Synthes report on the financial year 2010 (1)


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Synthes report on the financial year 2010 (1)

  1. 1. Synthes. Annual Report 2010Financial ReviewReport of Independent Auditors  FR2Report of Independent Accountants  FR3Consolidated Balance Sheets  FR4Consolidated Statements of Operations  FR6Consolidated Statements of Changes in Stockholders’ Equity  FR7Consolidated Statements of Cash Flows  FR8Notes to the Consolidated Financial Statements – Notes A  FR10Notes to the Consolidated Financial Statements – Notes B  FR11Notes to the Consolidated Financial Statements – Notes C  FR19Note to Directors and Shareholders  FR47Investor Key Data  FR48 Financial Review FR1
  2. 2. Financial ReviewReport of Independent AuditorsBoard of Directors and ShareholdersSynthes, Inc.We have audited the accompanying consolidated balance sheets of Synthes, Inc.and subsidiaries (the Group) as of ­ ecember 31, 2010 and 2009, and the related Dconsolidated statements of operations, changes in stockholders’ equity, and cashflows for the years then ended. These financial statements are the responsibilityof the Group’s management. Our responsibility is to express an opinion on thesefinancial statements based on our audits.We conducted our audits in accordance with auditing standards generally accept-ed in the United States. Those stand­ rds require that we plan and perform the au- adit to obtain reason­ ble assurance about whether the financial statements are free aof material misstatement. We were not engaged to perform an audit of the Group’sinternal control over financial reporting. Our audits included consideration of in-ternal control over financial reporting as a basis for designing audit proceduresthat are appropriate in the circumstances, but not for the purpose of expressingan opinion on the effectiveness of the Group’s internal control over financial re-porting. Accordingly, we express no such opinion. An audit also includes examin-ing, on a test basis, evidence supporting the amounts and disclosures in the finan-cial statements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statement presenta-tion. We believe that our audits provide a reasonable basis for our opinion.In our opinion, the financial statements referred to above pre­ ent fairly, in all ma- sterial respects, the consolidated financial position of the Group as of December31, 2010 and 2009, and the consolidated results of its operations and its cashflows for the years then ended, in conformity with accounting principles generallyaccepted in the United States.Philadelphia, PennsylvaniaFebruary 16, 2011FR2 Financial Review
  3. 3. Synthes. Annual Report 2010Report of Independent AccountantsBoard of DirectorsSynthes, Inc.We have examined the suitability of Synthes, Inc.’s design of internal control overfinancial reporting to prevent or detect material misstatements in the financialstatements on a timely basis as of December 31, 2010, based on criteria estab-lished in Internal Control-Integrated Framework issued by the Committee of Spon-soring Organizations of the Treadway Commission (COSO criteria). Synthes, Inc.’smanagement is responsible for the suitable design of internal control over finan-cial reporting. Our responsibility is to express an opinion on the design of internalcontrol based on our examination.Our examination was conducted in accordance with attestation standards estab-lished by the American Institute of Certified Public Accountants and, accordingly,included obtaining an understanding of internal control over financial reporting,evaluating the design of internal control, and performing such other proceduresas we considered necessary in the circumstances. Our procedures included per-forming walkthroughs to test for the existence of internal controls. We believethat our examination provides a reasonable basis for our opinion.We were not engaged to examine and report on the operating effectiveness ofSynthes, Inc.’s internal control over financial reporting as of December 31, 2010,and, accordingly, we express no opinion on operating effectiveness.Because of inherent limitations in any internal control, misstatement due to erroror fraud may occur and not be detected. Also, projections of any evaluation of theinternal control over financial reporting to future periods are subject to the riskthat the internal control may become inadequate because of changes in condi-tions, or that the degree of compliance with the policies or procedures may dete-riorate.In our opinion, Synthes, Inc.’s internal control over financial reporting is suitablydesigned, in all material respects, to prevent or detect material misstatements inthe financial statements on a timely basis as of December 31, 2010, based on theCOSO criteria.Philadelphia, PennsylvaniaFebruary 16, 2011 Financial Review FR3
  4. 4. Financial ReviewSynthes, Inc. and SubsidiariesConsolidated Balance Sheets as ofDecember 31, 2010 and 2009Assets 2010 2009Current assets in 1,000 US$ in 1,000 US$Cash and cash equivalents 736,565 1,419,246Marketable securities 1,254,683 -Accounts receivable Trade, less allowance of US$ 31.9 million and US$ 25.0 million in 2010 and 2009, respectively 706,127 613,225 Other 99,294 77,514Inventories, net 520,867 525,499Prepaid expenses and other current assets 44,096 26,368Deferred income taxes 53,269 42,428Total current assets 3,414,901 2,704,280Property, plant and equipment, net 893,817 743,885Other assetsIntangible assets, less accumulated amortization of US$ 303.1 millionand US$ 236.7 million in 2010 and 2009, respectively 2,119,322 1,911,541Goodwill 1,293,082 1,138,238Other assets 78,522 56,797Deferred income taxes 123,972 103,877Total other assets 3,614,898 3,210,453Total assets 7,923,616 6,658,618FR4 Financial Review
  5. 5. Synthes. Annual Report 2010Liabilities and stockholders’ equity 2010 2009Current liabilities in 1,000 US$ in 1,000 US$Current maturities of long-term debt 121 527Accounts payable 48,727 42,194Income taxes payable 40,230 90,208Accrued payroll and other compensation and benefits including withholding taxes and pensions 196,356 178,702Accrued taxes other than income and payroll 44,157 37,410Accrued expenses other 153,986 142,755Current acquisition-related liabilities 51,540 45,155Deferred income taxes 19,518 19,408Total current liabilities 554,635 556,359Long-term debt, net of current maturities 98,297 2,716Long-term acquisition-related liabilities 26,431 70,662Employee benefits and pension liabilities 61,706 28,693Other long-term liabilities 128,881 81,588Deferred income taxes 314,997 280,431Total liabilities 1,184,947 1,020,449Stockholders’ equityCommon stock CHF 0.001 par value; shares authorized – 150,000,000; shares issued – 2010 –118,777,075; 2009 – 118,717,913; shares outstanding – 2010 – 118,732,935; 2009 – 118,681,184 79 79Additional paid-in capital 1,938,525 1,932,814Treasury stock – at cost (5,149) (4,044)Retained earnings 3,925,243 3,169,123Accumulated other comprehensive income 879,971 540,197Total stockholders’ equity 6,738,669 5,638,169Total liabilities and stockholders’ equity 7,923,616 6,658,618The accompanying notes are an integral part of these consolidated financial statements. Financial Review FR5
