | % | ||||||||||||
| Rate of compensation increase | 3.29 | % | 3.29 | % | 3.29 | % | 2.20 | % | 2.08 | % | 2.00 | % | ||||||||||||
| Expected long-term rate of return on plan assets | 7.75 | % | 7.75 | % | 7.75 | % | 2.30 | % | 2.40 | % | 3.05 | % |
The expected long-term rate of return on plan assets is based on the historical and estimated future rates of return on the different asset classes held in the plans. The expected long-term rate of return is the weighted average of the target asset allocation of each individual asset class. We believe that historical asset results approximate expected market returns applicable to the funding of a long-term benefit obligation.
Discount rates were determined for each of our defined benefit retirement plans at their measurement date to reflect the yield of a portfolio of high quality bonds matched against the timing and amounts of projected future benefit payments. Beginning in 2016, we changed the method used to estimate the service and interest costs for pension and postretirement benefits. The new method utilizes a full yield curve approach to estimate service and interest costs by applying specific spot rates along the yield curve used to determine the benefit obligation of relevant projected cash outflows. Historically, we utilized a single weighted-average discount rate applied to projected cash
outflows. We made the change to provide a more precise measurement of service and interest costs by aligning the timing of the plan's liability cash flows to the corresponding spot rate on the yield curve. The change did not impact the measurement of the plan's obligations. We accounted for this change as a change in accounting estimate.
Changes in projected benefit obligations and plan assets were (in millions):
| For the Years Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| U.S. and Puerto Rico | Foreign | |||||||||||||||
| 2017 | 2016 | 2017 | 2016 | |||||||||||||
| Projected benefit obligation - beginning of year | $ | 376.9 | $ | 375.1 | $ | 568.6 | $ | 568.6 | ||||||||
| Service cost | 8.7 | 9.6 | 17.7 | 19.0 | ||||||||||||
| Interest cost | 14.0 | 13.8 | 8.4 | 10.0 | ||||||||||||
| Plan amendments | - | - | 0.6 | (23.4 | ) | |||||||||||
| Employee contributions | - | - | 17.0 | 23.6 | ||||||||||||
| Benefits paid | (14.9 | ) | (14.3 | ) | (34.5 | ) | (31.6 | ) | ||||||||
| Actuarial loss (gain) | 36.9 | (1.6 | ) | 15.6 | 46.7 | |||||||||||
| Expenses paid | - | - | (0.2 | ) | (0.2 | ) | ||||||||||
| Settlement | (0.9 | ) | (5.7 | ) | (0.8 | ) | - | |||||||||
| Translation gain (loss) | - | - | 31.2 | (44.1 | ) | |||||||||||
| Projected benefit obligation - end of year | $ | 420.7 | $ | 376.9 | $ | 623.6 | $ | 568.6 |
| For the Years Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| U.S. and Puerto Rico | Foreign | |||||||||||||||
| 2017 | 2016 | 2017 | 2016 | |||||||||||||
| Plan assets at fair market value - beginning of year | $ | 389.4 | $ | 374.1 | $ | 507.0 | $ | 505.6 | ||||||||
| Actual return on plan assets | 58.2 | 29.5 | 42.7 | 34.1 | ||||||||||||
| Employer contributions | 1.8 | 5.8 | 16.5 | 15.9 | ||||||||||||
| Employee contributions | - | - | 17.0 | 23.6 | ||||||||||||
| Settlements | (0.9 | ) | (5.7 | ) | - | - | ||||||||||
| Plan amendments | - | - | - | - | ||||||||||||
| Benefits paid | (14.9 | ) | (14.3 | ) | (34.5 | ) | (31.6 | ) | ||||||||
| Expenses paid | - | - | (0.2 | ) | (0.2 | ) | ||||||||||
| Translation gain (loss) | - | - | 26.4 | (40.4 | ) | |||||||||||
| Plan assets at fair market value - end of year | $ | 433.6 | $ | 389.4 | $ | 574.9 | $ | 507.0 | ||||||||
| Funded status | $ | 12.9 | $ | 12.5 | $ | (48.7 | ) | $ | (61.6 | ) |
| For the Years Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| U.S. and Puerto Rico | Foreign | |||||||||||||||
| 2017 | 2016 | 2017 | 2016 | |||||||||||||
| Amounts recognized in consolidated balance sheet: | ||||||||||||||||
| Prepaid pension | $ | 22.8 | $ | 24.0 | $ | 14.9 | $ | 10.2 | ||||||||
| Short-term accrued benefit liability | (5.6 | ) | (0.4 | ) | (0.8 | ) | (0.7 | ) | ||||||||
| Long-term accrued benefit liability | (4.3 | ) | (11.1 | ) | (62.8 | ) | (71.1 | ) | ||||||||
| Net amount recognized | $ | 12.9 | $ | 12.5 | $ | (48.7 | ) | $ | (61.6 | ) |
We estimate the following amounts recorded as part of accumulated other comprehensive income will be recognized as part of our net pension expense during 2018 (in millions):
| U.S. and | ||||||||
|---|---|---|---|---|---|---|---|---|
| Puerto Rico | Foreign | |||||||
| Unrecognized prior service cost | $ | (5.7 | ) | $ | (4.2 | ) | ||
| Unrecognized actuarial loss | 22.1 | 2.6 | ||||||
| $ | 16.4 | $ | (1.6 | ) |
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, | ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| U.S. and Puerto Rico | Foreign | |||||||||||||||||||||||
| 2017 | 2016 | 2015 | 2017 | 2016 | 2015 | |||||||||||||||||||
| Discount rate | 3.78 | % | 4.32 | % | 4.36 | % | 1.27 | % | 1.41 | % | 1.86 | % | ||||||||||||
| Rate of compensation increase | 3.29 | % | 3.29 | % | 3.29 | % | 2.19 | % | 2.08 | % | 2.02 | % |
Plans with projected benefit obligations in excess of plan assets were as follows (in millions):
| As of December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| U.S. and Puerto Rico | Foreign | |||||||||||||||
| 2017 | 2016 | 2017 | 2016 | |||||||||||||
| Projected benefit obligation | $ | 55.1 | $ | 51.3 | $ | 598.8 | $ | 545.7 | ||||||||
| Plan assets at fair market value | 45.2 | 39.8 | 544.2 | 480.2 |
Total accumulated benefit obligations and plans with accumulated benefit obligations in excess of plan assets were as follows (in millions):
| As of December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| U.S. and Puerto Rico | Foreign | |||||||||||||||
| 2017 | 2016 | 2017 | 2016 | |||||||||||||
| Total accumulated benefit obligations | $ | 412.1 | $ | 364.8 | $ | 609.1 | $ | 556.4 | ||||||||
| Plans with accumulated benefit obligations in excess of plan assets: | ||||||||||||||||
| Accumulated benefit obligation | 54.7 | 32.0 | 417.4 | 530.1 | ||||||||||||
| Plan assets at fair market value | 45.2 | 21.8 | 375.5 | 475.3 |
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, | U.S. and Puerto Rico | Foreign | ||||||
|---|---|---|---|---|---|---|---|---|
| 2018 | $ | 22.5 | $ | 23.4 | ||||
| 2019 | 18.0 | 25.2 | ||||||
| 2020 | 19.2 | 24.6 | ||||||
| 2021 | 20.2 | 25.0 | ||||||
| 2022 | 21.7 | 27.0 | ||||||
| 2023-2027 | 119.6 | 133.7 |
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 30 to 65 percent for equity securities, 30 to 50 percent for debt securities and 5 to 15 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.
