Zimmer Biomet Annual Report 2004

Plain-text annual report

Advantage:Zimmer 2004 Annual Report Zimmer Holdings, Inc. Training at the Zimmer Institute Advantage Zimmer: Performance Zimmer is the #1 pure-play orthopaedics company in the world. To maintain our advantage, we continue to execute the strategies that have served us well since we were spun off as a public company: 4 6 8 VALUE-ADDED EDUCATION Zimmer provides education and transfers skill sets to surgeons and nurses, collaborates with healthcare providers, and connects with patients through our Keeping Pace with Life® outreach program. INNOVATIVE INVESTMENT Zimmer has industry-leading research and development programs, devoting significant R&D resources to new technology and platforms such as Zimmer ® Minimally Invasive SolutionsTM (MISTM) Procedures and Technologies and Trabecular Metal TM Technology. FLAWLESS INTEGRATION Zimmer has moved quickly to realize the synergies of the Centerpulse acquisition with aggressive cross-training, worldwide adoption of best practices and expense reductions that we expect will amount to $100 million annually by the end of 2006. 10 ENHANCING QUALITY OF LIFE FOR PATIENTS WORLDWIDE Understanding the needs of patients worldwide and responding with products and services that enhance their quality of life is Zimmer’s overarching goal. TO OUR STOCKHOLDERS: The phrase Advantage Zimmer is likely to mean something different to each of our stakeholders. To our patients, it may mean faster recovery, shorter hospital stay, less rehab and a quicker return to work. To our surgeons, the Zimmer advantage consists of leading-edge educational pro- grams and advanced procedures, technologies and products. To investors, our advantage is found in clear strategies and flawless execution. To our dedicated employees, the Zimmer advantage is the opportunity to grow as part of a world leader while making life better for patients worldwide. Ray Elliott Chairman, President and Chief Executive Officer In 2004, we continued to deliver the Zimmer advantage to each • Raised estimates of annual synergy savings to $100 million of our stakeholder groups. After three full years as a public from our initial projection of $70 million to $90 million company, Zimmer today has a solid foundation for continued • Combined and trained sales organizations growth and leadership in the global reconstructive orthopaedics • Created common branding worldwide industry. We hold the #1 position in the reconstructive market • Created common worldwide financial consolidation and in the U.S., Europe and Japan, as well as the #1 worldwide quality systems position in both knees and hips. Our market capitalization • Implemented a global product development system to approximates $20 billion, with annual sales of nearly $3 billion. improve speed-to-market Every year we invest almost 6% of sales in research and • Consolidated orthobiologics research in Austin, Texas development to add new and better solutions and technologies • In-sourced a variety of formerly out-sourced manufacturing to our roster of more than 100,000 orthopaedic product SKUs. functions Further demonstrating our global footprint, our products are • Initiated a worldwide supply chain strategic plan for available in more than 100 countries. Our size and scope is manufacturing and distribution networks reflected in more than 1 million square feet of manufacturing • Unified professional medical education initiatives. capability. Best of all, more than 6,500 Zimmer employees are working hard to strengthen our advantage. The integration of Centerpulse has exceeded our expectations. 2004 HIGHLIGHTS An equally smooth process has been the creation of our new Trabecular Metal Technology division. Because of our As we began 2004, a key focus was the integration of Centerpulse, prior distribution relationship with Implex, we have a running including the realization of both targeted synergies and identi- start on both integration and new technology applications fied opportunities. Of the 3,364 scheduled milestones required that will allow us to expand our reconstructive, trauma and to execute the entire integration, we have accomplished 2,041. spinal product offerings significantly. We are tripling the Achievements to date include: production capacity of our new Trabecular Metal Technology 1 FINANCIAL HIGHLIGHTS Dollars in millions 27% 15% 6% 5% 7% 58% 82% Sales by Geographic Segment Reported (cid:1) Americas (cid:1) Europe (cid:1) Asia Pacific Consolidated Sales by Product Category Reported (cid:1) Reconstructive (cid:1) Trauma (cid:1) Spine (cid:1) Orthopaedic Surgical Products Consolidated 2002 $ 933 $ 170 $ 269 $1,372 2002 $1,061 $ 134 — $ 177 $1,372 2003 $1,208 $ 366 $ 327 $1,901 2003 $1,521 $ 150 $ 35 $ 195 $1,901 2004 $1,741 $ 809 $ 431 $2,981 2004 $2,456 $ 173 $ 134 $ 218 $2,981 division in New Jersey in order to meet the growing demand We take our commitment to deliver on expectations seriously, for this material that resembles and behaves like bone in and we have kept our pledge. In 2004, net sales increased certain aspects. 57% reported, and 15% pro forma,(2) to $2.98 billion, including We expect to be equally successful with other acquisitions a 4% increase due to changes in foreign exchange rates. Diluted and agreements announced recently. For example, we reached earnings per share were $2.19 reported, and $2.41 adjusted,(1) an agreement with CeramTec AG of Germany that, subject to an increase of 34% adjusted(1) over the prior year. FDA approval, will allow Zimmer to enter the U.S. market for A few of the many noteworthy facts include: 2004 was our ceramic-on-ceramic hip replacement, an attractive option for third full year as a public company, and our third consecutive younger patients. We also entered into a distribution agreement year with growth in adjusted(1) earnings per share in excess of with Baxter Healthcare Corporation that will allow Zimmer to mar- 30%. In addition, 2004’s $2.41 adjusted(1) earnings per share is ket Baxter’s ambulatory pump as part of a pain management kit 50 cents above the $1.91 First Call consensus estimate for for orthopaedic and other non-oncology surgical procedures in Zimmer at the time our intention to acquire Centerpulse was the United States. Most recently, Zimmer acquired U.S. distribu- announced. It’s clear that the acquisition of Centerpulse not only tion rights for the Palacos®* line of bone cement products man- was accretive to earnings on an adjusted(1) basis the very first day ufactured by Heraeus Kulzer of Germany, a world leader in the after closing but also continues to be, even with the issuance of development and production of orthopaedic bone cement prod- about 45 million new shares. ucts and other health care technologies. Our 2004 results reflect our detailed focus on operations. By the end of the year, our gross profit margin increased to FINANCIAL PERFORMANCE: DELIVERING ON EXPECTATIONS 76.4% reported and 76.8% adjusted,(1) which we believe is the Our ability to identify opportunities for growth and integrate best in our industry. In the first 15 months since closing the them into our business is creating an advantage for our acquisition of Centerpulse, we have generated more than $1 bil- investors. When we announced our acquisition of Centerpulse, lion in operating cash flow. As a result, we have accelerated the we indicated that we would deliver a minimum of 10 percent time frame to fully repay the debt related to the acquisitions of sales growth for the first two full years, 2004 and 2005. We both Centerpulse and Implex to mid-2006 at the latest. Also, also projected adjusted(1) growth of 20 percent or more in we have increased shareholder equity from $745 million at earnings per share for 2004; 20 to 25 percent for 2005; and the time of the Centerpulse acquisition to just under $4 billion the potential to exceed 25 percent for 2006. at the end of 2004. 2 * Trademark of Heraeus Kulzer GmbH Percentage growth reflects 2004 over 2003. Dollars in millions except for per share amounts. Dollar Values assume $100 was invested on August 7, 2001. Net Sales Operating Profit Operating Cash Flow Diluted Earnings Per Share Stock Performance +15% Pro forma(2) +57% Reported 2,981 2,590 1,901 2,168 1,372 +55% Adjusted (1) +74% Reported +69% Reported 904 763 862 +34% Adjusted (1) +34% Reported 2.41 2.19 1.80 1.64 495 1.31 584 451 401 220 $350 $300 $250 $200 $150 $100 $ 50 02 03 04 04 (1)“Adjusted” refers to performance measures that exclude in process R&D write-offs, acquisition and integration expenses, inventory step-up, a tax benefit from decreased Swiss deferred taxes and the change in accounting principle for instruments, as applicable. (2) “Pro forma” sales include Centerpulse sales for prior periods, as reflected by the green portion of the Net Sales bars above. See enclosed reconciliations of non-GAAP financial measures, page 72. 