  6. 6. Financial ReviewSynthes, Inc. and SubsidiariesConsolidated Statements of Operations for the YearsEnded December 31, 2010 and 2009 2010 2009 in 1,000 US$ in 1,000 US$Net sales 3,686,952 3,394,652Cost of goods sold 640,416 592,274Gross profit 3,046,536 2,802,378Operating expensesSelling and promotion 1,080,137 978,863General and administrative 393,260 382,351Research and development 172,365 168,345Royalty expense 71,154 65,816Amortization of intangible assets 46,262 44,272 1,763,178 1,639,647Operating income 1,283,358 1,162,731Other income (expenses)Interest expense (4,341) (5,739)Interest income 6,363 3,032Foreign exchange losses (13,400) (6,124)Other, net (16,810) 186 (28,188) (8,645)Earnings before income taxes 1,255,170 1,154,086Income taxes 347,437 330,131Net earnings 907,733 823,955Basic and diluted earnings per share (expressed in US$) 7.65 6.94 in 1,000 of shares in 1,000 of sharesWeighted-average number of common shares outstanding 118,678 118,677Weighted-average number of common shares outstanding with dilutive effect 118,699 118,687The accompanying notes are an integral part of these consolidated financial statements.FR6 Financial Review
  7. 7. Synthes. Annual Report 2010Synthes, Inc. and SubsidiariesConsolidated Statements of Changes in Stockholders’ Equityfor the Years Ended December 31, 2010 and 2009 Accumulated other Additional comprehensive Total Comprehen- Common stock paid-in Treasury Retained income Stockholders’ sive income in 1,000 capital stock earnings (loss) equity (loss) of shares in 1,000 US$ in 1,000 US$ in 1,000 US$ in 1,000 US$ in 1,000 US$ in 1,000 US$ in 1,000 US$Balance December 31, 2008 118,718 79 1,930,002 (6,623) 2,461,762 440,600 4,825,820 854,334Net earnings 2009 – – – – 823,955 – 823,955 823,955Re-issuance of treasury shares – – ­ 98 2,579 – – 2,677 –Dividends CHF 1.1000 – – – – (116,594) – (116,594) –(US$ 0.9824) per shareShare-based payment – – 2,714 – – – 2,714 –arrangements compensationDefined benefit pension plans, net of – – – – – 7,278 7,278 7,278deferred taxes of US$ (1.616) millionReclassification adjustment for gains – – – – – 1,238 1,238 1,238included in net earningsForeign currency translation – – – – – 91,081 91,081 91,081adjustment 2009Balance December 31, 2009 118,718 79 1,932,814 (4,044) 3,169,123 540,197 5,638,169 923,552Net earnings 2010 – – – – 907,733 – 907,733 907,733Issuance of common stock in connec-tion with share-based compensation- 59 – – – – – – –arrangementsPurchases of treasury shares – – – (3,688) – – (3,688) –Re-issuance of treasury shares – – ­ 146 2,583 – – 2,729 –Dividends CHF 1.3500 – – – – (151,613) – (151,613) –(US$ 1.2776) per shareShare-based payment – – 5,565 – – – 5,565 –arrangements compensationDefined benefit pension plans, net of – – – – – (26,244) (26,244) (26,244)deferred taxes of US$ 4.956 millionUrealized loss on interest rate swap – – – – – (4,325) (4,325) (4,325)Urealized gain on investment securi- – – – – – 59 59 59tiesForeign currency translation – – – – – 370,284 370,284 370,284adjustment 2010Balance December 31, 2010 118,777 79 1,938,525 (5,149) 3,925,243 879,971 6,738,669 1,247,507The accompanying notes are an integral part of these consolidated financial statements. Financial Review FR7
  8. 8. Financial ReviewSynthes, Inc. and SubsidiariesConsolidated Statements of Cash Flows for the YearsEnded December 31, 2010 and 2009 2010 2009Cash flows from operating activities in 1,000 US$ in 1,000 US$Net earnings 907,733 823,955Adjustments to reconcile net earnings to net cash provided by operating activities Depreciation 256,739 220,329 Amortization 47,605 44,689 Share-based compensation 8,148 5,293 Provisions for inventory obsolescence 44,963 45,458 Provisions for doubtful accounts 5,556 3,925 Deferred income tax benefit (16,205) (28,484) Losses on sale of property, plant and equipment 9,413 3,096 Realized foreign exchange gains (8,238) (6,358) Intangible asset impairment charge 9,000 - Other 9,020 (5,964) Changes in assets and liabilities, net of effects of business acquisitions Accounts receivable - trade (89,892) (32,442) Accounts receivable - other (18,416) (20,701) Inventories (20,202) (90,840) Prepaid expenses and other current assets (14,384) 24,926 Accounts payable 15,063 (7,307) Income taxes payable (25,275) 26,352 Accrued expenses 45,699 48,245Net cash provided by operating activities 1,166,327 1,054,172FR8 Financial Review
  9. 9. Synthes. Annual Report 2010 2010 2009Cash flows from investing activities in 1,000 US$ in 1,000 US$Capital expenditures for property, plant and equipment (345,463) (299,637)Consideration in connection with prior acquisitions (48,020) (108,555)Business acquisitions, net of cash acquired (189,715) –Proceeds from disposal of property, plant and equipment 488 143Proceeds of other instruments 8,238 6,358Investment in nonconsolidated investments and other long-term assets (7,283) (6,088)Disposals of nonconsolidated investments and other long-term assets 2,184 6,807Issuance of loans (1,023) –Proceeds from loans 1,742 1,053Purchases of available-for-sale securities (3,279,683) –Sales and maturities of available-for-sale securities 2,025,000 –Net cash used in investing activities (1,833,535) (399,919)Cash flows from financing activitiesPrincipal payments of debt and capital lease obligations (777) (1,646)Proceeds from issuance of long-term debt 86,435 –Purchases of treasury shares (3,688) –Dividends paid to stockholders (151,613) (116,594)Net cash used in financing activities (69,643) (118,240)Effect of exchange rate changes on cash and cash equivalents 54,170 11,690Net (decrease) increase in cash and cash equivalents (682,681) 547,703Cash and cash equivalents as of January 1 1,419,246 871,543Cash and cash equivalents as of December 31 736,565 1,419,246Supplemental disclosures of cash flow informationInterest paid 1,491 480Income taxes paid 366,623 330,144The accompanying notes are an integral part of these consolidated financial statements. Financial Review FR9
  10. 10. Financial Review. Note A/BSynthes, Inc. and SubsidiariesNotes to the Consolidated Financial StatementsDecember 31, 2010 and 2009Note A: Basis of presentation1 Description and nature of operationsSynthes, Inc. and its subsidiaries (the Group) develops, manufactures, and dis­ ributes tproducts for the operative treatment of bone fractures including both metallic andosteobiological materials. Additionally, the Group has a po­ er tools business wincluding development, manufacturing, and distribution.The Group is comprised of Synthes, Inc. and the companies shown in Note C20(list of fully consoli­ ated companies as of December 31, 2010). Synthes, Inc. is a d ­corporation registered in Delaware, USA.FR10 Financial Review