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, 2017 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fair Value Measurements at Reporting Date Using: | ||||||||||||||||
| Asset Category | Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Cash and cash equivalents | $ | 1.3 | $ | 1.3 | $ | - | $ | - | ||||||||
| Equity securities | 287.1 | - | 287.1 | - | ||||||||||||
| Intermediate fixed income securities | 145.2 | - | 145.2 | - | ||||||||||||
| Total | $ | 433.6 | $ | 1.3 | $ | 432.3 | $ | - |
| As of December 31, 2016 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fair Value Measurements at Reporting Date Using: | ||||||||||||||||
| Asset Category | Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Cash and cash equivalents | $ | 2.7 | $ | 2.7 | $ | - | $ | - | ||||||||
| Equity securities | 247.3 | - | 247.3 | - | ||||||||||||
| Intermediate fixed income securities | 139.4 | - | 139.4 | - | ||||||||||||
| Total | $ | 389.4 | $ | 2.7 | $ | 386.7 | $ | - |
The fair value of our foreign pension plan assets was as follows (in millions):
| As of December 31, 2017 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fair Value Measurements at Reporting Date Using: | ||||||||||||||||
| Asset Category | Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Cash and cash equivalents | $ | 31.8 | $ | 31.8 | $ | - | $ | - | ||||||||
| Equity securities | 161.6 | 157.6 | 4.0 | - | ||||||||||||
| Fixed income securities | 219.5 | - | 219.5 | - | ||||||||||||
| Other types of investments | 60.4 | - | 60.4 | - | ||||||||||||
| Real estate | 101.6 | - | 10.6 | 91.0 | ||||||||||||
| Total | $ | 574.9 | $ | 189.4 | $ | 294.5 | $ | 91.0 |
| As of December 31, 2016 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fair Value Measurements at Reporting Date Using: | ||||||||||||||||
| Asset Category | Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Cash and cash equivalents | $ | 37.8 | $ | 37.8 | $ | - | $ | - | ||||||||
| Equity securities | 144.7 | 141.3 | 3.4 | - | ||||||||||||
| Fixed income securities | 203.1 | - | 203.1 | - | ||||||||||||
| Other types of investments | 33.5 | - | 33.5 | - | ||||||||||||
| Real estate | 87.9 | - | 9.2 | 78.7 | ||||||||||||
| Total | $ | 507.0 | $ | 179.1 | $ | 249.2 | $ | 78.7 |
As of December 31, 2017 and 2016, our defined benefit pension plans’ assets did not hold any direct investment in Zimmer Biomet Holdings common stock.
Equity securities are valued using a market approach, based on quoted prices for the specific security from transactions in active exchange markets (Level 1), or in some cases where we are invested in mutual or collective funds, based upon the net asset value per unit of the fund which is determined from quoted market prices of the underlying securities in the fund’s portfolio (Level 2). Fixed income securities are valued using a market approach, based upon quoted prices for the specific security or from institutional bid evaluations. 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):
| December 31, 2017 | ||||
|---|---|---|---|---|
| Beginning Balance | $ | 78.7 | ||
| Gains on assets sold | 0.3 | |||
| Change in fair value of assets | 3.8 | |||
| Net purchases and sales | 5.2 | |||
| Translation gain | 3.0 | |||
| Ending Balance | $ | 91.0 |
We expect that we will have no legally required minimum funding requirements in 2018 for the qualified U.S. and Puerto Rico defined benefit retirement plans, nor do we expect to voluntarily contribute to these plans during 2018. Contributions to foreign defined benefit plans are estimated to be $17.0 million in 2018 . 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 $47.9 million, $42.5 million and $40.2 million related to these plans for the years ended December 31, 2017, 2016 and 2015, respectively.
| 15. | Income Taxes |
|---|
2017 Tax Act: The President signed U.S. tax reform legislation (“2017 Tax Act”) on December 22, 2017, which is considered the enactment date. The 2017 Tax Act includes a broad range of provisions, many of which significantly differ from those contained in previous U.S. tax law. Changes in tax law are accounted for in the period of enactment. As such, our 2017 consolidated financial statements reflect the immediate tax effect of the 2017 Tax Act.
The 2017 Tax Act contains several key provisions including, among other things:
| • | a one-time tax on the mandatory deemed repatriation of post-1986 untaxed foreign earnings and profits (E&P), referred to as the toll charge; |
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| • | a reduction in the corporate income tax rate from 35 percent to 21 percent for tax years beginning after December 31, 2017; |
|---|
| • | the introduction of a new U.S. tax on certain off-shore earnings referred to as global intangible low-taxed income (GILTI) at an effective tax rate of 10.5 percent for tax years beginning after December 31, 2017 (increasing to 13.125 percent for tax years beginning after December 31, 2025), with a partial offset by foreign tax credits; and |
|---|
| • | the introduction of a territorial tax system beginning in 2018 by providing a 100 percent dividend received deduction on certain qualified dividends from foreign subsidiaries. |
|---|
During the fourth quarter of 2017, we recorded an income tax benefit of $1,272.4 million, which was comprised of the following:
| • | income tax benefit of $715.0 million for the one-time deemed repatriation of foreign earnings. This is composed of a $1,181.0 million benefit from the removal of a deferred tax liability we had recorded for the repatriation of foreign earnings prior to the 2017 Tax Act offset by $466.0 million for the toll charge recognized under the 2017 Tax Act. In accordance with the 2017 Tax Act, we expect to elect to pay the toll charge in installments over eight years. As of December 31, 2017, we have recorded current and non-current income tax liabilities related to the toll charge of $82.0 million and $384.0 million, respectively. |
|---|
| • | an income tax benefit of $557.4 million, primarily related to the remeasurement of our deferred tax assets and liabilities at the enacted corporate income tax rate of 21 percent. |
|---|
The net benefit recorded was based on currently available information and interpretations made in applying the provisions of the 2017 Tax Act as of the time of filing this Annual Report on Form 10-K. We further refined our estimates related to the impact of the 2017 Tax Act subsequent to the issuance of our earnings release for the fourth quarter of 2017. In accordance with authoritative guidance issued by the SEC, the income tax effect for certain aspects of the 2017 Tax Act represent provisional amounts for which our accounting is incomplete, but with respect to which a reasonable estimate could be determined and recorded during the fourth quarter of 2017. The actual effects of the 2017 Tax Act and final amounts recorded may differ materially from our current estimate of provisional amounts due to, among other things, further interpretive guidance that may be issued by U.S. tax authorities or regulatory bodies, including the SEC and the FASB. We will continue to analyze the 2017 Tax Act and any additional guidance that may be issued so we can finalize the full effects of applying the new legislation on our financial statements in the measurement period, which ends in the fourth quarter of 2018.
We continue to evaluate the impacts of the 2017 Tax Act and consider the amounts recorded to be provisional. In addition, we are still evaluating the GILTI provisions of the 2017 Tax Act and their impact, if any, on our consolidated financial statements as of December 31, 2017. The FASB allows companies to adopt an accounting policy to either recognize deferred taxes for GILTI or treat such as a tax cost in the year incurred. We have not yet determined which accounting policy to adopt because determining the impact of the GILTI provisions requires analysis of our existing legal entity structure, the reversal of our U.S. GAAP and U.S. tax basis differences in the assets and liabilities of our foreign subsidiaries, and our ability to offset any tax with foreign tax credits. As such, we did not record a deferred income tax expense or benefit related to the GILTI provisions in our consolidated statement of earnings for the year ended December 31, 2017, and we plan to finalize this during the measurement period.