02 03 04 02 03 02 03 04 02 01 ZIMMER S&P 500 HEALTHCARE EQUIPMENT INDEX S&P 500 03 04 During the year, we also were able to improve our effective tax rate to 25.9% reported and 31.5% adjusted,(1) compared with INNOVATIVE INVESTMENT Zimmer continues to invest in products and technologies that will 33.6% reported and 33.4% adjusted(1) in 2003, an improvement yield still greater improvements in patient quality of life. Our R&D of almost two points year-to-year and in excess of four points pipeline contains 146 projects with over $1 million of development from our first quarter as a public company compared with 2004. each and some 163 projects in total. Of the 146 projects, about VALUE-ADDED EDUCATION two-thirds involve new platforms, new technologies and MIS Technologies. For example, the Orthobiologics Group in Austin is By collaborating with innovative surgeons worldwide, Zimmer developing innovative solutions for hip fracture and cartilage strives to improve patient quality of life with our MIS Procedures regeneration. Similarly, new technology platforms in the dental and Technologies. Through medical education events, live and spine areas will spark growth in those markets. We expect Webcast surgery, interactive learning tools and The Zimmer new products to consistently deliver 15% to 20% of our sales, Institute, we have exposed more than 7,500 surgeons or in the near term $500 million to $600 million each year. In worldwide to our innovative techniques and designs. Some 2004, new products contributed $541 million or 18% of sales, 100,000 patients and medical staff have visited our Zimmer up from 17% in 2003. Mobile Learning Center, in more than 150 stops across the Clearly, 2004 was another year of noteworthy achievements United States in 2004 alone. More than 2.6 million visitors for Zimmer, as shown by our being named one of the Medical logged onto Zimmer Web properties, including more than Manufacturers of the Year by Medical Device and Diagnostics 400,000 who visited the patient education portion of our Industry Magazine. This distinction is a tribute to the relentless site, www.pacewithlife.com. efforts of more than 6,500 Zimmer employees. It’s their dedica- The evidence continues to grow that our MIS Procedures are tion that will continue to deliver the Zimmer advantage to our improving productivity and profitability for surgeons and hospitals. patients, surgeons and stockholders for years to come. In a study of clinical data and a white paper on more than 700 hip patients who received Zimmer MIS 2-IncisionTM, MIS Mini-Incision, and traditional surgery at 20 hospitals, the Zimmer MIS 2-Incision Procedure delivered improvements in per patient profitability. Ray Elliott The study also demonstrated lower hospital and rehabilitative Chairman, President and Chief Executive Officer care utilization as well as significantly improved patient outcomes.** January 31, 2005 ** As demonstrated by Zimmer study. Patient outcome improvement measured as change in SF-36 function score. See page 10 for more information. 3 Advantage Zimmer: Value-Added Education Connecting with patients The NexGen® LPS-Flex Knee (left) accommodates flexion up to 155 degrees (far right), and is avail- able with ProlongTM Highly Crosslinked Polyethylene, complementing the NexGen Complete Knee Solution. Zimmer launched the MIS Quad-Sparing Total Knee Arthroplasty (TKA) (near right) in November of 2004 which allows surgeons to perform TKA through a 7-10 cm incision without cutting muscles or tendons. Direct-to-Consumer education and marketing programs (center) help the public understand mini- mally invasive joint replacement surgery and find surgeons trained in the latest techniques (bottom). The world’s leading orthopaedic specialists use Zimmer techniques procedures, along with a consumer education program to help and procedures to improve their patients’ lives. The Zimmer patients understand important differences between various types network of educational locations contributes to a common pool of minimally invasive joint replacement surgery. of data and best practices, enabling each participant to benefit Our public education campaign encompasses a number of from the experience and development of the others. resources for consumers who want to learn more about minimally ZIMMER INSTITUTE EXPANDS THE BENEFITS OF MIS The Zimmer Institute and its Satellites, the flagship of our MIS Procedures and Technologies education efforts, offer surgeons the opportunity to learn surgical procedures in a laboratory environment that closely simulates an operating room. Since we established the Zimmer Institute at our Warsaw, Indiana headquarters in 2003, we have expanded its reach by adding many leading institutions to the list of participating organi- Expanding education zations. To date, we have secured partnerships with invasive joint replacement and locate orthopaedic surgeons trained in the latest techniques. During the year, the Company added two new Zimmer Institute Satellites; launched a 13-city, low-cost public relations and Direct-to-Consumer (DTC) campaign capitalizing on more than 100,000 visits to the Company’s “Find-a-Doctor” Web-based surgeon locator; and supported 17 different MIS-related papers. In addition, Zimmer placed more than 2,000 MIS Quad-Sparing and MIS Mini-Incision Knee Replacement instrument sets in the field — by management estimates, more than the Company’s top three competitors combined. such prestigious institu- ECONOMIC VALUE-ADDED FOR HOSPITALS Because today’s tions as Johns Hopkins patients need joint implants earlier than in the past, Zimmer will University School of also be focusing on hospitals and payors besides Medicare, such Medicine, University of as insurance companies, HMOs and Workmen’s Compensation Nebraska Medical Center, carriers. As part of our “Economic Value-Added” strategy, we Tucson Orthopaedic Institute, Ohio Orthopaedic Surgery Institute, are emphasizing to these payors the potential of MIS Procedures University of British Columbia Centre for Excellence in Education not only to enhance the quality of patients’ lives but also to and Innovation, Alabama Orthopaedic Institute in North America, shorten hospital stays and rehabilitation time. and with several international partners. We also have established Healthcare providers also are beginning to realize the benefits learning centers at leading hospitals throughout North America. of using MIS Procedures. For example, recent data indicate that, GROWING ACCEPTANCE OF MIS Zimmer has spearheaded the growth and acceptance of MIS Procedures and Technologies and moved proactively to train surgeons in different MIS approaches for both knee and hip replacement procedures. Last November, for example, Zimmer launched its MIS Quad-SparingTM Total Knee Arthroplasty, one of the least-invasive and first widely available minimally invasive knee replacement compared with traditional open surgery, Zimmer’s patented MIS 2-Incision Hip Replacement Procedure can yield significant benefits in cost reduction and productivity while enhancing patient quality of life. Compared with conventional techniques, the MIS 2-Incision Technique showed the highest incremental value after three months, with 30% less cost and 30% greater improvement in physical function.* 4 * As demonstrated by Zimmer study. Patient outcome improvement measured as change in SF-36 function score. See page 10 for more information. MIS Quad-Sparing TKA Direct-to-Consumer education and marketing Up to 155 degrees of flexion 30% improvement in both cost and patient outcomes is possible with Zimmer 2-Incision hip replacement* Training at The Zimmer Institute in Warsaw, IN 5 Advantage Zimmer: Innovative Investment Advancements in orthopaedic materials, procedures and technologies Zimmer is using Trabecular Metal Technology (left) across an array of primary and revision hip, knee and spinal implants. Woven materials (near right) are used in a prototype for a next generation hip fixation product. Electromagnetic (EM) tracking from Zimmer Computer Assisted Solutions (center) is being developed for hip and knee MIS applications. Bone regeneration materials from Zimmer Dental (far right) can be used for various bone grafting needs. Zimmer continues to build on its leadership in research and devel- Products introduced in 2004 included the expansion of our opment, particularly in Minimally Invasive Solutions Procedures, Tapered Screw-Vent ® Implant System, which enhances stability while Trabecular Metal Technology, Zimmer Computer Assisted Solutions, allowing placement in even the most challenging locations. Further, orthobiologics and our expansion into spine and dental. we successfully expanded our Puros® Allograft family of bone regen- INDUSTRY-LEADING R&D In 2004, while completing the integration of Centerpulse, 146 projects for the future About two-thirds of our R&D is invested in new technologies, MIS Technologies and new platforms. eration products. POSITIONING OUR SPINAL BUSINESS FOR GROWTH Our flagship spinal offering, Dynesys® Dynamic Stabilization System, can alleviate lower back and leg pain using flexible materials to stabilize the spine, as an adjunct to fusion. For other patients, 30% we are planning to add a second-generation disc replacement 15% 9% 6% MIS New Technologies New Platforms Revision Support offering to address that clinical indication. New product developments are in the areas of Trabecular Metal Technology and posterior MIS Procedures and Technologies. Zimmer delivered more than 40 major development projects to 40% the market. We generated more than $540 million in new prod- uct sales, which represents 18 percent of sales – consistent with our goal of 15 to 20 percent. PURSUING BREAKTHROUGHS IN ORTHOBIOLOGICS Zimmer is INNOVATIONS IN COMPUTER ASSISTED SOLUTIONS We success- developing biological solutions to repair and regenerate damaged or fully completed the first computer image-guided MIS 2-Incision Hip degenerated orthopaedic tissues. In 2004, we completed work to Replacement live surgery early in 2004 with new software and instru- launch the Zimmer ® Collagen Repair Patch to treat rotator cuff tears, mentation co-developed with our partner, Medtronic Navigation. which is planned for release in early 2005. We also continued our With this technology, surgeons can accurately position and track collaboration with ISTO Technologies to develop a chondral graft for implants and instruments used in total hip and knee arthroplasty. cartilage repair and pursued the European release of our Denovo®-T In early 2005, Zimmer Computer Assisted Solutions (CAS) Autologous Chrondrocyte Transplantation Graft for articular cartilage set new standards with state of the art navigation tools such as repair. In addition, we have ongoing programs and technology survey electromagnetic (EM) tracking. For the first time in orthopaedic activities in the areas of soft tissue repair and regeneration including history, the successful use of EM MIS Technology provides tendon, ligament and meniscus and in bone regeneration, spine surgeons with improved ease of use due to the elimination of and dental areas. OUR EXPANDING DENTAL BUSINESS We are developing less inva- sive, less time-consuming dental procedures that produce more visually pleasing results. Our strategy is to combine our expertise in prosthetics with our strong array of implant options. To help dentists deliver better care to their patients, we offer a variety of industry-leading educational and practice-building programs such as Peer Practicum® and DuSER.