  11. 11. Synthes. Annual Report 2010Synthes, Inc. and SubsidiariesNotes to the Consolidated Financial StatementsDecember 31, 2010 and 2009Note B: Summary of significant accounting policiesA summary of the Group’s significant accounting policies that were applied in thepreparation of the accompanying consolidated ­ nan­ ial statements follows: fi c1 Basis of the consolidated financial statementsThe consolidated financial statements have been prepared in ­ ccor­ ance with a da­ ccounting principles generally accepted in the United States of America (U.S.GAAP). All policies and procedures are consistent with these principles.The consolidated financial statements include the accounts of Synthes, Inc. andall companies in which Synthes, Inc. has directly or indirectly more than a 50%voting interest or is the primary beneficiary of a variable interest entity. For thoseconsolidated subsidiaries where ownership is less than 100%, the outside stock-holders’ interests are shown in noncontrolling interest in the accompanying con-solidated financial statements. As of December 31, 2010 and 2009, the Groupdoes not have a noncontrolling interest in a consolidated subsidiary. Subsidiariesare consolidated from the date of acquisition. Acquisitions of subsidiaries are ac-counted for using the purchase method of accounting. All intercompany transac-tions and balances between Group companies are eliminated.Pursuant to the Subsequent Events topic of the Financial Accounting StandardsBoard (FASB) Codification, the Group evaluated subsequent events after Decem-ber 31, 2010 through February 16, 2011, representing the date that these consol-idated financial statements were approved by the Group’s management and areavailable to be issued. The Group concluded that no material transactions occurredsubsequent to December 31, 2010 that provided additional evidence about condi-tions that existed at December 31, 2010 or after that requires adjustment to theaudited consolidated financial statements.2 Foreign currency translationThe financial statements of the holding company’s subsidiaries outside the UnitedStates of America are translated into US dollars (US$), the Group’s reportingcurrency, as follows:The consolidated balance sheets are translated at year-end exchange rates.The consolidated statements of operations are translated at the weighted-averageexchange rates for the period. Weighted-average exchange rates are calculatedbased on monthly average rates for the applicable currencies. Translation adjust-ments are charged or credited to accumulated other comprehensive income. Financial Review FR11
  12. 12. Financial Review. Note BForeign currency transactions are accounted for at the exchange rates prevailingat the date of the transaction. Gains and losses resulting from the settlement ofsuch transactions and from the remeasurement of monetary assets and liabilitiesdenominated in ­ oreign currencies are recognized in the consolidated statements fof operations.The following is a summary of the Group’s major exchange rates used in relationto US$: Weighted- Year-end rates average rates for year at December 31 ended December 31 2010 2009 2010 2009CHF 1= 1.0661 0.9662 0.9604 0.9211CDN 1= 1.0000 0.9493 0.9706 0.8775GBP 1= 1.5441 1.6077 1.5450 1.5416EUR 1= 1.3300 1.4366 1.3250 1.3907BRL 1= 0.6025 0.5759 0.5689 0.5041COP 100 = 0.0525 0.0488 0.0527 0.0465AUD 1= 1.0168 0.8967 0.9187 0.7882CNY 1= 0.1519 0.1471 0.1479 0.1464INR 1= 0.0224 0.0215 0.0219 0.0207JPY 100 = 1.2271 1.0820 1.1413 1.06913 ReclassificationsCertain 2009 financial information has been reclassified to conform to the cur-rent-year presentation.4 Cash and cash equivalentsCash and cash equivalents consist of cash and highly liquid short-term investmentswith original maturities of three months or less. The Group places its cash and cashequivalents in financial institutions that are highly rated. Management believes iteffectively safeguards cash assets given the current economic conditions.5 Marketable securitiesThe Group’s marketable securities are available-for-sale securities recorded at fairvalue on the consolidated balance sheets, with the change in fair value during theperiod excluded from earnings and recorded net of tax as a component of accu-mulated other comprehensive income with any unrealized losses which aredeemed to be other-than-temporary included in current period earnings, if appli-cable. Realized and unrealized gains and losses are determined based on the spe-cific-identification method.At December 31, 2010 and 2009, the Group had no held-to-maturity or tradingsecurities. During 2010, the Group purchased US$ 3.3 billion and had maturitiesof US$ 2.0 billion in U.S. Government securities. The securities are classified asshort-term available-for-sale marketable securities on the consolidated balancesheets. The Group had no investments in marketable securities outstanding as ofDecember 31, 2009.FR12 Financial Review
  13. 13. Synthes. Annual Report 20106 Accounts receivableThe majority of the Group’s accounts receivable are due from vari­ us health care ofacilities. Credit is extended based on evaluation of a customer’s financial con-dition and, generally, collateral is not required. Accounts receivable are statedat amounts due from customers net of an allowance for doubtful ­ ccounts. aP m­ ay­ ent terms vary. Accounts outstanding longer than the payment terms areconsidered past due. The Group determines its allowance for doubtful ­ ccounts aby considering a number of ­ actors, including the length of time trade accounts freceivable are past due, previous loss history, the customer’s current ability topay its obligation, and the condition of the general economy and industry as awhole. The Group writes off ­ ccounts ­ eceivable when they are determined to a rbe uncollectible.7 InventoriesInventories are stated at the lower of cost or market, using the first-in, first-out meth-od. The Group maintains provisions for excess and obsolete inventory. The Group es-timates these provisions based on historical experience and expected ­ uture trends. f8 Property, plant and equipmentProperty, plant and equipment are stated at cost less accumulated depreciation.Depreciation is calculated on the straight-line method over the estimated usefullife of the asset. The estimated useful lives are as follows:Land –Buildings 30 – 50 yearsBuilding improvements 10 – 20 yearsMachinery and fixtures 3 – 12 yearsEquipment/EDP 3 – 8 yearsLoan sets and samples 3 yearsVehicles 3 – 8 years9 Impairment of long-lived assetsThe Group periodically evaluates whether current facts or circumstances indicatethat the carrying value of long-lived assets (other than goodwill and indefinite-lived intangible assets) to be held and used may not be recoverable. If such cir-cumstances are determined to exist, an estimate of undiscounted future cashflows to be produced by the long-lived asset is compared to the carrying value todetermine whether impairment ­ xists. If an asset is determined to be impaired, ethe loss is mea­ ured based on fair value using quoted market prices in active mar- skets, if available. If quoted market prices are not available, the estimate of fairvalue is based on various valuation techniques, including discounted estimatedfuture cash flows.10 Intangible assetsIntangible assets with finite lives consist mainly of ­ ustomer relationships, acquired cpatents and patent rights, software, product-related know-how, and licensing andmarketing agreements and are amortized on a straight-line basis over their esti-mated useful lives, ranging from 5 to 40 years. Such assets are evaluated for im-pairment whenever impairment indicators exist. Financial Review FR13