We recorded a provisional amount for the toll charge, which represents our reasonable estimate of the liability due for the one-time mandatory deemed repatriation of our post-1986 untaxed foreign E&P. Determining the provisional toll charge liability required a significant effort based on a number of factors including:
| • | analyzing our accumulated untaxed foreign E&P since 1986, including historical practices and assertions made in determining such E&P; |
|---|
| • | determining the composition, including intercompany receivables and payables of specified foreign corporations, of our post-1986 untaxed foreign E&P that is held in cash or liquid assets and other assets at several measurement dates, as a different tax rate is applied to each when determining the toll charge liability; |
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| • | assessing the potential impact of existing uncertain tax positions in determining our accumulated undistributed E&P; and |
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| • | assessing the impact of November 30 tax year end entities which have measurement dates into 2018. |
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For the aforementioned factors, as well as the proximity of the enactment of the 2017 Tax Act to our year-end, we had limited time to understand the 2017 Tax Act and its various interpretations (including any additional guidance issued through the time of filing this Annual Report on Form 10-K), to assess how to apply the new law to our specific facts and circumstances and determine the toll charge. These factors also contributed to the tax effects recorded being provisional amounts. In addition, we made certain assumptions in determining the provisional toll charge that may result in adjustments when we finalize our analysis and accounting for the 2017 Tax Act, which will include, but will not be limited to, the following:
| • | finalizing our analysis of our post-1986 untaxed foreign E&P; |
|---|
| • | finalizing the impact of November 30 tax year ends of certain entities, including 2018 results; |
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| • | finalizing our analysis as to the amounts and nature of, among other items, our intercompany transactions and balances as of various dates to determine the appropriate composition of our post-1986 untaxed E&P as either cash / liquid assets or other assets; and |
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| • | finalizing our analysis of the impacts on our accounting of the GILTI provisions of the 2017 Tax Act. |
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The components of earnings before income taxes consisted of the following (in millions):
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2017 | 2016 | 2015 | ||||||||||
| United States operations | $ | (114.0 | ) | $ | (251.8 | ) | $ | (246.2 | ) | |||
| Foreign operations | 578.6 | 651.4 | 399.4 | |||||||||
| Total | $ | 464.6 | $ | 399.6 | $ | 153.2 |
The provision/(benefit) for income taxes and the income taxes paid consisted of the following (in millions):
| Current: | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Federal | $ | 438.5 | $ | 134.2 | $ | 55.8 | ||||||
| State | 2.4 | 12.4 | 18.9 | |||||||||
| Foreign | (13.7 | ) | 101.6 | 96.3 | ||||||||
| 427.2 | 248.2 | 171.0 | ||||||||||
| Deferred: | ||||||||||||
| Federal | (1,728.5 | ) | (108.5 | ) | (120.6 | ) | ||||||
| State | (95.5 | ) | 2.3 | (20.0 | ) | |||||||
| Foreign | 48.0 | (47.0 | ) | (23.4 | ) | |||||||
| (1,776.0 | ) | (153.2 | ) | (164.0 | ) | |||||||
| (Benefit) provision for income taxes | $ | (1,348.8 | ) | $ | 95.0 | $ | 7.0 | |||||
| Income taxes paid | $ | 266.9 | $ | 269.6 | $ | 193.6 |
A reconciliation of the U.S. statutory income tax rate to our effective tax rate is as follows:
| For the Years Ended December 31, | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2017 | 2016 | 2015 | |||||||||||||
| U.S. statutory income tax rate | 35.0 | % | 35.0 | % | 35.0 | % | |||||||||
| State taxes, net of federal deduction | 1.8 | 2.0 | (1.7 | ) | |||||||||||
| Tax impact of foreign operations, including U.S. taxes on international income and foreign tax credits | (32.0 | ) | (11.0 | ) | (62.3 | ) | |||||||||
| Change in valuation allowance | 0.8 | - | (3.7 | ) | |||||||||||
| Non-deductible expenses | 2.7 | 0.9 | 2.4 | ||||||||||||
| Goodwill impairment | 22.5 | - | - | ||||||||||||
| Tax rate change | (24.0 | ) | - | - | |||||||||||
| Tax impact of certain significant transactions | - | 1.6 | 21.6 | ||||||||||||
| Tax benefit relating to U.S. manufacturer’s deduction | (1.7 | ) | (4.7 | ) | (6.2 | ) | |||||||||
| R&D tax credit | (1.2 | ) | (1.9 | ) | (4.2 | ) | |||||||||
| Share-based compensation | (2.6 | ) | (2.9 | ) | 1.1 | ||||||||||
| Net uncertain tax positions, including interest and penalties | (17.0 | ) | 4.2 | 22.9 | |||||||||||
| U.S. tax reform | (273.8 | ) | - | - | |||||||||||
| Other | (0.8 | ) | 0.6 | (0.3 | ) | ||||||||||
| Effective income tax rate | (290.3 | ) | % | 23.8 | % | 4.6 | % |
Our operations in Puerto Rico and Switzerland benefit from various tax incentive grants. These grants expire between fiscal years 2019 and 2029.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Valuation allowances are recorded to reduce deferred income tax assets when it is more likely than not that an income tax benefit will not be realized. As a result of the 2017 Tax Act, we recorded a provisional income tax benefit of $1,738.4 million, primarily related to the remeasurement of our deferred tax assets and liabilities at the enacted corporate income tax rate of 21 percent and the removal of the deferred tax liability for repatriation of foreign earnings due to the toll charge provisions.
The components of deferred taxes consisted of the following (in millions):
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2017 | 2016 | |||||||
| Deferred tax assets: | ||||||||
| Inventory | $ | 246.8 | $ | 260.3 | ||||
| Net operating loss carryover | 165.1 | 181.3 | ||||||
| Tax credit carryover | 163.8 | 110.4 | ||||||
| Capital loss carryover | 6.9 | 2.3 | ||||||
| Accrued liabilities | 102.5 | 182.2 | ||||||
| Share-based compensation | 26.8 | 60.3 | ||||||
| Accounts receivable | 17.3 | 22.3 | ||||||
| Other | 84.9 | 101.9 | ||||||
| Total deferred tax assets | 814.1 | 921.0 | ||||||
| Less: Valuation allowances | (140.6 | ) | (88.3 | ) | ||||
| Total deferred tax assets after valuation allowances | 673.5 | 832.7 | ||||||
| Deferred tax liabilities: | ||||||||
| Fixed assets | $ | 85.6 | $ | 138.7 | ||||
| Intangible assets | 1,423.0 | 2,343.7 | ||||||
| Unremitted earnings of foreign subsidiaries | - | 1,159.4 | ||||||
| Other | 18.2 | - | ||||||
| Total deferred tax liabilities | 1,526.8 | 3,641.8 | ||||||
| Total net deferred income taxes | $ | (853.3 | ) | $ | (2,809.1 | ) |
Net operating loss carryovers are available to reduce future federal, state and foreign taxable earnings. At December 31, 2017, $107.4 million of these net operating loss carryovers generally expire within a period of 1 to 20 years and $57.7 million of these net operating loss carryovers have an indefinite life. Valuation allowances for net operating loss carryovers have been established in the amount of $105.0 million and $70.8 million at December 31, 2017 and 2016, respectively.