® 6 line of sight issues experienced with existing optical approaches. The technology is presently being developed for both hip and knee MIS applications and could be used in virtually any reconstructive procedure. In February of 2005 the world’s first successful TKA procedure using EM navigation was performed using the MIS Quad-Sparing Technique. Next generation hip fixation product Zimmer Computer Assisted Solutions Puros Block Allograft 18% of 2004 sales came from new products* The cellular structure of Trabecular Metal Material (middle of photo) resembles bone (top of photo) and approximates its properties more closely than other prosthetic metals. * Sales from “new products” defined as sales of products introduced in the preceding rolling 36-month period. 7 Advantage Zimmer: Flawless Integration Creating a global leader After acquiring Centerpulse, Zimmer created a brand identity that communicated its global leadership (left). Some examples of completed integration milestones include the insourcing of investment castings to Warsaw (bottom) and forgings to Winterthur (center). We are moving the Cancellous-Structured TitaniumTM (CSTi)TM Porous Coating process (far right) from Austin to Warsaw. We are tripling the capacity of our Trabecular Metal reactor production in the New Jersey area (near right) to meet growing demand for this material. The acquisitions of Centerpulse and Implex illustrate the way In addition, we began transferring production from Austin, Zimmer has moved to add capabilities that will assist us in Texas to Warsaw, Indiana; Ponce, Puerto Rico; and Winterthur, continuing to be a leader in the orthopaedics industry. Switzerland; and are expanding the manufacturing capacity of CENTERPULSE In acquiring Centerpulse, Zimmer combined a U.S. company with a European company, and moved quickly to brand the resulting entity as a global provider. Just over one year after the successful completion of our offer for Centerpulse, our integration efforts are ahead of schedule and expected annual cost savings Integration on track With nearly two-thirds of our now exceed $100 million, which is higher than our origi- integration milestones completed, nal estimates of $70 million we expect annual cost savings to $90 million. The success of 100% 3,364 this integration is a tribute to more than 6,500 worldwide employees, including approxi- mately 100 full-time people to exceed $100 million. 61% 52% 2,041 41% 1,745 1,379 21% 701 those facilities and our distribution facility in Warsaw. We also are moving to best practices from across the company, and are insourcing forgings to Winterthur and investment castings and high volume instruments to Warsaw. Equally impressive has been the ongoing cultural integration of the two companies, a process made easier by the similarities in the two companies’ core values. Zimmer conducts regular employee perception surveys to ensure the integration process is on track. While there has been tremendous progress, certain integration activities will continue for the next two years. Complete integration, of all information technology systems and the manufacturing optimiza- tion are expected to be ongoing activities over the next two years. who contributed thousands IMPLEX Completed in April 2004, our acquisition of Implex of dedicated hours integrating will enable us to increase Trabecular Metal sales to more than the two companies. We have $100 million in 2005. The cellular structure of Trabecular Metal– completed more than 2,000 The Best Thing Next To BoneTM– approximates the physical and Q1 04 Q2 04 Q3 04 Q4 04 2006 Completed Planned of the 3,364 milestones that mechanical properties of bone more closely than other prosthetic were identified by our integra- materials. The unique, highly porous, trabecular configuration is tion teams. Those milestones represent more than 350 individ- conducive to bone formation, enabling rapid and extensive tissue ual projects, which are tracked by company management on a infiltration and strong attachment. Because Zimmer has been daily and weekly basis. marketing Trabecular Metal Products for more than three years, Among those milestones were the restructuring of our sales we have a running start on both integration and new technology forces in the U.S., Europe and Asia Pacific and the conversion of applications. Zimmer has 13 active Trabecular Metal Technology select distributor markets to a direct sales model. By the end of development projects in the reconstructive area, and we will be 2004, the global cross-training of the two sales forces was more expanding our spinal products significantly. than 70 percent complete. 8 Trabecular Metal Reactor in New Jersey Forging process in Winterthur Vacuum furnace in Warsaw 6,500+ employees worldwide contributed thousands of dedicated hours to make the integration a success Investment casting in Warsaw 9 Advantage Zimmer: Enhancing Quality of Life for Patients Worldwide Zimmer’s commitment to under- standing the needs of patients is yielding improved clinical outcomes. Zimmer’s business is driven by the needs of a “new patient” who is more active, more knowledgeable, and living longer. The new patient is likely to be a woman, as women now represent 63 percent of knee patients, compared with 52 percent 10 years ago. The increase is due at least in part to a higher incidence of arthritis and osteoporosis among older females compared with males. Women also make 85 percent of healthcare purchasing decisions.* Our MIS Hip and Knee Procedures are meeting patient expectations for enhanced post-surgery quality of life. Zimmer studies, for example, indicated that compared with traditional open hip replacement surgery, Zimmer’s advanced MIS 2-Incision Procedure targets minimal blood donation or loss, 50 to 75 percent less rehabilitation time, minimal tissue disruption and scarring, and reduced or elimi- nated narcotic pain relief. Many patients are often able to walk and return home on the same day. * Source: U.S. Government Statistics Zimmer MIS Hip Procedures Yield Clinical and Cost Benefits Three months after surgery, patients receiving Zimmer MIS 2-Incision and Mini-Incision Hip Procedures showed greater improvement in SF-36* Physical Function than with conventional surgery, and at lower cost. Total Inpatient Acute Hospital and Post-Discharge Rehabilitation Cost in Dollars 39 11,072 13,006 34 15,000 12,000 9,000 6,000 3,000 0 SF-36 Physical Function Change PreOp to 3 Months Post Op 14,449 27 50 40 30 20 10 0 ■ MIS 2- ■ MIS Mini- ■ Conventional Incision Incision Surgery * SF-36 is a registered trademark of the Medical Outcomes Trust, Inc. The 36-item short-form SF-36 Health Survey was designed for use in clinical practice and research, health policy evaluations, and general population surveys. 10 Exercising and gardening again after MIS Quad-Sparing Knee Replacement Procedure “Immediately after surgery, the pain was gone for the first time in 15 years. Within a month, I was back to doing everything I had enjoyed, only without the pain. I even danced at a wedding and sent a photograph to my surgeon. It felt great.” Martha Morris, Alabama Hospital to home in less than two days “I was amazed to be out of hospital so Martha Morris quickly, and my knee is infinitely better than it has been.” Tim Barnard, Winchmore Hill, United Kingdom Treating patients 17 days after surgery “When the surgeon told me that I could have MIS Quad-Sparing TKA and be back to work in a matter of weeks, not months, I scheduled the procedure right away.” Dr. Martin Ungerleider, New Jersey Two months after total hip surgery “My recommendation is not to wait for too long. The quality of life returns quickly after surgery. I am doing very well and do not have any pain.” Hugo Braendle, Hergiswil NW, Switzerland Yoga instructor without pain after Zimmer’s MIS 2-Incision Hip Replacement Procedure “I didn’t want a major operation with a big cut. It was a gift to get out of the hospital so quickly.” Kathleen Flanagan, California Dr. Martin Ungerleider Kathleen Flanagan 11 Advantage Zimmer: More Innovation Reconstructive Implant Our spirit of innovation in products, processes and technologies changes orthopaedic care every day. Our broad range of applications enables us to improve the quality of life for both younger and older patients along the continuum of care. Minimally Invasive Solutions Procedures and Technologies Zimmer has developed procedures and instrumentation that make it possible for surgeons to use minimally invasive techniques with a number of its knee and hip implants, and has plans to release implants specifically for minimally invasive procedures. Zimmer Computer-Assisted Solutions Zimmer CAS image guidance tools were developed exclusively by Zimmer for both MIS and traditional procedures. Zimmer CAS uses high-speed comput- ers and multiple imaging technology to track, in real time, the location of surgical instrumentation. Trabecular Metal