  14. 14. Financial Review. Note BIntangible assets with indefinite lives consist of the Synthes trade names, corpo-rate trade names, and ­ eo­ raphic marketing rights. ­n­ e­ nite-lived assets are not g g I d fiamortized but are ­ equired to be tested for potential impairment at least ­ nnually, r aor whenever impairment indicators exist. Such assets are deemed to be impairedif book value exceeds estimated fair value.11 GoodwillThe excess of cost over fair value of assets acquired in business combinations(goodwill) is assigned to specific reporting units and is ­ ested for possible impair- tment at least annually, or whenever impairment indicators exist. Potential impair-ment is indicated when the carrying value of a reporting unit, including goodwill,exceeds its fair value. If potential for impairment exists, an impairment charge isr­ ecognized when the carrying value of a reporting unit’s goodwill ­ x­ eeds its e cimplied fair value. Goodwill is allocated among the Group’s four reportable seg-ments that manufacture and sell similar products in different geographic areas.12 Other assetsOther long-term assets are primarily nonconsolidated investments, loans and­other deferred costs. Nonconsolidated investments are stated at cost, less anyimpairment adjustments. Loans are long-term loans to third parties which arecarried at cost.13 ContingenciesThe Group records provisions for contingencies when it is judged probable that aliability has been incurred and the amount can be reasonably estimated. Theseprovisions are adjusted periodically as assessments change or additional informa-tion becomes available.Product liabilitiesProduct liability cases are routinely handled by in-house counsel and external coun-sel. Provisions are made for present product liability obligations resulting from pastsales including related legal and other fees and expenses. The provision is actuar-ially determined taking into consideration such factors as past experience, amountand number of claims reported and estimates of claims incurred but not yetreported. Individually significant cases are provided for when probable and rea-sonably estimable. Management does not anticipate that any material losses notcovered by the provision will be sustained by the Group as a result of these claims.Legal liabilitiesProvisions are made for anticipated settlement or judgment costs where a reason-able estimate can be made of the probable outcome of legal proceedings or claimsagainst the Group.14 Revenue recognitionSales are recognized on products when the related goods have been shipped, ­­­ titlehas passed to the customer, and there are no undelivered elements or uncertainties.For consignment inventory, revenue is recognized when the Group is notified thatthe product has been used.FR14 Financial Review
  15. 15. Synthes. Annual Report 2010Services revenue, which is insignificant, is recognized upon the completion of re-furbishment of certain products and the shipment of that product back to the cus-tomer. Amounts billed to customers for shipping and handling of products are in-cluded in net sales. Costs incurred related to shipping and hand­ing are included in lcost of sales.The Group records estimated sales returns and allowances as a reduction of net salesin the same period revenue is recognized.15 Income taxesThe Group accounts for income taxes using the liability method that requires de-termination of deferred tax assets and liabilities based on the difference betweenthe financial statement and tax bases of assets and liabilities as measured by thee­ nacted tax rates that will be in effect when these differences ­ re expected to ar­ everse. Deferred income tax expense (benefit) is the result of changes in deferredtax assets and liabilities during the year. The Group recognizes interest and pe-nalties related to unrecognized income tax positions in income tax expense.16 Equity compensationThe Group has an equity incentive plan for directors and em­ loyees, which is a fixed pemployee stock-based compensation plan. Under this plan, the Group may grantoptions and shares for up to 1,500,000 shares of Common Stock. The exercise priceof each ­ ption is equal to the market price of the Group’s stock on the date of grant. oThe maximum term of the options ranges from 8 to 14 years and the ­ ptions vest over operiods ranging from immediately to 5 years. Certain option and share awards pro-vide for accelerated vesting if there is a change of control (as defined by the plan).During 2010, the equity incentive plan was renewed for 10 years, and each new-ly granted option has a life of 10 years rather than the previous 8 to 14 year range.The Group recognizes compensation cost for all share-based payments based onthe grant-date fair value.17 Financial instrumentsIn assessing the fair value of financial instruments, the Group uses a variety of meth-ods and makes assumptions that are based on market conditions existing at eachbalance sheet date. The fair values of invest­ ents are based on quoted market pric- mes at the ­ alance sheet date. Other techniques, such as estimated ­ iscounted val- b due of future cash flows, are used to determine fair value for the remai­ ing financial ninstruments. The carrying value of financial instruments approximates fair value.18 Concentrations of credit riskFinancial instruments that may potentially subject the Group to concentration of cred-it risk consist principally of cash, cash equiva­ents, marketable securities, trade ac- lcounts receivable, and derivatives. All cash, cash equivalents, marketable securities,and derivatives are placed in financial institutions with strong credit ratings, whichminimizes the risk of loss due to nonpayment.Concentration of credit risks with respect to trade accounts receivable is limited, dueto the large number of customers and their dispersion across many geo­ raphic areas. gAlso, the Group has policies in place to ensure that sales of products and services are Financial Review FR15