Deferred tax assets related to tax credit carryovers are available to offset future federal, state and foreign tax liabilities. At December 31, 2017, $163.7 million of these tax credit carryovers generally expire within a period of 1 to 19 years and $0.1 million of these tax credit carryovers have an indefinite life. Valuation allowances for certain tax credit carryovers have been established in the amount of $18.5 million and $11.9 million at December 31, 2017 and 2016, respectively.
Deferred tax assets related to capital loss carryovers are also available to reduce future federal and foreign capital gains. At December 31, 2017, $2.7 million of these capital loss carryovers generally expire within a period of 1 to 4 years and $4.2 million of these capital loss carryovers have an indefinite life. Valuation allowances for certain capital loss carryovers have been established in the amount of $5.5 million and $0.2 million at December 31, 2017 and 2016, respectively. The remaining valuation allowances booked against deferred tax assets of $11.6 million and $5.4 million at December 31, 2017 and 2016, respectively, relate primarily to accrued liabilities and intangible assets that management believes, more likely than not, will not be realized.
Many of our operations are conducted outside the United States. Under the 2017 Tax Act, a company’s post-1986 previously untaxed foreign E&P are mandatorily deemed to be repatriated and taxed, which is also referred to as the toll charge. The toll charge is assessed regardless of whether or not a company has cash in its foreign subsidiaries. In prior years, we recorded U.S. deferred tax liabilities of $1,159.4 million for certain offshore earnings that were expected to be remitted to our domestic operations. These deferred tax liabilities reduced the income tax expense recorded in the fourth quarter of 2017 for the toll charge. We intend to repatriate at least $3.6 billion of unremitted earnings, in line with our prior year assertion. The remaining amounts earned overseas were expected to be permanently reinvested outside of the United States, and therefore, no accrual for U.S. taxes was recorded. We continue to evaluate our assertions on any remaining outside basis differences in our foreign subsidiaries as of December 31, 2017 and have not completed our analysis. In accordance with authoritative guidance issued by the SEC, we expect to finalize our accounting related to the toll charge and any remaining outside basis differences in our foreign subsidiaries during later periods as we complete our analysis, computations and assertions.
The following is a tabular reconciliation of the total amounts of unrecognized tax benefits (in millions):
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2017 | 2016 | 2015 | ||||||||||
| Balance at January 1 | $ | 649.3 | $ | 591.9 | $ | 321.7 | ||||||
| Increases related to business combinations | 70.2 | 70.2 | 247.6 | |||||||||
| Increases related to prior periods | 172.8 | 36.7 | 1.3 | |||||||||
| Decreases related to prior periods | (262.2 | ) | (94.7 | ) | - | |||||||
| Increases related to current period | 24.8 | 53.0 | 25.7 | |||||||||
| Decreases related to settlements with taxing authorities | (21.7 | ) | (3.2 | ) | (1.4 | ) | ||||||
| Decreases related to lapse of statute of limitations | (6.4 | ) | (4.6 | ) | (3.0 | ) | ||||||
| Balance at December 31 | $ | 626.8 | $ | 649.3 | $ | 591.9 | ||||||
| Amounts impacting effective tax rate, if recognized balance at December 31 | $ | 499.6 | $ | 511.5 | $ | 443.7 |
We recognize accrued interest and penalties related to unrecognized tax benefits as income tax expense. During 2017, we released interest and penalties of $38.3 million, and as of December 31, 2017, had a recognized liability for interest and penalties of $75.7 million, which included an increase of $3.0 million from December 31, 2016 related to business combinations.
During 2016, we accrued interest and penalties of $19.3 million, and as of December 31, 2016, had recognized a liability for interest and penalties of $110.8 million, which included an $8.6 million increase from December 31, 2015 related to the Biomet merger. During 2015, we accrued interest and penalties of $4.8 million, and as of
December 31, 2015, had recognized a liability for interest and penalties of $82.9 million, which included an increase of $29.8 million from December 31, 2014 related to the Biomet merger.
We operate on a global basis and are subject to numerous and complex tax laws and regulations. Additionally, tax laws have and continue to undergo rapid changes in both application and interpretation by various countries, including state aid interpretations and the Organization for Economic Cooperation and Development led initiatives. Our income tax filings are subject to examinations by taxing authorities throughout the world. 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. Although ultimate timing is uncertain, 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. Management’s best estimate of such change is within the range of a $115 million decrease to a $25 million increase.
Our U.S. Federal income tax returns have been audited through 2009 and are currently under audit for years 2010-2015. The IRS has proposed adjustments for years 2005-2012, reallocating profits between certain of our U.S. and foreign subsidiaries. We have disputed these adjustments and intend to continue to vigorously defend our positions. For years 2005-2007, we have filed a petition with the U.S. Tax Court. For years 2008-2009, we are pursuing resolution through the IRS Administrative Appeals Process.
State income tax returns are generally subject to examination for a period of 3 to 5 years after filing of the respective return. The state impact of any federal changes generally remains subject to examination by various states for a period of up to one year after formal notification to the states. We have various state income tax return positions in the process of examination, administrative appeals or litigation.
In other major jurisdictions, open years are generally 2009 or later.
| 16. | Capital Stock and Earnings per Share |
|---|
We are authorized to issue 250.0 million shares of preferred stock, none of which were issued or outstanding as of December 31, 2017.
The numerator for both basic and diluted earnings per share is net earnings available to common stockholders. The denominator for basic earnings per share is the weighted average number of common shares outstanding during the period. The denominator for diluted earnings per share is weighted average shares outstanding adjusted for the effect of dilutive stock options and other equity awards. The following is a reconciliation of weighted average shares for the basic and diluted share computations (in millions):
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2017 | 2016 | 2015 | ||||||||||
| Weighted average shares outstanding for basic net earnings per share | 201.9 | 200.0 | 187.4 | |||||||||
| Effect of dilutive stock options and other equity awards | 1.8 | 2.4 | 2.4 | |||||||||
| Weighted average shares outstanding for diluted net earnings per share | 203.7 | 202.4 | 189.8 |
For the years ended December 31, 2017, 2016 and 2015, an average of 1.0 million, 0.9 million and 0.5 million options, respectively, to purchase shares of common stock were not included in the computation of diluted earnings per share as the exercise prices of these options were greater than the average market price of the common stock.
During 2016, we repurchased 4.2 million shares of our common stock at an average price of $98.50 per share for a total cash outlay of $415.5 million, including commissions.
| 17. | Segment Data |
|---|
We design, manufacture and market orthopaedic reconstructive products; sports medicine, biologics, extremities and trauma products; spine, craniomaxillofacial and thoracic products (“CMF”); office based technologies; dental implants; and related surgical products. We allocate resources to achieve our operating profit goals through seven operating segments. Our operating segments are comprised of both geographic and product category business units.
The geographic operating segments are the Americas, which is comprised principally of the U.S. and includes other North, Central and South American markets; EMEA, which is comprised principally of Europe and includes the Middle East and African markets; and Asia Pacific, which is comprised primarily of Japan, China and Australia and includes other Asian and Pacific markets. The product category operating segments are Spine, Office Based Technologies, CMF and Dental. The geographic operating segments include results from all of our product categories except those in the product category operating segments. The Office Based Technologies, CMF and Dental product category operating segments reflect those respective product category results from all regions, whereas the Spine product category operating segment includes all spine product results excluding those from Asia Pacific.