Technology 12 Zimmer’s advanced instrument concepts allow surgeons to perform our minimally invasive procedures with smaller instruments that accommodate smaller incisions and cause less disruption of surrounding tissues, muscles and tendons. As a result, patients have the potential to experience faster recovery time and require less rehabilitation and pain medication. Trabecular Metal Technology This highly porous material is made of elemental tantalum and resembles bone very closely in its structure and mechanical properties. Clinical experience in thou- sands of cases has proven the versatility of Trabecular Metal Technology in diverse orthopaedic applications and is currently used in primary and revision hip, knee, spine, trauma and shoulder products. Alternate Bearing Surfaces Highly Crosslinked Polyethylene Technology This bearing surface material for total knee replacement is designed to offer improved wear performance over that of conventional polyethylene. Highly crosslinked polyethylene materials, under our Durasul,® Longevity®and Prolong brands, have become Zimmer’s most popular articulating surface. Metasul® Metal-on-Metal Technology This technology for hip implants has become Zimmer’s most popular tri- bological solution in Europe. Metasul provides highly wear resistant metal- on-metal articulation. Zimmer Orthobiologics Zimmer is developing biological solutions to repair and regenerate damaged or degenerated tissues. We are collaborating with ISTO Technologies in the develop- ment of a cartilage graft for cartilage tissue repair and regeneration, and we worked with Tissue Science Laboratories on the development of the Zimmer Collagen Repair Patch. Transformational Technology Products for proximal femoral fractures— this advanced proprietary technology is designed for less invasive treatment of the most common fracture in the body. Knees Knee replacement surgeries include f for the replacement of arthritic areas for the replacement, repair or enhan from a previous procedure. Knee rep total or partial reconstruction of the limited knee degeneration and invo compartment of the knee. Total reco all three compartments of the knee. MIS Minimally Invasive Solutions for Total Knee Arthroplasty In collaboration with renowned surgeons, Zimmer has developed a comprehensive portfolio of MIS Knee Procedures and training, enabling surgeons to choose the approach they feel most confident in performing. Approaches currently include the MIS Quad-Sparing, Subvastus and Midvastus Procedures, and MIS Medial Parapatellar techniques. NexGen® Complete Knee Solution The top-selling knee system in the world, this comprehensive knee replacement system allows surgeons to create solutions specific to the unique needs of each patient for primary or revision surgery. It offers several surgical philosophies including market-leading posterior stabilized (PS) designs. Recent releases in the NexGen System are the LPS-Flex and the patented cruciate retaining CR-Flex for patients who require deep flexion during their daily activities. NexGen LPS-Flex Total Knee s first-time joint replacement procedures s of the knee and revision procedures ncement of an implant or component placement procedures may involve knee. Partial reconstructions treat olve the replacement of only one onstruction refers to replacement of Innex TM(1) Total Knee System This knee prosthesis system, which was launched in 2001, enables unique intra-operative flexibility for all tricompart- mental implantations and is available with both mobile and fixed bearing options. (1) Not available for commercial distribution in the U.S. Natural-Knee® II System The Natural-Knee System consists of inter- changeable implants with features including a proprietary CSTi Porous Coating option for stable fixation in active patients, a deepened trochlear groove to maximize range of motion, and simple to use instrumentation. The Natural-Knee II System is based on the design principles of the Natural-Knee System, which has 20 years of excellent clinical experience. Natural-Knee II System Hips Total hip replacement surgeries replace both the head of the femur and the socket portion of the pelvis. These surgeries include first time joint replacement procedures and revision procedures for the replacement, repair or enhancement of an implant or component from a previous procedure. Today, many replacement components are porous and do not require bone cement because bone can grow into, and onto, the implant surface. MIS Minimally Invasive Solutions for Total Hip Arthroplasty In collaboration with renowned surgeons, Zimmer has developed a comprehensive portfolio of MIS Hip Procedures and training, enabling surgeons to choose the approach they feel most confident in performing. Approaches currently available or in develop- ment include the MIS 2-Incision, Anterior, Anterolateral, and Posterior procedures, as well as the MIS Mini-Incision Anterolateral and Posterolateral Procedures. Alloclassic® (Zweymüller TM) Hip Prosthesis This is one of the largest selling stems available today that is practically unchanged since its introduction in 1979, with minor modifications made to address demands of today’s patients and surgeons. Zimmer M/L Taper Hip Prosthesis This product was launched in 2003 as part of Zimmer’s portfolio of cementless tapered stems, a rapidly growing segment in the primary stem market. Zimmer Unicompartmental Knee Zimmer Unicompartmental Knee System This system adds to Zimmer’s portfolio of high flexion knee replacement options. It was designed for less invasive surgeries and offers three new surgical approaches. Its design builds on the Zimmer M/G® Unicompartmental Knee System introduced in 1987. Prolong Highly Crosslinked Polyethylene This bearing surface material for total knee replacement is designed to offer improved wear performance and is the only articulating surface product with the ability to claim “resistance to delamination.” Trabecular Metal Augments and Tibial Cones These components combine the benefits of Trabecular Metal Technology with the clinically proven geometries of the NexGen Total Knee. They provide structural support in areas of bone loss and offer an innovative alternative to grafting procedures. Clockwise from left: Trilogy, Allofit and Trabecular Metal Modular Acetabular Cups VerSys® Hip System This is one of the most comprehensive single system brands of hip implants in the world. It incorporates a wide variety of design philosophies while utilizing a single set of instruments, thus reducing the need for extensive training of hospital staff. The VerSys FullCoat and Fiber Metal Taper stems are used extensively with Zimmer’s MIS Mini- and MIS 2-Incision techniques for primary hip replacement. CLS® Hip System The CLS Hip is a grit-blasted, titanium, cementless stem. With a 100% implant survivorship at 11 years,(2) the CLS stem has become a standard for proximal press-fit design. (2) 2004 Swedish National Registry Trabecular Metal Tibial Cones Alloclassic Hip Stem and Metasul Articulation Technology Zimmer M/L Taper VerSys Fiber Metal Taper 13 Spine Extremities Dental Zimmer’s shoulder and elbow products are designed to treat arthritic conditions and fractures as well as to enhance the outcome of primary or revision surgery. Zimmer’s dental products consist of implants used to take the place of missing teeth, as well as regenerative materials, periodontal membranes and bone grafting products used to restore hard tissue in the upper and lower jaw. Zimmer has numerous active research and development projects in the areas of fusion, non-fusion, and biologic fusion alternatives. The company currently offers spine products in four key categories or franchises. Zimmer Collagen Repair Patch Zimmer® Collagen Repair Patch Zimmer worked with Tissue Science Laboratories to develop an innovative, nonresorbable biological collagen patch for repair of rotator cuff injuries. The Coonrad/Morrey® Total Elbow The Coonrad/Morrey Total Elbow is designed to restore elbow joint function in cases of primary, revision, or trauma surgery. A wide variety of joint sizes and combinations allow the physician to create solutions that are specific to each patient. Bigliani/Flatow ® The Complete Shoulder Solution The Bigliani/Flatow Shoulder allows for the restoration of shoulder joint function in cases of shoulder replacement surgery. It is designed to replicate the natural shoulder’s mobility, balance, and stability with a multitude of component sizes. Bigliani/Flatow Shoulder Tapered Screw-Vent Internal Hex Implant System A new Fixture Mount Transfer was designed for easier preparation and more accurate impression taking. This multi-purpose fixture mount is both a transfer for first-stage impres- sions and a prepable temporary abutment. Tapered Screw-Vent Implant System Puros Family of Allograft Materials Zimmer Dental offers three unique Puros Allograft Products to use together or sepa- rately for various bone grafting needs: Puros Cancellous Particulate, Puros Cortical Particulate, and Puros Block Allografts. The natural collagen and minerals found in Puros Allografts foster strong and rigid bone growth, and facilitate full bone remodeling. AtlantisTM(4) Abutment Atlantis patient specific abutments use a patented process that employs 3D optical scanning, automated design software and integrated machining to manufacture indi- vidualized components for the dental implant market. The use of Atlantis Abutments simplifies the restorative proce- dure and improves outcomes for patients and practitioners. (4) Trademark of Atlantis Components Inc. Atlantis Abutment Trilogy ® Acetabular System The Trilogy System combines proven features with new technology designed to inhibit the formation and migration of polyethylene debris. With this product, Zimmer