  16. 16. Financial Review. Note Bmade to customers with an appropriate credit history. However, a significant portionof trade accounts receivable is with national health care systems in several countries.Although the Group does not currently foresee a credit risk associated with thesereceivables, repayment is dependent upon the financial stability of those customers. ­19 DerivativesThe Group uses derivative financial instruments to manage interest rate risk and cur-rency exchange risk. While these derivative financial instruments are subject to fluctu-ations in value, these fluctuations are generally offset by the value of the underlyingexposures. The Group minimizes the risk of credit loss by entering into these agree-ments with major financial institutions that have high credit ratings. The Group recog-nizes all of its derivative instruments as either assets or ­iabilities in the consolidated lbalance sheets at fair value.The Group is exposed to foreign currency fluctuations relating to its operationsthroughout the world. The Group periodically ­ nters into forward exchange con- etracts in order to minimize the impact of currency fluctuations on transactions andcash flows. These undesignated contracts are valued and recorded at their fair val-ue on the accompanying consolidated balance sheets in other current assets andaccrued liabilities. Changes in the fair value of these undesignated derivative con-tracts are recorded currently in the consolidated statements of operations in “for-eign exchange (losses) gains” (Note C23). None of the foreign exchange contractsoutstanding in 2010 and 2009 were designated as cash-flow hedges.The Group had an interest rate derivative with a notional value of CHF 120 mil-lion and a maturity of less than six years outstanding at December 31, 2010. Thisinterest rate swap is designated as a cash flow hedge of the debt disclosed in NoteC8, and is recorded at its fair value on the accompanying consolidated balancesheets in other current assets and accrued liabilities, while the related gains andlosses are deferred in other comprehensive income in the equity section of theconsolidated balance sheets. The group did not have any interest rate derivativesoutstanding as of December 31, 2009.20 Advertising costsAdvertising and promotion costs are expensed as incurred, and were US$ 37.1million and US$ 39.4 million in 2010 and 2009, respectively.21 Use of estimatesThe preparation of financial statements in conformity with account­ng principles igenerally accepted in the United States requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities, disclo-sure of contingent assets and liabilities and the reported amounts of revenues andexpenses. Actual results could differ from these estimates. Significant areas thatrequire management’s estimates include the allowance for doubtful accountsreceivable, provision for obsolete inventories, fair values of acquired assets andliabilities, useful lives of assets, product liability claims, commitments and contin-gencies, and income taxes. The Group is subject to risks and uncertainties, suchas changes in the health care environment, regulatory oversight, changes in thefinancial markets, competition and legislation that may cause actual results todiffer from ­ stimated results. eFR16 Financial Review
  17. 17. Synthes. Annual Report 201022 New accounting standardsOn January 1, 2010, the Group adopted the provisions of the Improvement to Fi-nancial Reporting by Enterprises Involved with Variable Interest Entities topic ofthe FASB Codification. The topic requires a qualitative approach to identifying acontrolling financial interest in a variable interest entity (VIE), and requires ongo-ing assessment of whether an entity is a VIE and whether an interest in a VIE makesthe holder the primary beneficiary of the VIE. The adoption of these provisions didnot have an impact on the Group’s consolidated financial statements.On January 1, 2010, the Group adopted the provisions of the Fair Value Measure-ments and Disclosures Topic Improving Disclosures About Fair Value Measurementsof the FASB Codification. This topic requires companies to make new disclosuresabout recurring and nonrecurring fair value measurements including significanttransfers into and out of Level 1 and Level 2 fair value measurements, and infor-mation on purchases, sales, issuances, and settlements on a gross basis in the rec-onciliation of Level 3 fair value measurements. The enhanced disclosures about re-curring and nonrecurring fair value measurements are included in Note C23 to theGroup’s consolidated financial statements.As disclosed in Note C23, effective January 1, 2008, the Group adopted the provisionsof the Fair Value Measurements and Disclosures topic of the FASB Codification re-lated to financial assets and financial liabilities. Additionally, in accordance withthe provisions of this topic, the Group adopted the provisions for its fair value mea-surement of its nonfinancial assets and nonfinancial liabilities, except those itemsrecognized or disclosed at fair value on an annual or more frequently recurring ba-sis, on January 1, 2009. The adoption of these provisions did not have an impacton the Group’s consolidated financial statements, except as disclosed in Note C21in relation to the acquisition of Anspach.In 2009, the Group adopted the provisions of the Subsequent Events topic of theFASB Codification. This topic establishes general standard of accounting for anddisclosure of events that occur after the balance sheet date but before the datethat the financial statements are issued or are available to be issued. This topicrequires disclosure of the date through which an entity has evaluated subsequentevents. The required disclosures are included in Note B1 to the consolidated finan-cial statements.In 2008, the FASB issued new authoritative guidance regarding employer disclosuresabout postretirement benefit plan assets which now is included within the FASBCodification topic, Plan Accounting - Defined Benefit Pension Plans. This new guid-ance requires increased disclosures about an employer’s defined benefit pension orother postretirement plan assets. Specifically, the new guidance requires an entityto disclose information regarding its investment policies and strategies, its catego-ries of plan assets, its fair value measurements of plan assets and any significantconcentrations of risk in plan assets. The new authoritative guidance was effectivefor the Group in the year ended December 31, 2009, and the additional disclosuresnecessary to the consolidated financial statements are included in Note C10.In December 2007, the FASB issued new authoritative guidance regarding busi-ness combinations and noncontrolling interests in consolidated financial state- Financial Review FR17
  18. 18. Financial Review. Note Bments which now is included within the FASB Codification topic, BusinessCombinations. The provisions of this guidance established new principles andrequirements for accounting for business combinations, including recognition andmeasurement of identifiable assets acquired, goodwill acquired, liabilities as-sumed, and noncontrolling financial interests. Additionally, the provisions of thisguidance require all entities to report noncontrolling (minority) interests in sub-sidiaries as equity in the consolidated financial statements. These new provisionswill significantly change the accounting for and reporting of business combina-tion transactions and noncontrolling (minority) interests in consolidated financialstatements. The provisions of this guidance were required to be adopted simul-taneously and were effective for fiscal years beginning on or after December 15,2008. Earlier adoption was prohibited. Effective January 1, 2009, the Group ad-opted the new authoritative guidance regarding business combinations and non-controlling interests in consolidated financial statements, as required, and theadoption of these provisions did not have a material effect on the Group’s con-solidated financial statements.In March 2008, the FASB issued new authoritative guidance regarding disclosuresabout