As it relates to the geographic operating segments, we evaluate performance based upon segment operating profit exclusive of operating expenses pertaining to inventory step-up and certain other inventory and manufacturing related charges, “Certain claims,” goodwill impairment, intangible asset amortization, “Special items,” and global operations and corporate functions. Global operations and corporate functions include research, development engineering, medical education, brand management, corporate legal, finance and human resource functions, manufacturing operations and logistics and share-based payment expense. As it relates to each product category operating segment, research, development engineering, medical education, brand management and other various costs that are specific to the product category operating segment’s operations are reflected in its operating profit results. Due to these additional costs included in the product category operating segments, profitability metrics among the geographic operating segments and product category operating segments are not comparable. Intercompany transactions have been eliminated from segment operating profit.
We do not review asset information by operating segment. Instead, we review cash flow and other financial ratios by operating segment.
These seven operating segments are the basis for our reportable segment information provided below. The four product category operating segments are individually insignificant to our consolidated results and therefore do not constitute a reporting segment either individually or combined. For presentation purposes, these product category operating segments have been aggregated. In 2017, due to a change in management responsibilities, the sales and operating profit results of our spine business in EMEA were combined with the previous Americas Spine operating segment to form the product category operating segment, Spine. Prior period reportable segment financial information has been restated to conform to the current presentation.
Net sales and other information by segment is as follows (in millions):
| Americas | EMEA | Asia Pacific | Immaterial Product Category Operating Segments | Global Operations and Corporate Functions | Total | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| For the Year Ended December 31, 2017 | ||||||||||||||||||||||||
| Net sales | $ | 3,951.1 | $ | 1,522.1 | $ | 1,158.3 | $ | 1,192.6 | $ | - | $ | 7,824.1 | ||||||||||||
| Depreciation and amortization | 127.5 | 68.5 | 58.2 | 45.6 | 762.9 | 1,062.7 | ||||||||||||||||||
| Segment operating profit | 2,126.8 | 481.7 | 420.8 | 272.9 | (867.7 | ) | 2,434.5 | |||||||||||||||||
| Inventory step-up and certain other inventory and manufacturing related charges | (84.6 | ) | ||||||||||||||||||||||
| Intangible asset amortization | (603.9 | ) | ||||||||||||||||||||||
| Goodwill impairment | (304.7 | ) | ||||||||||||||||||||||
| Special items | ||||||||||||||||||||||||
| Biomet merger related | (248.0 | ) | ||||||||||||||||||||||
| Other special items | (385.1 | ) | ||||||||||||||||||||||
| Operating profit | 808.2 | |||||||||||||||||||||||
| For the Year Ended December 31, 2016 | ||||||||||||||||||||||||
| Net sales | $ | 3,947.1 | $ | 1,508.9 | $ | 1,095.6 | $ | 1,132.3 | $ | - | $ | 7,683.9 | ||||||||||||
| Depreciation and amortization | 135.4 | 68.8 | 51.7 | 37.8 | 745.6 | 1,039.3 | ||||||||||||||||||
| Segment operating profit | 2,132.7 | 482.4 | 432.1 | 264.5 | (839.0 | ) | 2,472.7 | |||||||||||||||||
| Inventory step-up and certain other inventory and manufacturing related charges | (469.1 | ) | ||||||||||||||||||||||
| Intangible asset amortization | (565.9 | ) | ||||||||||||||||||||||
| Special items | ||||||||||||||||||||||||
| Biomet merger related | (487.3 | ) | ||||||||||||||||||||||
| Other special items | (124.5 | ) | ||||||||||||||||||||||
| Operating profit | 825.9 | |||||||||||||||||||||||
| For the Year Ended December 31, 2015 | ||||||||||||||||||||||||
| Net sales | $ | 3,107.8 | $ | 1,250.7 | $ | 881.6 | $ | 757.7 | $ | - | $ | 5,997.8 | ||||||||||||
| Depreciation and amortization | 109.9 | 41.1 | 37.9 | 24.6 | 498.9 | 712.4 | ||||||||||||||||||
| Segment operating profit | 1,633.6 | 423.6 | 422.2 | 179.2 | (665.6 | ) | 1,993.0 | |||||||||||||||||
| Inventory step-up and certain other inventory and manufacturing related charges | (348.8 | ) | ||||||||||||||||||||||
| Intangible asset amortization | (337.4 | ) | ||||||||||||||||||||||
| Special items | ||||||||||||||||||||||||
| Biomet merger related | (619.1 | ) | ||||||||||||||||||||||
| Other special items | (220.4 | ) | ||||||||||||||||||||||
| Operating profit | 467.3 |
We conduct business in the following countries that hold 10 percent or more of our total consolidated Property, plant and equipment, net (in millions):
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2017 | 2016 | |||||||
| United States | $ | 1,151.6 | $ | 1,181.3 | ||||
| Other countries | 887.0 | 856.6 | ||||||
| Property, plant and equipment, net | $ | 2,038.6 | $ | 2,037.9 |
U.S. sales were $4,603.1 million, $4,541.3 million, and $3,447.2 million for the years ended December 31, 2017, 2016 and 2015, respectively. Sales within any other individual country were less than 10 percent of our consolidated sales in each of those years. Sales are attributable to a country based upon the customer's country of domicile.
Net sales by product category are as follows (in millions):
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2017 | 2016 | 2015 | ||||||||||
| Knees | $ | 2,737.1 | $ | 2,752.6 | $ | 2,276.8 | ||||||
| Hips | 1,879.1 | 1,867.9 | 1,533.0 | |||||||||
| S.E.T | 1,709.1 | 1,644.4 | 1,214.6 | |||||||||
| Dental | 418.6 | 427.9 | 335.7 | |||||||||
| Spine & CMF | 759.5 | 662.0 | 404.4 | |||||||||
| Other | 320.7 | 329.1 | 233.3 | |||||||||
| Total | $ | 7,824.1 | $ | 7,683.9 | $ | 5,997.8 |
| 18. | Leases |
|---|
Total rent expense for the years ended December 31, 2017, 2016 and 2015 aggregated $87.2 million, $74.0 million, and $60.1 million, respectively.
Future minimum rental commitments under non-cancelable operating leases in effect as of December 31, 2017 were (in millions):
| For the Years Ending December 31, | ||||
|---|---|---|---|---|
| 2018 | $ | 66.7 | ||
| 2019 | 54.2 | |||
| 2020 | 45.8 | |||
| 2021 | 35.8 | |||
| 2022 | 26.9 | |||
| Thereafter | 81.9 |
| 19. | Commitments and Contingencies |
|---|
On a quarterly and annual basis, we review relevant information with respect to loss contingencies and update our accruals, disclosures and estimates of reasonably possible losses or ranges of loss based on such reviews. We establish liabilities for loss contingencies when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. For matters where a loss is believed to be reasonably possible, but not probable, no accrual has been made.
Litigation
Durom® Cup-related claims: On July 22, 2008, we temporarily suspended marketing and distribution of the Durom Cup in the U.S. Subsequently, a number of product liability lawsuits were filed against us in various U.S. and foreign jurisdictions. The plaintiffs seek damages for personal injury, and they generally allege that the Durom Cup contains defects that result in complications and premature revision of the device. We have settled some of these claims and others are still pending. The majority of the pending U.S. lawsuits are currently in an 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.). The initial trial in Santas took place in November 2014, the initial trial in the MDL took place in May 2015 and the initial trial in McAllister took place in July 2015. As of December 31, 2017, litigation activity in the MDL, Santas and McAllister is stayed to allow participation in the U.S. Durom Cup Settlement Program, an extrajudicial program created to resolve actions and claims of eligible U.S. plaintiffs and claimants. Other lawsuits are pending in various domestic and foreign jurisdictions, and additional claims may be asserted in the future. The majority of claims outside the U.S. are pending in Canada, Germany, Netherlands, Italy and the UK. A Canadian class settlement was approved in late 2016. Trials have commenced in Germany, and the majority of claims in the UK are consolidated in a Group Litigation Order.