provides multiple defense mechanisms against the poly debris that can be associated with osteolysis. Allofit TM Hip Acetabular System The Allofit Acetabular System is designed to achieve maximum stability in virtually every press-fit situation. It is available to use with advanced tribological technologies such as metal-on-metal and highly crosslinked polyethylene. Trabecular Metal Acetabular Cup Systems The elliptical shape of the cup creates an interference fit with the spherically reamed acetabulum. From the pole of the dome, the interference fit increases until a 2mm differential is achieved at the face of the cup. This maximizes bone contact and enhances initial stability. Longevity Highly Crosslinked Polyethylene Made from a proprietary process that interlinks molecular chains, Longevity Polyethylene leaves virtually no free radicals that promote oxidation. The product was developed to address the issue of wear in total hip arthroplasty. DuromTM(3) Hip Resurfacing System The Durom Hip Resurfacing System is particularly suited to younger patients, allowing them to return to an active lifestyle. It uses Zimmer’s highly wear resistant Metasul Metal-on-Metal Technology as the bearing surface for the implant design and preserves femoral bone, making it ideal for young and active patients. (3) Not available for commercial distribution in the U.S. Durom Hip Resurfacing System Dynesys System Dynesys® Dynamic Stabilization System The Dynesys System uses flexible materials to stabilize the affected lower spine while preserving the natural anatomy of the spine. The system is indicated as an adjunct to fusion. NeuGraft ®(5) Strip A mixture of purified fibrillar collagen (PFC) and hydroxyapatite/tricalcium phosphate ceramic (HA/TCP), the NeuGraft Strip, when coated with autogenous bone marrow, is indicated for use in bony voids or gaps that are not intrinsic to the stability of the bony structure. (5) Trademark of NeuColl, Inc. Trinica® Select Anterior Cervical Plate System(6) The Trinica Select Plate System and All- Through-One (ATO) instrumentation simplifies the surgical procedure while requiring less retraction and reduces the risk of soft-tissue damage. The Trinica Select Self Drilling Screws seek to provide the surgeon with the option to reduce the amount of instruments, thereby potentially reducing the amount of retraction and OR time to implant the Trinica Select Plate. (6)The Trinica® and Trinica® Select Anterior Cervical Plate Systems technology was invented by GARY KARLIN MICHELSON, M.D. and is covered by one or more of the following: U.S. Patents 6,193,721, 6,398,783, 6,454,771 and D449,692; and pending U.S. and international patent applications. Trabecular Metal Spacers The Trabecular Metal Technology has a wide range of spinal applications. In the United States, Trabecular Metal shapes are cleared for both Thoracolumbar and Vertebral Body Replacement procedures as well as bone void fillers. Trabecular Metal Spacers 14 Trauma Orthopaedic Surgical Products Trauma products include devices used primarily to reattach or stabilize damaged bone and tissue to support the body’s natural healing process. Zimmer offers a comprehensive line of products for use in the fixation of fractures. Zimmer Periarticular Plating System The comprehensive stainless steel Periarticular Plating System includes the recently released locking plates, which are pre-contoured to closely follow the shape of the bone and create a fit that requires little or no additional bending. Zimmer Periarticular Locking Plate NCB® Locking Plates The titanium NCB Locking Plates feature variable-angle locking screws to allow sur- geons the choice of where to apply screws in the treatment of complex fractures. Sirus® Nail System This system covers all indications for both non-reamed and reamed medullary nailing, including all closed and open femoral shaft fractures; subtrochanteric fractures; shaft fractures in combination with femoral neck or pertrochanteric fractures; and pseudoarthrosis or delayed union. Sirus Nail System M/DN ® Intramedullary Fixation System A nailing system for internal fixation of long bone fractures, this product offers multiple screw options for increased surgical flexibility. ITST TM Intertrochanteric/ Subtrochanteric Fixation System This system permits less invasive fixation of femoral fractures that were traditionally repaired with more invasive compression hip screws. TransFx TM External Fixation System This product is designed for upper and lower extremity fracture management. It provides the physician with choices in frame construction, simplicity in frame management, and ease of transition in frame sizes, based upon anatomy and fracture type. WristoreTM(7) Distal Radius Fracture Fixator An adjustable and stable approach for fractures of the distal radius, the Wristore Distal Radius Fracture Fixator stabilizes fracture fragments near the joint. It can be used to quickly help restore joint function. (7) Trademark of Millennium Medical Technologies, Inc. Wristore Fixator Zimmer has developed and con- tinues to develop technologically advanced surgical products to support its reconstructive implant and trauma product systems in the operating room environment with a focus on blood and pain management products. Zimmer Blood Reinfusion System This product salvages, filters and then reinfuses a patient’s own blood following surgery. It, therefore, reduces the need for donor blood and its related cost or potential problems. OrthoPAT ®(8) Orthopedic Perioperative Autotransfusion System This blood management system is designed specifically for orthopaedic surgery to salvage, wash and reinfuse a patient’s own blood both during and after the procedure. This reduces or eliminates the need for stored blood and related complications. (8) Trademark of Haemonetics Corporation A.T.S.® Automatic Tourniquet Systems Zimmer is the market leader in surgical tourniquet systems and accessories. These products are used to create a bloodless surgical field. Pulsavac® Plus and Pulsavac Plus LP Wound Debridement Systems These products are used for cleaning and debridement of contaminants and foreign matter from wounds using simultaneous irrigation and suction. Both systems are completely disposable to reduce the risk of cross contamination. Zimmer Ambulatory Pump This product is part of a kit(9) that is designed to deliver a slow, continuous administration of anesthetic agent for post-surgical pain management. The system can stay with the patient during recovery and rehabilitation. (9) Not yet available for commercial distribution Zimmer Ambulatory Pump Blood Reinfusion System 15 Advantage Zimmer: Global Leadership The worldwide #1 pure-play orthopaedic company, Zimmer has operations in more than 24 countries around the world and sells products in more than 100 countries. Zimmer’s mission is to develop, produce and globally market the highest quality orthopaedic products and services that repair, replace and regenerate. Through the hands of skilled surgeons, we enhance patient quality of life. We are supported in that mission by the efforts of more than 6,500 employees. STOCKHOLM, SWEDEN KIEL, GERMANY BRUSSELS, BELGIUM SWINDON, UK PARIS, FRANCE RENNES, FRANCE FREIBURG, GERMANY ETUPES, FRANCE TOULOUSE, FRANCE BARCELONA, SPAIN AIX EN PROVENCE, FRANCE CATANIA, ITALY MISSISSAUGA, CANADA CEDAR KNOLLS, NJ DOVER, OH BALTIMORE, MD COLUMBUS, OH STATESVILLE, NC ORLANDO, FL PLANTATION, FL SAN JUAN, PUERTO RICO PONCE, PUERTO RICO INNSBRUCK, AUSTRIA BUDAPEST, HUNGARY MÖDLING, AUSTRIA TREVISO, ITALY MILAN, ITALY TALLINN, ESTONIA UTRECHT, NETHERLANDS MOSCOW, RUSSIA MÜNSINGEN, SWITZERLAND WINTERTHUR, SWITZERLAND BAAR, SWITZERLAND RAMAT GAN, ISRAEL BEIJING, CHINA SHANGHAI, CHINA CHENGDU, CHINA GUANGZHOU, CHINA CHENNAI, INDIA GREENSIDE, SOUTH AFRICA SEOUL, SOUTH KOREA TOKYO, JAPAN GOTEMBA, JAPAN FUKUOKA, JAPAN TAIPEI, TAIWAN HONG KONG BANGKOK, THAILAND SINGAPORE PERTH, AUSTRALIA SYDNEY, AUSTRALIA AUCKLAND, NEW ZEALAND WARSAW, IN MINNEAPOLIS, MN VANCOUVER, CANADA OMAHA, NE ST. LOUIS, MO MEMPHIS, TN DALLAS, TX CARLSBAD, CA TUCSON, AZ AUSTIN, TX BIRMINGHAM, AL ZIMMER CORPORATE HEADQUARTERS ( ) MANUFACTURING AND/OR MAJOR DISTRIBUTION FACILITIES OTHER OPERATING SUBSIDIARIES MEDICAL EDUCATION LOCATIONS 16 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K United States Securities and Exchange Commission Washington, D.C. 20549 FORM 10-K ¥ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For year ended December 31, 2004 Commission ﬁle number 001-16407 ZIMMER HOLDINGS, INC. (Exact name of registrant as speciﬁed in its charter) Delaware (State of Incorporation) 345 East Main Street Warsaw, Indiana (Address of principal executive ofﬁces) 13-4151777 (IRS Employer Identiﬁcation No.) 46580 (Zip Code) Registrant’s telephone number, including area code: (574) 267-6131 Securities registered pursuant to Section 12(b) of the Act: Title of each class Common Stock, $.01 par value Name of each exchange on which registered New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has ﬁled all reports required to be ﬁled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to ﬁle such reports), and (2) has been subject to such ﬁling requirements for the past 90 days. Yes ¥ No n Indicate by check mark if disclosure of delinquent ﬁlers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in deﬁnitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¥ Indicate by checkmark whether the registrant is an accelerated ﬁler (as deﬁned in Rule 12b-2 of the Act). Yes ¥ No n The aggregate market value of shares held by non-afﬁliates was $21,590,347,993 (based on closing price of these shares on the New York Stock Exchange on June 30, 2004, and assuming solely for the purpose of this calculation that all directors and executive ofﬁcers of the registrant are ‘‘afﬁliates’’). As of February 18, 2005, 246,690,710 shares of the registrant’s $.01 par value common stock were outstanding. Document Proxy Statement with respect to the 2005 Annual Meeting of Stockholders Documents Incorporated by Reference Form 10-K Part III Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K This annual report contains certain statements that are forward-looking statements within the meaning of federal securities laws. When used in this report, the words ‘‘may,’’ ‘‘will,’’ ‘‘should,’’ ‘‘anticipate,’’ ‘‘estimate,’’ ‘‘expect,’’ ‘‘plan,’’ ‘‘believe,’’ ‘‘predict,’’ ‘‘potential,’’ ‘‘project,’’ ‘‘target,’’ ‘‘forecast,’’ ‘‘intend’’ and similar expressions are intended to identify forward-looking statements. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, price and product competition, rapid technological development, demographic changes, dependence on new product development, the mix of our products and services, supply and prices of raw materials and products, customer demand for our products and services, the ability to successfully integrate acquired companies including Centerpulse AG and Implex Corp., the outcome of the pending informal Securities and Exchange Commission investigation of Centerpulse AG accounting, control of costs and expenses, the ability to form and implement alliances, changes in reimbursement programs by third-party payors, governmental laws and regulations affecting our U.S. and international businesses, including tax obligations and risks, product liability and intellectual property litigation losses, international growth, general industry and market conditions and growth rates and general domestic and international economic conditions including interest rate and currency exchange rate ﬂuctuations. Readers of this report are cautioned not to place undue reliance on these forward-looking statements, since, while the Company believes the assumptions on which the forward- looking statements are based are reasonable, there can be no assurance that these forward-looking statements will prove to be accurate. This cautionary statement is applicable to all forward-looking statements contained in this report and the material accompanying this report which comprise the Company’s annual report to stockholders. Table of Contents PART I Item 1. Business Item 2. Properties Item 3. Legal Proceedings Item 4. Submission of Matters to a Vote of Security Holders PART II Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Item 6. Selected Financial Data Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Item 7A. Quantitative and Qualitative Disclosures About Market Risk Item 8. Financial Statements and Supplementary Data Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure Item 9A. Controls and Procedures Item 9B. Other Information PART III Item 10. Directors and Executive Ofﬁcers of the Registrant Item 11. Executive Compensation Item 12. Security Ownership of Certain Beneﬁcial Owners and Management and Related Stockholder Matters Item 13. Certain Relationships and Related Transactions Item 14. Principal Accountant Fees and Services PART IV Item 15. Exhibits and Financial Statement Schedules Signatures 2 Page 3 17 17 17 18 19 20 33 36 61 61 61 62 62 62 62 62 63 64 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Part I ITEM 1. Business GENERAL Zimmer Holdings, Inc., a Delaware corporation, is a global leader in the design, development, manufacture and marketing of reconstructive orthopaedic implants, including joint and dental, spinal implants, and trauma products and related orthopaedic surgical products. The Company is headquartered in Warsaw, Indiana. Unless the context requires otherwise, the terms ‘‘Zimmer’’ and ‘‘Company’’ refer to Zimmer Holdings, Inc. and all of its subsidiaries. In October 2003, the Company ﬁnalized its acquisition of Centerpulse AG (‘‘Centerpulse’’), a Switzerland-based orthopaedics company and the leader in the European reconstructive market. In addition to providing the Company with a leading position in the European orthopaedic reconstructive implant market, the Centerpulse acquisition provided the Company with a platform in the faster growing spine and dental implant markets. As discussed in detail in this report, the Centerpulse acquisition had a signiﬁcant impact on the Company’s ﬁnancial results in 2004. On April 23, 2004, the Company acquired Implex Corp. (‘‘Implex’’), a New Jersey based company, pursuant to an Amended and Restated Agreement and Plan of Merger (the ‘‘Merger Agreement’’). The Implex acquisition was a culmination of a distribution and strategic alliance agreement, under which the Company and Implex had been operating since 2000, relating to the commercialization of reconstructive implant and trauma products incorporating Trabecular MetalTM Technology. Subsequent to the acquisition, the Company changed the name of Implex to Zimmer Trabecular Metal Technology, Inc. Throughout 2004 and entering 2005, a key focus of the Company has been, and will continue to be, the successful integration of the Centerpulse and Implex businesses. In 2004, the Company performed ahead of schedule under its comprehensive integration plan. As of the conclusion of 2004, the Company accomplished more than 2,000 of the total planned 3,364 integration milestones for the Centerpulse acquisition and the Company raised the estimated, sustainable integration cost synergies for this transaction to slightly over $100 million annually, an increase from the original estimates of $70 to $90 million. The Company also expects cash on hand to be in excess of total outstanding debt incurred from the Centerpulse and Implex acquisitions by June 30, 2006, absent any cash requirements for acquisitions. Zimmer was incorporated on January 12, 2001 as a wholly-owned subsidiary of Bristol-Myers Squibb Company (‘‘Bristol-Myers’’). Zimmer, Inc., a predecessor founded in 1927, was acquired by Bristol-Myers in 1972 and along with its wholly-owned subsidiaries and certain other of Bristol- Myers’ operations comprised the orthopaedics business of Bristol-Myers. On August 6, 2001, the Company was spun off from Bristol-Myers and became an independent public company. CUSTOMERS, SALES AND MARKETING The Company’s primary customers include musculoskeletal surgeons, neuro-surgeons, oral surgeons, dentists, hospitals, distributors, healthcare dealers and, in their capacity as agents, healthcare purchasing organizations or buying groups. These customers range from large multinational enterprises to independent surgeons. The Company has operations in more than 24 countries and markets products in more than 100 countries, with corporate headquarters in Warsaw, Indiana, and more than 100 manufacturing, distribution and warehousing and/or ofﬁce facilities worldwide. The Company manages its operations through three major geographic segments – the Americas, which is comprised principally of the United States and includes other North, Central and South American markets; Europe, which is comprised principally of Europe and includes the Middle East and Africa; and Asia Paciﬁc, which is comprised primarily of Japan and includes other Asian and Paciﬁc markets. Information about geographic segments can be found in Note 14 to the Consolidated Financial Statements, which are included herein under Item 8. The Company markets and sells product through three principal channels: 1) direct to health care institutions, such as hospitals, which is referred to as a direct channel account, 2) through stocking distributors and, in the Asia Paciﬁc region, healthcare dealers, and 3) directly to dental practices and dental laboratories. Through the direct channel accounts, inventory is generally consigned to sales agents or customers so that products are available when needed for surgical procedures. With the sales to stocking distributors, healthcare dealers, dental practices and dental laboratories, title to product passes generally upon shipment. Products are marketed and sold to all types of Company customers via both direct channel accounts and stocking distributors and healthcare dealers. No individual direct channel account, stocking distributor, healthcare dealer, dental practice or dental laboratory accounted for more than 10 percent of the Company’s net revenues for 2004. The Company carries inventory in warehouse facilities and retains title to consigned inventory in sufﬁcient quantities so that products are available when needed for surgical procedures. Safety stock levels are determined based on a number of factors, including demand, manufacturing lead times and optimal quantities required to maintain the highest possible service levels. The Company also carries trade accounts receivable balances based on credit terms that are generally consistent with local market practices. The Company utilizes a network of sales associates, sales managers and support personnel, most of who are employed by independent distributors and sales agencies. The Company 3 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K invests a signiﬁcant amount of time and expense in providing training in such areas as product features and beneﬁts, how to use speciﬁc products and how to best inform surgeons of such features and uses. Sales force representatives rely heavily on strong technical selling skills, medical education and the ability to provide staff technical support for surgeons. In response to the different healthcare systems throughout the world, the Company’s sales and marketing strategies and organizational structures differ by region. The Company utilizes a global approach to sales force training, marketing and medical education into each locality to provide consistent, high quality service. Additionally, the Company keeps current with key surgical developments and other