derivative instruments and hedging activities which now is included with-in the FASB Codification topic, Derivatives and Hedging. These new provisions re-quire increased disclosures about an entity’s strategies and objectives for usingderivative instruments; the location and amounts of derivative instruments in anentity’s financial statements; how derivative instruments and related hedged itemsare accounted for under the FASB Codification topic, Derivatives and Hedging;and how derivative instruments and related hedged items affect an entity’s finan-cial position, financial performance, and cash flows. Certain disclosures will alsobe required with respect to derivative features that are credit-risk related. The pro-visions of this guidance were effective for financial statements issued for fiscalyears and interim periods beginning after November 15, 2008, with early appli-cation encouraged. The provisions of this guidance encourage, but do not require,comparative disclosures for earlier periods at initial adoption. Effective January 1,2009, the Group adopted the new authoritative guidance regarding disclosuresabout derivative instruments and hedging activities, as required, and the adop-tion of these provisions did not have a material effect on the Group’s consolidat-ed financial statements.FR18 Financial Review
  19. 19. Synthes. Annual Report 2010Synthes, Inc. and SubsidiariesNotes to the Consolidated Financial StatementsDecember 31, 2010 and 2009Note C: Footnotes1 Marketable securitiesInvestments in marketable securities are summarized as follows at December 31,2010: Cost Gross unrealized gain Gross unrealized loss Fair value in 1,000 US$ in 1,000 US$ in 1,000 US$ in 1,000 US$Available-for-sale:U.S. Government obligations 1,254,624 63 (4) 1,254,683Total 1,254,624 63 (4) 1,254,683The net carrying value and estimated fair value of available-for-sale marketable se-curities at December 31, 2010, by contractual maturity, are as follows (in 1,000 US$):Due in 1 year or less 1,254,683Due from 1 through 5 years -Due from 5 through 10 years -Due after 10 years - 1,254,683As of December 31, 2010, the gross unrealized losses of the Group’s available-for-sale marketable securities was US$ 0.004 million and the fair value of the avail-able-for-sale marketable securities with unrealized losses was US$ 234.9 million.The investments with unrealized losses have been in an unrealized loss positionfor less than twelve months, were caused by changes in interest rates and the un-realized losses recognized do not represent an other-than-temporary decline invalue.For the twelve months ended December 31, 2010 and 2009, the cost of securi-ties purchased, proceeds from sales and maturities and gross realized gains andlosses on securities classified as available-for-sale were: 2010 2009 in 1,000 US$ in 1,000 US$Cost of securities purchased (3,279,683) -Sales/maturities proceeds 2,025,000 -Gross realized losses - -Gross realized gains - - Financial Review FR19
  20. 20. Financial Review. Note C2 InventoriesInventories are summarized at December 31, as follows: 2010 2009 in 1,000 US$ in 1,000 US$Raw materials 60,669 67,848Work-in-progress and semi-finished products 128,992 118,071Finished products 415,929 379,302Customer consignment stock 48,690 64,450Gross value 654,280 629,671Less provision for obsolescence (133,413) (104,172)Net value 520,867 525,4993 Property, plant and equipmentDetails of property, plant and equipment at December 31, are as follows: ­ 2010 2009 in 1,000 US$ in 1,000 US$Land and buildings 278,902 270,628Machines and fixtures 497,735 444,796Office equipment, field equipment and vehicles 1,349,213 1,145,447 2,125,850 1,860,871Less: accumulated depreciation (1,430,942) (1,222,725) 694,908 638,146Construction in progress 198,909 105,739 893,817 743,885Depreciation expense recorded in the consolidated statements of operations wasUS$ 256.7 million and US$ 220.3 million in 2010 and 2009, respectively.4 Accounts receivable otherFollowing is a summary of accounts receivable other at December 31: 2010 2009 in 1,000 US$ in 1,000 US$Refundable taxes, principally value-added tax (V.A.T.) 55,163 41,259Receivable due from the AO Foundation 24,630 24,630Deposits 2,679 4,480Due from officers, directors and employees 3,918 2,549All other 12,904 4,596 99,294 77,514FR20 Financial Review
  21. 21. Synthes. Annual Report 20105 Intangible assetsFollowing is a summary of intangible assets, excluding goodwill, at the end of theyear: December 31, 2010 Gross Accumulated Total amount amortization in 1,000 US$ in 1,000 US$ in 1,000 US$Finite-lived:Product intangible assets 47,447 96,400 (48,953)Customer relationships 823,477 986,907 (163,430)Patents/Patent rights 178,374 239,902 (61,528)Other intangible assets 12,485 41,669 (29,184)Subtotal – finite-lived intangible assets 1,061,783 1,364,878 (303,095)Indefinite-lived:Geographic marketing rights 266,535 266,535 -Trade names 791,004 791,004 -Subtotal – indefinite-lived intangible assets 1,057,539 1,057,539 -Total – intangible assets 2,119,322 2,422,417 (303,095) December 31, 2009 Gross Accumulated Total amount amortization in 1,000 US$ in 1,000 US$ in 1,000 US$Finite-lived:Product intangible assets 64,320 105,400 (41,080)Customer relationships 716,256 843,259 (127,003)Patents/Patent rights 171,270 215,712 (44,442)Other intangible assets 15,901 40,067 (24,166)Subtotal – finite-lived intangible assets 967,747 1,204,438 (236,691)Indefinite-lived:Geographic marketing rights 241,550 241,550 –Trade names 702,244 702,244 –Subtotal – indefinite-lived intangible assets 943,794 943,794 –Total – intangible assets 1,911,541 2,148,232 (236,691)As disclosed in Note C21, customer relationships, patents/patent rights and tradenames intangible assets increased by US$ 100.4 million as a result of the Group’sacquisition of Anspach during 2010. The remaining increases in gross intangible as-sets from December 31, 2009 to December 31, 2010 result from changes in foreigncurrency translation rates. Additionally, during 2010, the Group made a decision toremove, from the U.S. market, a product related to the N Spine, Inc. acquisition. Aspart of that plan, an impairment loss of US$ 9.0 million was recognized, which isincluded in “Other, net” in the 2010 consolidated statement of operations, repre-senting the excess of the aggregate carrying amount of certain intangible assetsover the aggregate of their fair value. All of the impaired assets are part of the NorthAmerica reportable segment. Financial Review FR21