Since 2008, we have recognized expense of $489.7 million for Durom Cup-related claims. Our estimate of our total liability for these claims as of December 31, 2017 remains generally consistent with our estimate as of December 31, 2016. We recognized $10.3 million and $7.7 million in expense for Durom Cup-related claims in 2017 and 2015, respectively, with no expense recorded in 2016.
We maintain insurance for product liability claims, subject to self-insurance retention requirements. We have recovered insurance proceeds from certain of our insurance carriers for Durom Cup-related claims. While we may recover additional insurance proceeds in the future for Durom Cup-related claims, we do not have a receivable recorded on our consolidated balance sheet as of December 31, 2017 for any possible future insurance recoveries for these claims.
Our estimate as of December 31, 2017 of the remaining liability for all Durom Cup-related claims is $199.4 million, of which $78.0 million is classified as short-term in “Other current liabilities” and $121.4 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. Although we are vigorously defending these lawsuits, their ultimate resolution is uncertain.
Margo and Daniel Polett v. Zimmer, Inc. et al.: On August 20, 2008, Margo and Daniel Polett filed an action against us and an unrelated third party, Public Communications, Inc. (“PCI”), in the Court of Common Pleas, Philadelphia, Pennsylvania seeking an unspecified amount of damages for injuries and loss of consortium allegedly suffered by Mrs. Polett and her spouse, respectively. The complaint alleged that defendants were negligent in connection with Mrs. Polett’s participation in a promotional video featuring one of our knee products. The case was tried in November 2010 and the jury returned a verdict in favor of plaintiffs. The jury awarded $27.6 million in compensatory damages and apportioned fault 30 percent to plaintiffs, 34 percent to us and 36 percent to PCI. Under applicable law, we may be liable for any portion of the damages apportioned to PCI that it does not pay. On December 2, 2010, we and PCI filed a motion for post-trial relief seeking a judgment notwithstanding the verdict, a new trial or a remittitur. On June 10, 2011, the trial court entered an order denying our motion for post-trial relief and affirming the jury verdict in full and entered judgment for $20.3 million against us and PCI. On June 29, 2011, we filed a notice of appeal to the Superior Court of Pennsylvania and posted a bond for the verdict amount plus interest. Oral argument before the appellate court in Philadelphia, Pennsylvania was held on March 13, 2012. On March 1, 2013, the Superior Court of Pennsylvania vacated the $27.6 million judgment and remanded the case for a new trial. On March 15, 2013, plaintiffs filed a motion for re-argument en banc, and on March 28, 2013, we filed our response in opposition. On May 9, 2013, the Superior Court of Pennsylvania granted plaintiffs’ motion for re-argument en banc. Oral argument (re-argument en banc) before the Superior Court of Pennsylvania was held on October 16, 2013. On December 20, 2013, the Court issued its opinion again vacating the trial court judgment and remanding the case for a new trial. On January 21, 2014, plaintiffs filed a petition for allowance of appeal in the Supreme Court of Pennsylvania, which was granted on May 21, 2014. Oral argument before the Supreme Court of Pennsylvania took place on October 8, 2014. On October 27, 2015, the Supreme Court of Pennsylvania reversed the order of the Superior Court of Pennsylvania and remanded the case to that court to consider the question of whether the trial court erred in refusing to remit the jury’s compensatory damages award. On June 6, 2016, an en banc panel of the Superior Court of Pennsylvania vacated the $27.6 million verdict and remanded the case back to the trial court for remittitur. On December 2, 2016, the trial court remitted the verdict to $21.5 million, which, after being molded to reduce for plaintiffs’ comparative negligence, totals approximately $15.8 million. On December 5, 2016, we filed a notice of appeal to the Superior Court of Pennsylvania. Oral argument before the Superior Court of Pennsylvania took place on September 20, 2017, and on December 15, 2017, the Superior Court of Pennsylvania issued its decision affirming the $21.5 million remitted award. We subsequently filed a motion for re-argument en banc on December 29, 2017, which motion was denied without opinion on February 12, 2018. While we are considering further appellate options, including appeal to the Pennsylvania Supreme Court, we have recorded a charge for the approximately $15.8 million remitted and molded verdict, plus post-judgment interest from the date of verdict in 2010.
NexGen® Knee System claims: Following a wide-spread advertising campaign conducted by certain law firms beginning in 2010, a number of product liability lawsuits have been filed against us in various jurisdictions. The plaintiffs seek damages for personal injury, alleging that certain products within the NexGen Knee System, specifically the NexGen Flex Femoral Components and MIS Stemmed Tibial Component, suffer from defects that cause them to loosen prematurely. The majority of the cases are currently pending in a federal MDL in the Northern District of Illinois (In Re: Zimmer NexGen Knee Implant Products Liability Litigation). Other cases are pending in various state courts, and additional lawsuits may be filed. Thus far, all cases decided by the MDL court or a jury on the merits have involved NexGen Flex Femoral Components, which represent the majority of cases in the MDL.
The initial bellwether trial took place in October 2015 and resulted in a defense verdict. The next scheduled bellwether trial, which was set to commence in November 2016, was dismissed following the court’s grant of summary judgment in our favor in October 2016. The second bellwether trial took place in January 2017 and resulted in a defense verdict. The parties attended a court-ordered mediation in January 2018. Although we are vigorously defending these lawsuits, their ultimate resolution is uncertain.
Biomet metal-on-metal hip implant claims: Biomet is a defendant in a number of product liability lawsuits relating to metal-on-metal hip implants. The majority of these cases involve the M2a-MagnumTM hip system. The majority of the cases are currently consolidated in one federal MDL proceeding in the U.S. District Court for the Northern District of Indiana (In Re: Biomet M2a Magnum Hip Implant Product Liability Litigation). Other cases are pending in various state and foreign courts.
On February 3, 2014, Biomet announced the settlement of the MDL. Lawsuits filed in the MDL by April 15, 2014 were eligible to participate in the settlement. Those claims that did not settle via the MDL settlement program have re-commenced litigation in the MDL under a new case management plan. The settlement does not affect certain other claims relating to Biomet’s metal-on-metal hip products that are pending in various state and foreign courts, or other claims that may be filed in the future. Our estimate as of December 31, 2017 of the remaining liability for all Biomet metal-on-metal hip implant claims is $36.0 million.
Biomet has exhausted the self-insured retention in its insurance program and has been reimbursed for claims related to its metal-on-metal products up to its policy limits in the program. Zimmer Biomet is responsible for any amounts by which the ultimate losses exceed the amount of Biomet’s third-party insurance coverage. As of December 31, 2017, Biomet had received all of the insurance proceeds it expects to recover under the excess policies. Although we are vigorously defending these lawsuits, their ultimate resolution is uncertain.
Heraeus trade secret misappropriation lawsuits: In December 2008, Heraeus Kulzer GmbH (together with its affiliates, “Heraeus”) initiated legal proceedings in Germany against Biomet, Inc., Biomet Europe BV, certain other entities and certain employees alleging that the defendants misappropriated Heraeus trade secrets when developing Biomet Europe’s Refobacin and Biomet Bone Cement line of cements (“European Cements”). The lawsuit sought to preclude the defendants from producing, marketing and offering for sale their current line of European Cements and to compensate Heraeus for any damages incurred.