issues related to musculoskeletal surgeons and the medical procedures they perform, in part through sponsorship of medical education events. In 2004, the Company sponsored more than 250 medical education events and meetings with and among musculoskeletal surgeons around the world. Americas. The Americas is the largest geographic segment, accounting for $1,741.3 million, or 58.4 percent, of 2004 net sales, with the United States accounting for $1,665 million of sales in this region. The United States sales force consists of independent sales agents, together with sales associates, sales managers and sales support personnel, the majority of which sell Company products exclusively for Zimmer. Sales agents in the United States receive a commission on product sales and are responsible for many operating decisions and costs. Sales commissions are accrued at the time of sale. In this region, the Company has also concentrated on negotiating contracts with purchasing organizations or buying groups and managed care accounts and has increased unit growth by linking the level of discount received to volume of purchases by customer health care institutions within a speciﬁed group. At negotiated thresholds within a contract buying period, price discounts increase. For these buying groups and managed care accounts, the Company tracks sales volume by contract and as contractual volume thresholds are achieved, the higher discounts are applied at an item level on customer invoices. Under these buying contracts, the Company is generally designated as one of several identiﬁed preferred purchasing sources for the members of the buying group for speciﬁed products, although the members are not obligated to purchase the Company’s products. A majority of hospitals in the United States belong to at least one group purchasing organization. In 2004, individual hospital orders purchased through contractual arrangements with such purchasing organizations or buying groups accounted for approximately 45 percent of the Company’s net sales in the United States. Contractual sales were highest through Novation, LLC (‘‘Novation’’), Premier Purchasing Partners, L.P. (‘‘Premier’’), and Health Trust Purchasing Group, representing 21.9 percent, 15.0 percent and 6.3 percent, respectively, of net sales in the United States. No individual end-user, however, accounted for over 1 percent of the Company’s net sales, and the top ten end- 4 users accounted for approximately 3.5 percent of the Company’s aggregate net sales in the United States. These buying contracts generally have a term of three years with extensions as warranted. The Company’s current arrangements with Premier, Novation and Health Trust Purchasing Group have all been renegotiated and updated in the past 12 months. In the Americas, the Company maintains an extensive monitoring and incentive system ranking sales agents across a range of performance metrics. The Company evaluates and rewards sales agents based on achieving certain sales targets and on maintaining efﬁcient levels of working capital. The Company sets expectations for efﬁcient management of inventory and provides sales agents a motivation to aid in the collection of receivables. Europe. The European geographic segment accounted for $808.3 million, or 27.1 percent, of 2004 net sales, with France, Germany, Italy, Spain, Switzerland and the United Kingdom collectively accounting for more than 82 percent of net sales in the region. In addition, the Company also operates in other key markets such as the Benelux, Austria, Nordic, and Central and Eastern Europe. The Company’s sales force in this region is comprised of independent distributors, commissioned agents, direct sales associates and sales support personnel. During 2004, the Company converted its distribution model in France, Italy, Switzerland and Austria from third-party distributors to direct sales. As expected following the acquisition of Centerpulse, in 2004 the Company substantially increased its presence in the European orthopaedic reconstructive implant market. In marketing its orthopaedic implant portfolio in Europe, the Company has continued to emphasize the advantages of clinically proven, established designs. Asia Paciﬁc. The Asia Paciﬁc geographic segment accounted for $431.3 million, or 14.5 percent of 2004 net sales, with Japan being the largest market within this segment, accounting for 65 percent of the sales in this region. In addition, the Company operates in key markets such as Australia, New Zealand, Korea, China, Taiwan, India, Thailand and Singapore. In Japan and most countries in the Asia Paciﬁc region, the Company maintains a network of dealers who act principally as order agents on behalf of hospitals in the region, together with sales associates who build and maintain strong relationships with musculoskeletal surgeons in their markets. These sales associates cover over 7,000 hospitals in the region. The knowledge and skills of the Company’s sales associates play a critical role in providing service, product information and support to surgeons who continue to enhance their knowledge and skills to improve the quality of surgical outcomes. The Company has strengthened, and intends to continue to support the clinical needs of surgeons in the region primarily through sponsorship of medical education and training programs relating to orthopaedic surgery. The key marketing and educational activities in the region center on minimally invasive surgical procedures and technologies, increased range of motion and improved patient outcomes. Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K The Company’s business is generally not seasonal in nature; however, many of the Company’s products are used in elective procedures, which typically decline during the summer months and holiday seasons. DISTRIBUTION The Company generally ships its orders via overnight courier. The Company’s operations support local language labeling for all shipments to the European Union member countries. The Company operates distribution facilities, among other places, in Warsaw, Indiana; Dover, Ohio; Statesville, North Carolina; Memphis, Tennessee; Carlsbad, California; and internationally in Australia, Belgium, Canada, France, Germany, Italy, Japan, Korea, the Netherlands, Singapore, Spain, Switzerland and the United Kingdom. The Company’s backlog of ﬁrm orders is not considered material to an understanding of its business. PRODUCTS The Company designs, develops, manufactures and markets reconstructive orthopaedic implants, including joint and dental, spinal implants, and trauma products, and related orthopaedic surgical products. Orthopaedic reconstructive implants restore joint function lost due to disease or trauma in joints such as knees, hips, shoulders, and elbows. Dental reconstructive implants restore function and aesthetics in patients that have lost teeth due to trauma or disease. Spinal implants are utilized by orthopaedic surgeons and neurosurgeons in the treatment of degenerative diseases, deformities and trauma in all regions of the spine. Trauma products are devices used primarily to reattach or stabilize damaged bone or tissue to support the body’s natural healing process. The Company’s related orthopaedic surgical products include surgical supplies and instruments designed to aid in orthopaedic surgical procedures. The Company also has a limited array of sports medicine products. Orthopaedic Reconstructive Implants The majority of reconstructive implant procedures restore joint function lost due to degenerative diseases such as arthritis and relieve pain in knees and hips. In 2004, the Company continued its efforts to maximize the potential patient beneﬁts of applying minimally invasive surgical techniques to orthopaedic surgery, which the Company refers to as Minimally Invasive SolutionsTM (MISTM) Procedures and Technologies. The Zimmer Institute, with its main facility located at the Company’s global headquarters, has been used, in addition to 17 satellite centers and wet lab locations, to facilitate the training of over 2,200 surgeons, sales associates, and other medical professionals on several innovative MIS Procedures. The Company expects another 1,800 surgeons to be trained through The Zimmer Institute and its satellite locations during 2005. Company announced that it is working with Johns Hopkins University School of Medicine to advance education in MIS Technologies. The Company also announced a similar relationship with a group of surgeons afﬁliated with the University of British Columbia in Vancouver, Canada, as well as relationships with the University of Nebraska Medical Center, Ohio Orthopaedic Surgery Institute, Alabama Orthopaedic Institute, and Tucson Orthopaedic Institute. The Company has plans to continue to afﬁliate with additional North American and international institutions to provide surgeon education at the Zimmer Institute and its satellite locations. The principal goals of these MIS Technology efforts are to reduce the hardships of having a total joint replacement, such as the time a patient must spend in rehabilitation, pain reduction and lost time from work. The Company is continuing its work to develop navigation systems, through the use of image-guided surgical technology, to aid surgeons in learning procedures and gaining conﬁdence in the placement of instrumentation and implants where navigation is difﬁcult due to the small incisions necessary in effectuating MIS Procedures. The Company is focused both on further commercializing existing MIS Technique approaches and investigating new ways to apply MIS Technology principles to additional procedures and products. The Company’s ﬁnancial investment in the MIS Technology program in 2004 was more than $30 million, excluding instruments. Knee Implants Total