  22. 22. Financial Review. Note CAmortization expense for intangible assets, was ­­ US$ 47.6 million and US$ 44.7million in 2010 and 2009, respectively. Estimated amortization expense for eachof the five years through December 31, 2015 is as follows (in millions): US$ 46.2,US$ 45.8, US$ 44.0, US$ 41.5 and US$ 40.2, respectively.6 Income taxesDeferred income taxes reflect the net tax effects of temporary ­ ifferences ­ etween d bthe carrying amounts of assets and liabilities for financial reporting purposes andthe amounts used for income tax purposes.Deferred tax assets and liabilities recognized in the consolidated balance sheets asof December 31, are as follows: 2010 2009Deferred income tax assets in 1,000 US$ in 1,000 US$Product liability 9,753 7,872Net operating loss carryforwards 6,390 10,722Inventories 94,035 69,415Accounts receivable 5,371 11,654Payments to employees 8,017 8,531Other 52,508 42,524Gross deferred income tax assets 176,074 150,718Valuation allowance (6,178) (8,299)Net deferred income tax assets 169,896 142,419Deferred income tax liabilitiesAccelerated tax depreciation (63,046) (43,500)Intangible assets (250,415) (226,223)Inventories (12,130) (9,895)Other (1,579) (16,335)Gross deferred income tax liabilities (327,170) (295,953)Net deferred income tax liabilities (157,274) (153,534)At December 31, 2010, the approximate amounts and expiration of net operat-ing loss carryforwards (primarily foreign) are as follows (in millions): 2011: ­ S$ 0.2, U2012–2015: US$ 5.6, 2016 and later years: US$ 1.5, and US$ 13.7 have an indef-inite carryforward period.The change in net deferred income tax liabilities is as follows: 2010 2009 in 1,000 US$ in 1,000 US$Beginning of the year (153,534) (179,231)Statement of operations benefit 16,205 28,484Anspach purchase accounting 601 -Pension liability adjustment 4,956 (1,564)Currency translation adjustment (25,502) (1,223)End of the year (157,274) (153,534)FR22 Financial Review
  23. 23. Synthes. Annual Report 2010Deferred income tax assets and liabilities are included in the consolidated ­ alance bsheets as follows: 2010 2009 in 1,000 US$ in 1,000 US$Current assets – deferred income taxes 53,269 42,428Noncurrent assets – deferred income taxes 123,972 103,877Current liabilities – deferred income taxes (19,518) (19,408)Noncurrent liabilities – deferred income taxes (314,997) (280,431)Total net deferred tax liabilities (157,274) (153,534)Cumulative undistributed earnings of foreign subsidiaries, for which no U.S. incomeor foreign withholding taxes have been recorded, approximated US$ 1.154 billionat December 31, 2010. As the Group intends to permanently reinvest all such earn-ings, no provision has been made for income taxes that may become payable upondistribution of such earnings, and it is not practicable to determine the amount ofthe related unrecognized deferred income tax liability. While there are no specificplans to distribute the undistributed earnings in the immediate future, where eco-nomically appropriate to do so, such earnings may be remitted.Tax expense consists of: 2010 2009 in 1,000 US$ in 1,000 US$Current taxes 363,642 358,615Deferred tax benefit (16,205) (28,484) 347,437 330,131The following reconciles the provision for income taxes, at the U.S. statutory ­ e­ e­ al f d rincome tax rate to the provision for income taxes as reported: 2010 2009 in 1,000 US$ in 1,000 US$Earnings before income taxes 1,255,169 1,154,086Tax expense calculated at a statutory tax rate of 35% 439,309 403,930Effect of permanent items (7,394) (9,993)Effect of taxes in other countries (89,295) (71,230)State income taxes, net of federal income tax benefit 18,180 19,016Tax benefits relating to tax credits (18,898) (10,050)Change in unrecognized tax positions, net 5,535 (1,542)Income tax expense 347,437 330,131The Group recognizes tax benefits only if it is more likely than not that the bene-fit will be sustained on examination by tax authorities based on technical meritsof the tax position creating the benefit.The amount of gross unrecognized income tax benefits at December 31, 2009 isUS$ 58.9 million, and the amount of accrued interest and penalties related to un-resolved income tax positions is US$ 16.3 million, net of tax. The amount of netunrecognized income tax benefits at January 1, 2010, all of which would, if recog-nized, impact the Group’s effective tax rate, is US$ 45.5 million including accruedinterest and penalties. At December 31, 2010, the amount of gross unrecognized Financial Review FR23
  24. 24. Financial Review. Note Cincome tax benefits is US$ 64.8 million. The amount of net unrecognized incometax benefits, all of which would, if recognized, impact the Group’s effective tax rateis US$ 52.9 million including accrued interest and penalties. In 2010, the increasein expense for interest and penalties related to unresolved income tax positionsamounted to US$ 3.2 million, net of tax. At December 31, 2010, accrued interestand penalties related to unresolved income tax positions were US$ 19.5 million,net of tax.The Group operates in various tax jurisdictions both inside and outside the Unit-ed States. At December 31, 2010, tax authorities in several tax jurisdictions wereconducting routine audits of the Group’s income tax returns filed in prior years.With a few exceptions, the Group is no longer subject to audits by tax authoritiesfor tax years prior to 2007. Tax years subsequent to 2006 are open to examina-tion in many of the tax jurisdictions in which the Group operates.Following is a reconciliation of beginning and ending amounts of gross unrecog-nized income tax positions for fiscal years 2010 and 2009: 2010 2009 in 1,000 US$ in 1,000 US$Beginning Balance January 1st 58,929 64,036Increase from current-year tax positions 4,365 4,906Increase from prior years’ tax positions 3,506 2,742Decrease from prior years’ tax positions (2,964) (7,748)Decrease from settlements with taxing authorities (791) (2,219)Decrease from lapse of statute of limitations (120) (4,434)Currency translation adjustment 1,853 1,646Ending Balance December 31st 64,778 58,929It is expected that the amount of tax liability for unrecognized income tax posi-tions will change in the next twelve months; however, these changes are notexpected to have a significant impact on the Group’s consolidated statements ofoperations or financial position.7 GoodwillChanges in the carrying amount of goodwill during 2010 and 2009, by reportingunit and in the aggregate, are summarized in the following tables: Total North America Europe Asia Pacific Latin America2010 in 1,000 US$ in 1,000 US$ in 1,000 US$ in 1,000 US$ in 1,000 US$Balance, January 1, 2010 1,138,238 72,962 938,654 77,006 49,616Arising in business acquisitions 52,376 51,063 827 – 486Currency translation adjustments 102,143 – 89,335 7,965 4,843Other 325 – – – 325Balance, December 31, 2010 1,293,082 124,025 1,028,816 84,971 55,270 Total North America Europe Asia Pacific Latin America2009 in 1,000 US$ in 1,000 US$ in 1,000 US$ in 1,000 US$ in 1,000 US$Balance, January 1, 2009 1,123,716 81,642 918,494 75,319 48,261Currency translation adjustments 22,962 – 20,160 1,687 1,115Other (8,440) (8,680) – – 240Balance, December 31, 2009 1,138,238 72,962 938,654 77,006 49,616FR24 Financial Review