On June 5, 2014, the German appeals court in Frankfurt (i) enjoined Biomet, Inc., Biomet Europe BV and Biomet Deutschland GmbH from manufacturing, selling or offering the European Cements to the extent they contain certain raw materials in particular specifications; (ii) held the defendants jointly and severally liable to Heraeus for any damages from the sale of European Cements since 2005; and (iii) ruled that no further review may be sought (the “Frankfurt Decision”). The Heraeus and Biomet parties both sought appeal against the Frankfurt Decision. In a decision dated June 16, 2016, the German Supreme Court dismissed the parties’ appeals without reaching the merits, rendering that decision final.
In December 2016, Heraeus filed papers to restart proceedings against Biomet Orthopaedics Switzerland GmbH, seeking to require that entity to relinquish its CE certificates for the European Cements. In January 2017, Heraeus notified Biomet it had filed a claim for damages in the amount of €121.9 million for sales in Germany. In September 2017, Heraeus filed an enforcement action in the Frankfurt court against Biomet Europe, requesting that a fine be imposed against Biomet Europe for failure to prevent Biomet Orthopaedics Switzerland from having bone cements for the Chinese market manufactured in Germany. Also in September 2017, Heraeus filed suit against Zimmer Biomet Deutschland in the court of first instance in Freiberg concerning the sale of the European Cements with certain changed raw materials. Heraeus seeks an injunction on the basis that the continued use of the product names for the European Cements is misleading for customers and thus an act of unfair competition. As of December 31, 2017, these claims were still pending.
On September 8, 2014, Heraeus filed a complaint against a Biomet supplier, Esschem, Inc. (“Esschem”), in the United States District Court for the Eastern District of Pennsylvania. The lawsuit contained allegations that focused on two copolymer compounds that Esschem sells to Biomet, which Biomet incorporates into certain bone cement products that compete with Heraeus’ bone cement products. The complaint alleged that Biomet helped Esschem to develop these copolymers, using Heraeus trade secrets that Biomet allegedly misappropriated. The complaint asserted a claim under the Pennsylvania Trade Secrets Act, as well as other various common law tort claims, all based upon the same trade secret misappropriation theory. Heraeus sought to enjoin Esschem from supplying the copolymers to any third party and actual damages. The complaint also sought punitive damages, costs and attorneys’ fees. Although Biomet was not a party to this lawsuit, Biomet agreed, at Esschem’s request and subject to certain limitations, to indemnify Esschem for any liability, damages and legal costs related to this matter. On November 3, 2014, the court entered an order denying Heraeus’ motion for a temporary restraining order. On June 30, 2016, the court entered an order denying Heraeus’ request to give preclusive effect to the factual findings in the
Frankfurt Decision. On June 6, 2017, the court entered an order denying Heraeus’ motion to add Biomet as a party to the lawsuit. On January 26, 2018, the court entered an order granting Esschem’s motion for summary judgment and dismissed all of Heraeus’ claims with prejudice.
Heraeus continues to pursue other related legal proceedings in Europe seeking various forms of relief, including injunctive relief and damages, against Biomet-related entities relating to the European Cements.
We have accrued an estimated loss relating to the Frankfurt Decision, but have not recognized any losses for Heraeus-related lawsuits in other jurisdictions because we do not believe it is probable that we have incurred a liability, and we cannot reasonably estimate any loss that might eventually be incurred. Damages relating to the Frankfurt Decision are subject to separate proceedings and it is reasonably possible that our estimate of the loss we may incur may change in the future. Although we are vigorously defending these lawsuits, their ultimate resolution is uncertain.
Stryker patent infringement lawsuit: On December 10, 2010, Stryker Corporation and related entities (“Stryker”) filed suit against us in the U.S. District Court for the Western District of Michigan, alleging that certain of our Pulsavac® Plus Wound Debridement Products infringe three U.S. patents assigned to Stryker. The case was tried beginning on January 15, 2013, and on February 5, 2013, the jury found that we infringed certain claims of the subject patents. The jury awarded $70.0 million in monetary damages for lost profits. The jury also found that we willfully infringed the subject patents. We filed multiple post-trial motions, including a motion seeking a new trial. On August 7, 2013, the trial court issued a ruling denying all of our motions and awarded treble damages and attorneys’ fees to Stryker. We filed a notice of appeal to the Court of Appeals for the Federal Circuit to seek reversal of both the jury’s verdict and the trial court’s rulings on our post-trial motions. Oral argument before the Court of Appeals for the Federal Circuit took place on September 8, 2014. On December 19, 2014, the Federal Circuit issued a decision affirming the $70.0 million lost profits award but reversed the willfulness finding, vacating the treble damages award and vacating and remanding the attorneys’ fees award. We accrued an estimated loss of $70.0 million related to this matter in the three month period ended December 31, 2014. On January 20, 2015, Stryker filed a motion with the Federal Circuit for a rehearing en banc. On March 23, 2015, the Federal Circuit denied Stryker’s petition. Stryker subsequently filed a petition for certiorari to the U.S. Supreme Court. In July 2015, we paid the final award of $90.3 million, which includes the original $70.0 million plus pre- and post-judgment interest and damages for sales that occurred post-trial but prior to our entry into a license agreement with Stryker. On October 19, 2015, the U.S. Supreme Court granted Stryker’s petition for certiorari. Oral argument took place on February 23, 2016. On June 13, 2016, the U.S. Supreme Court issued its decision, vacating the judgment of the Federal Circuit and remanding the case for further proceedings related to the willfulness issue. On September 12, 2016, the Federal Circuit issued an opinion affirming the jury’s willfulness finding and vacating and remanding the trial court’s award of treble damages, its finding that this was an exceptional case and its award of attorneys’ fees. The case was remanded back to the trial court. Oral argument on Stryker’s renewed consolidated motion for enhanced damages and attorneys’ fees took place on June 28, 2017. On July 12, 2017, the trial court issued an order reaffirming its award of treble damages, its finding that this was an exceptional case and its award of attorney’s fees. On July 24, 2017, we appealed the ruling to the Federal Circuit and obtained a supersedeas bond staying enforcement of the judgment pending appeal. Although we are defending this lawsuit vigorously, the ultimate resolution of this matter is uncertain. In the future, we could be required to record a charge of up to $165.0 million that could have a material adverse effect on our results of operations and cash flows.
Putative Class Action: On December 2, 2016, a complaint was filed in the U.S. District Court for the Northern District of Indiana (Shah v. Zimmer Biomet Holdings, Inc. et al.), naming us, two of our officers and one of our now former officers as defendants. On June 28, 2017, the plaintiffs filed a corrected amended complaint, naming as defendants, in addition to those previously named, current and former members of our Board of Directors, one additional officer, and the underwriters in connection with secondary offerings of our common stock by certain selling stockholders in 2016. On October 6, 2017, the plaintiffs voluntarily dismissed the underwriters without prejudice. On October 8, 2017, the plaintiffs filed a second amended complaint, naming as defendants, in addition to those current and former officers and Board members previously named, certain former stockholders of ours who sold shares of our common stock in secondary public offerings in 2016. The second amended complaint relates to a putative class action on behalf of persons who purchased our common stock between June 7, 2016 and November 7, 2016. The second amended complaint alleges that the defendants violated federal securities laws by making materially false and/or misleading statements and/or omissions about our compliance with FDA regulations and our ability to continue to accelerate our organic revenue growth rate in the second half of 2016. The defendants filed their respective motions to dismiss on December 20, 2017. The plaintiffs seek unspecified damages and interest, attorneys’ fees, costs and other relief. We believe this lawsuit is without merit, and we and the individual defendants are defending it vigorously.