  25. 25. Synthes. Annual Report 20108 Long-term debtIn January 2010, the Group entered a CHF 120 million credit facility with threeSwiss banks. Borrowings under the credit facility bear interest at a floating rateand the principal balances at December 31, 2010 total CHF 90.0 million (US$ 96.0million). The credit facility is hedged by an interest rate swap to fix the rate on theCHF 120 million of planned borrowings to maturity in December 2016. The bor-rowing is secured by a new European headquarters building in Solothurn, Swit-zerland and is intended to fund the construction of the same. Interest expenseassociated with the credit facility of CHF 0.4 million (US$ 0.4 million) has beencapitalized as of December 31, 2010.Details of long-term debt as of December 31, are as follows: 2010 2009 in 1,000 US$ in 1,000 US$Secured loans 95,953 -Unsecured loans - 57Other, including capital lease obligations 2,465 3,186 98,418 3,243Less: current maturities (121) (527) 98,297 2,716Required principal payments for the next five years and thereafter are as follows:Year ended December 31 in 1,000 US$2011 1212012 1212013 1522014 1702015 191Thereafter 97,6639 LeasesLeased assets included in property, plant and equipment, where the Group is a les-see under a capital lease, are comprised of a single building, office equipment andvehicles as of December 31, 2010 and 2009. Following is a summary of propertyheld under capital leases as of December 31: 2010 2009 in 1,000 US$ in 1,000 US$Cost 6,428 6,139Accumulated depreciation (4,668) (4,151)Net book amount 1,760 1,988The Group leases office buildings from a related party. One of the leases is classi-fied as a capital lease with the related asset and liability recorded. The lease pro-vides for minimum annual lease payments, in the aggregate, of US$ 4.4 millionthrough 2021, plus contingent annual rentals based on the change in the U.S.Consumer Price Index. Financial Review FR25
  26. 26. Financial Review. Note CMinimum future lease payments under capital leases as of December 31, 2010 foreach of the next five years and in the aggregate are: AmountYear ended December 31 in 1,000 US$2011 3992012 3992013 3992014 3992015 399Thereafter 2,360Total minimum lease payments 4,355Less: amount representing interest (1,878)Present value of minimum lease payments 2,477Operating leases consist primarily of rental agreements for real estate, aircraft, ma-chinery and office equipment expiring in various years through 2021, generallywith options to renew.Payments made under operating leases are charged to the consolidated statementof operations on a straight-line basis over the period of the lease.The future minimum rental payments as of December 31, 2010 under noncancel-able operating leases ­ aving initial or remaining terms in excess of one year are: h AmountYear ended December 31 in 1,000 US$2011 15,2752012 11,6502013 7,3582014 4,9522015 3,417Thereafter 623Total minimum future rental payments 43,275Operating lease expense for the years ended December 31, 2010 and 2009 wasUS$ 24.3 million and US$ 19.8 million, respectively.10 Pensions and other postretirement benefitsUpon retirement, employees of certain non-U.S. subsidiaries are entitled to pen-sions according to the laws and practices of the individual countries where theemployees are located.Certain non-U.S. subsidiaries have defined benefit pension plans. The major de-fined benefit pension plans provide pensions as well as life and disability insurancemainly for subsidiaries in Switzerland.FR26 Financial Review
  27. 27. Synthes. Annual Report 2010Following are reconciliations of the pension benefit obligation and plan assets for 2010and 2009. 2010 2009 in 1,000 US$ in 1,000 US$Pension benefit obligationBalance, beginning of year (322,037) (274,583)Service cost (28,728) (24,569)Interest cost (10,400) (9,390)Benefits paid 8,553 4,284Actuarial losses (18,833) (9,655)Changes in foreign currency exchange rates (38,309) (8,124)Balance, end of year (409,754) (322,037)Plan assetsFair value, beginning of year 310,860 250,598Actual return on plan assets 3,219 27,997Company contributions 19,474 16,823Contributions by plan participants 12,678 11,461Changes in foreign currency exchange rates 34,576 8,265Benefits paid to plan participants (8,553) (4,284)Fair value, end of year 372,254 310,860Funded status (37,500) (11,177)For 2010 and 2009, the amounts recognized in the consolidated balance sheets wereclassified as follows: 2010 2009 in 1,000 US$ in 1,000 US$Other assets – noncurrent 22,846 16,686Employee benefits and pension liabilities – noncurrent (60,346) (27,863)Accrued pension liability, net – noncurrent (37,500) (11,177)Accumulated other comprehensive income 47,819 21,575The underfunded status of the plans of US$ 37.500 million and US$ 11.177 million atDecember 31, 2010 and 2009, respectively, is recognized in the accompanying consol-idated balance sheets in other long-term liabilities. No plan assets are expected to bereturned to the Group during the fiscal year ending December 31, 2011.The accumulated benefit obligation was US$ 384.1 million and US$ 305.0 million atDecember 31, 2010 and 2009, respectively. The projected benefit obligation, accumu-lated benefit obligation and fair value of plan assets for plans with accumula­ ed and tprojected benefit obligations in excess of plan assets were US$ 406.1 million, US$381.0 million and US$ 368.7 million, respectively, as of December 31, 2010. The pro-jected benefit obligation, accumulated benefit obligation and fair value of plan assetsfor plans with projected benefit obligations in excess of plan assets were US$ 5.4 mil-lion, US$ 3.5 million and US$ 2.7 million, respectively, as of December 31, 2009. Financial Review FR27
  28. 28. Financial Review. Note CThe amounts recognized in the consolidated statements of operations, for theyears ended December 31, are as follows: 2010 2009 in 1,000 US$ in 1,000 US$Service cost 28,728 24,569Interest cost 10,400 9,390Expected return on plan assets (11,615) (9,445)Net actuarial losses recognized during the year 122 834Employee contributions (12,678) (11,461)Settlement or curtailment loss 207 -Total pension expense, included in personnel costs 15,164 13,887The pension plan assets include corporate bonds and equity securities of Swiss andinternational companies, real estate and cash with a total fair value of US$ 372.3million at December 31, 2010. The Swiss pension fund complies with the provisionsof the Swiss Pension Fund Act (BVG; Bundesgesetz über die berufliche Vorsorge).The last actuarial valuation was completed December 31, 2010.Principal actuarial assumptions (express­ d as weighted averages): e 2010 2009 in % in %Discount rate 2.64 3.24Expected return on plan assets 3.58 3.73Future salary increases 2.02 2.03Future pension increases 0.25 0.25The Group’s defined benefit pension funds’ investment managers propose the ex-pected long-term rate-of-return on assets assumption for each asset category, andthe Group’s management then reviews and confirms the proposal. The expectedlong-term rate-of-return on assets for the Group’s major defined benefit pensionfund in Switzerland is as follows: domestic equities at 6.50%, foreign equities at5.50%, domestic bonds at 3.00%, foreign bonds at 3.50% and real estate at4.00%. This results in a weighted expected long-term rate-of-return on assetsassumption of 3.60% for the Group. The pension plan asset allocation at Decem-ber 31, 2010 and the target asset allocation for 2011 are as follows: Percentage of Target allocation plan assets at 2011 December 31, 2010Asset category in % in %Equity securities 25.37 25.22Debt securities 59.74 59.86Real estate 11.87 11.90Other 3.02 3.02Total 100.00 100.00FR28 Financial Review