Regulatory Matters, Government Investigations and Other Matters
FDA warning letters: In September 2012, Zimmer received a warning letter from the FDA citing concerns relating to certain processes pertaining to products manufactured at our Ponce, Puerto Rico manufacturing facility. In May 2016, Zimmer received a warning letter from the FDA related to observed non-conformities with current good manufacturing practice requirements of the FDA’s Quality System Regulation (21 CFR Part 820) at our facility in Montreal, Quebec, Canada. We have provided detailed responses to the FDA as to our corrective actions and will continue to work expeditiously to address the issues identified by the FDA during inspections in Ponce and Montreal. As of December 31, 2017, these warning letters remained pending. Until the violations cited in the pending warning letters are corrected, we may be subject to additional regulatory action by the FDA, as described more fully below. Additionally, requests for Certificates to Foreign Governments related to products manufactured at certain of our facilities may not be granted and premarket approval applications for Class III devices to which the Quality System Regulation deviations at these facilities are reasonably related will not be approved until the violations have been corrected. In addition to responding to the warning letters described above, we are in the process of addressing various FDA Form 483 inspectional observations at certain of our manufacturing facilities, including at both the legacy Zimmer and the legacy Biomet manufacturing facilities in Warsaw, Indiana. The ultimate outcome of these matters is presently uncertain. Among other available regulatory actions, the FDA may impose operating restrictions, including a ceasing of operations, at one or more facilities, enjoining and restraining certain violations of applicable law pertaining to medical devices and assessing civil or criminal penalties against our officers, employees or us. The FDA could also issue a corporate warning letter, a recidivist warning letter or a consent decree of permanent injunction. The FDA may also recommend prosecution by the DOJ. Any adverse regulatory action, depending on its magnitude, may restrict us from effectively manufacturing, marketing and selling our products and could have a material adverse effect on our business, financial condition and results of operations.
DPA relating to FCPA matters: On January 12, 2017, we resolved previously-disclosed FCPA matters involving Biomet and certain of its subsidiaries. As part of the settlement, Biomet resolved matters with the SEC through an administrative cease-and-desist order (the “Order”); (ii) we entered into a DPA with the DOJ; and (iii) JERDS Luxembourg Holding S.à r.l. (“JERDS”), the direct parent company of Biomet 3i Mexico SA de CV and an indirect, wholly-owned subsidiary of Biomet, entered into a plea agreement (the “Plea Agreement”) with the DOJ. The conduct underlying these resolutions occurred prior to our acquisition of Biomet.
Pursuant to the terms of the Order, Biomet resolved claims with the SEC related to violations of the books and records, internal controls and anti-bribery provisions of the FCPA by disgorging profits to the U.S. government in an aggregate amount of approximately $6.5 million, inclusive of pre-judgment interest, and paying a civil penalty in the amount of $6.5 million (collectively, the “Civil Settlement Payments”). We also agreed to pay a criminal penalty of approximately $17.5 million (together with the Civil Settlement Payments, the “Settlement Payments”) to the U.S. government pursuant to the terms of the DPA. We made the Settlement Payments in January 2017 and, as previously disclosed, had accrued, as of June 24, 2015, the closing date of the Biomet merger, an amount sufficient to cover this matter.
Under the DPA, which has a term of three years, the DOJ agreed to defer criminal prosecution of us in connection with the charged violation of the internal controls provision of the FCPA as long as we comply with the terms of the DPA. In addition, we will be subject to oversight by an independent compliance monitor for at least 12 months. The monitor, who was appointed effective as of July 2017, will focus on legacy Biomet operations as integrated into our operations. If we remain in compliance with the DPA during its term, the charges against us will be dismissed with prejudice. The term of the DPA may be extended for up to one additional year at the DOJ’s discretion. In addition, under its Plea Agreement with the DOJ, JERDS pleaded guilty on January 13, 2017 to aiding and abetting a violation of the books and records provision of the FCPA. In light of the DPA we entered into, JERDS paid only a nominal assessment and no criminal penalty.
If we do not comply with the terms of the DPA, we could be subject to prosecution for violating the internal controls provisions of the FCPA and the conduct of Biomet and its subsidiaries described in the DPA, which conduct pre-dated our acquisition of Biomet, as well as any new or continuing violations. We could also be subject to exclusion by OIG-HHS from participation in federal healthcare programs, including Medicaid and Medicare. Any of these events could have a material adverse effect on our business, financial condition, results of operations and cash flows.
OIG subpoena: In June 2017, we received a subpoena from the OIG. The subpoena requests that we produce a variety of records primarily related to our healthcare professional consulting arrangements (including in the areas of medical education, product development, and clinical research) for the period spanning January 1, 2010 to the present. The subpoena does not indicate the nature of the OIG’s investigation beyond reference to possible false or otherwise improper claims submitted for payment. We are in the process of responding to the subpoena. We cannot currently predict the outcome of this investigation.
| 20. | Quarterly Financial Information (Unaudited) |
|---|
| (in millions, except per share data) | ||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2017 Quarter Ended | 2016 Quarter Ended | |||||||||||||||||||||||||||||||
| Mar | Jun | Sep | Dec | Mar | Jun | Sep | Dec | |||||||||||||||||||||||||
| Net sales | $ | 1,977.3 | $ | 1,954.4 | $ | 1,818.1 | $ | 2,074.3 | $ | 1,904.0 | $ | 1,934.0 | $ | 1,832.8 | $ | 2,013.1 | ||||||||||||||||
| Gross profit | 1,312.4 | 1,279.0 | 1,164.5 | 1,331.4 | 1,136.8 | 1,160.1 | 1,189.2 | 1,250.1 | ||||||||||||||||||||||||
| Net earnings (loss) of Zimmer Biomet Holdings, Inc. | 299.4 | 184.2 | 98.8 | 1,231.4 | 108.8 | (31.3 | ) | 158.8 | 69.6 | |||||||||||||||||||||||
| Earnings (loss) per common share | ||||||||||||||||||||||||||||||||
| Basic | 1.49 | 0.91 | 0.49 | 6.08 | 0.54 | (0.16 | ) | 0.79 | 0.35 | |||||||||||||||||||||||
| Diluted | 1.47 | 0.90 | 0.48 | 6.03 | 0.54 | (0.16 | ) | 0.78 | 0.34 |
In the three month period ended December 31, 2017, we recognized a $1,272.4 million income tax benefit related to the 2017 Tax Act. The benefit was partially offset by a $272.0 million goodwill impairment charge related to our Spine reporting unit.
In the three month period ended September 30, 2016, we recognized $21.0 million of tax benefits and $12.2 million of pre-tax operating expenses that were related to previous periods. The majority of the tax benefits were related to adjusting certain Biomet purchase accounting values. In the three month period ended December 31, 2016, we recognized $13.0 million of tax provisions that were related to previous periods.
We have evaluated the effect of these out-of-period adjustments on the applicable interim and annual periods of 2016 and prior years in which they should have been recognized, and concluded for both quantitative and qualitative reasons that these adjustments were not material to any of the periods affected.
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