knee surgeries typically include a femoral component, a patella (knee cap), a tibial tray and an articulating surface (placed on the tibial tray). Knee replacement surgeries include ﬁrst-time joint replacement procedures and revision procedures for the replacement, repair or enhancement of an implant or component from a previous procedure. Knee implants are designed to accommodate different levels of ligament stabilization of the joint. While some knee implant designs, called cruciate retaining (‘‘CR’’) designs, require the retention of the posterior cruciate ligament, other designs, called posterior stabilized (‘‘PS’’) designs, provide joint stability without the posterior cruciate ligament. There are also procedures for partial reconstruction of the knee, which treat limited knee degeneration and involve the replacement of only one side or compartment of the knee with a unicompartmental knee prosthesis. The Company offers a wide range of products for specialized knee procedures, including, among others, the following brands: ProlongTM Highly Crosslinked Polyethylene Articular Surfaces. The Prolong Polyethylene is a bearing surface material for total knee replacement. It is believed to be the only articulating surface product with the ability to claim ‘‘resistance to delamination’’. NexGen˛ Complete Knee Solution. The NexGen The Company is working with several global medical centers to evaluate and reﬁne advanced minimally invasive knee and hip replacement procedures. In February 2004, the Knee product line is a comprehensive system for knee replacement surgery which has had signiﬁcant application in PS, CR and revision procedures. The NexGen Knee System 5 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K offers joint stability and sizing that can be tailored to individual patient needs while providing surgeons with a uniﬁed system of interchangeable components. The NexGen Knee System provides surgeons with complete and versatile knee instrument options, including MIS Quad-SparingTM and MIS Mini-Incision Instruments, milling and multiple traditional saw blade cutting instrument systems. The breadth and versatility of the NexGen Knee System allows surgeons to change from one type of implant to another during surgery, according to the needs of the patient, and to support current surgical philosophies. The ongoing use of Trabecular Metal Monoblock Tibial Components in both CR and PS philosophies enhances the Company’s strategy to add new innovative technologies to this brand. Trabecular Metal Materials provide a dramatically higher level of porosity and surface friction than existing alternatives, are similar in stiffness to natural bone and are believed to be a major advancement in orthopaedic materials. The NexGen Complete Knee Solution Legacy˛ Knee-Posterior Stabilized product line provides stability in the absence of the posterior cruciate ligament. The PS capabilities have been augmented through the introduction of the NexGen Legacy Posterior Stabilized Flex Knee (the ‘‘LPS-Flex Knee’’), a high-ﬂexion implant that has the potential to safely accommodate knee ﬂexion up to a 155-degree range of motion in some patients when implanted using a specialized surgical technique. The NexGen LPS-Flex Fixed Prolong Articular Surfaces and Femoral Implants were released in December 2004. The NexGen CR product line is designed to be used in conjunction with a functioning posterior cruciate ligament. The NexGen CR-Flex Fixed Bearing Knee was added to the product line in 2003 and is designed with components to provide a greater range of motion for patients who require deep bending in their daily activities. The NexGen CR-Flex Femoral Components allow the surgeon to adjust component sizing without removing additional bone. The NexGen Revision Knee product line consists of several different products that are designed to provide clinical solutions to surgeons for various revision situations. In 2004, the Company commercialized a new bone augmentation implant system made from Trabecular Metal Technology material. These new augments are designed to address signiﬁcant bone loss in revision surgery. The Natural-Knee˛ System. The Natural-Knee Prosthesis System consists of a complete range of interchangeable, anatomically designed implants which include several innovative features the Company believes cannot be found in other current systems, including a proprietary Cancellous-Structured TitaniumTM (CSTiTM) Porous Coating option for stable ﬁxation in active patients. The original Natural-Knee System will be celebrating its 20th anniversary of clinical use in 2005. New Natural-Knee II MIS Instrumentation was launched in December 2004. These instruments are designed to accommodate a smaller incision during the knee procedure. 6 The InnexTM Total Knee System. The Innex Knee System offers ﬁxed bearing and mobile bearing knee components all designed within the same system philosophy. While the Innex Knee System is best known for its mobile bearing knee offering, the availability of differing levels of articular constraint and the Innex Revision Knee components provide for a comprehensive mobile and ﬁxed bearing knee system. The Innex Knee System is currently distributed in Europe and Asia Paciﬁc, but is not available for commercial distribution in the United States. Unicompartmental Knee Systems. The M/G˛, Natural-Knee II and AllegrettoTM Unicompartmental Knee Systems apply the same ﬂexibility and quality of the Company’s other knee implant products to unicompartmental, or single compartment disease. These systems offer the surgeon the ability to conserve bone by replacing only the compartment of the knee that has had degenerative changes. The Zimmer˛ Unicompartmental Knee System was commercialized in 2004 offering a high ﬂexion design to unicompartmental knee surgery. The high ﬂexion design is a patient lifestyle attribute and this product was designed speciﬁcally for less invasive surgeries and strengthens the Company’s offering in MIS Procedures and Technologies. The Company has further established itself in the use of minimally invasive knee surgery with the development of minimally invasive instruments for the M/G Unicompartmental Knee System. MIS Mini-Incision Total Knee Procedures and MIS Quad-Sparing Total Knee Procedures have allowed the Company to build upon its industry position by offering surgeons the beneﬁts of MIS Surgery for their total knee procedures. The MIS Mini- Incision Total Knee Instruments feature smaller instruments which accommodate a smaller incision and less disruption of the surrounding soft tissues. The MIS Quad-Sparing Total Knee Procedure features advanced instrument concepts which allow surgeons to perform the total knee arthroplasty through a 7-10 cm incision without cutting the patient’s muscles or tendons. Navigation system capability (similar to an automotive Ground Positioning System (GPS)) was added by the Company in December 2004 as a tool to aid in the placement of the implants during surgery. Hip Implants Total hip replacement surgeries replace both the head of the femur and the socket portion of the pelvis (acetabulum) of the natural hip. Hip procedures include ﬁrst time, or primary, joint replacement as well as revision procedures for the replacement, repair or enhancement of an implant product or component from a previous procedure. Historically, most hip implant procedures have involved the use of bone cement to attach the prosthetic components to the surrounding bone. Today, most of the components used in total hip replacement procedures are porous, which means they do not require bone cement because bone can actually grow into, and onto, the implant surface. Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K The Company’s portfolio of MIS Techniques includes the MIS 2-IncisionTM Hip Replacement Procedure, the Mini- Incision Posterior Procedure, the Mini-Incision Anterior Procedure, and the MIS Anterolateral Single Incision Technique launched in December 2004. The new anterolateral procedure has the potential to offer similar patient outcomes as the MIS 2-Incision Procedure. Standard implants are used in all MIS Procedures. The incision for a traditional open hip primary replacement may be 12 inches long. Other less invasive approaches, such as a ‘‘mini’’ incision for hips, have been in existence for approximately six years. In January 2004, the ﬁrst computer image-guided MIS 2- Incision Hip Replacement Procedure live surgery was performed utilizing new technology and instrumentation co- developed by the Company and its MIS Technologies computer navigation partner, Medtronic, Inc. In January 2004, the United States Patent and Trademark Ofﬁce granted the Company a patent speciﬁc to the Company’s MIS 2-Incision Hip Replacement Procedure, and such patent includes 17 approved claims related to the procedure. The Company’s key hip replacement products include, among others: VerSys˛ Hip System. The VerSys Hip System, a Zimmer ﬂagship brand, is supported by a common instrumentation set and is an integrated family of hip products that offers surgeons design-speciﬁc options to meet varying surgical philosophies and patient needs. The VerSys Hip System includes the following features: a variety of stem designs and ﬁxation options for both primary and revision situations, a modular design that allows for a variety of femoral heads, optimal sizing selections, and a common instrumentation set for use with virtually all VerSys Stems. Zimmer˛ M/L Taper Prosthesis. The M/L Taper Prosthesis was launched in early 2004 and in a short period of time has become a key product in the Company’s portfolio. The prosthesis offers a dual wedge and proximally coated design that was based on long term clinically proven concepts. The M/L Taper has become widely used in the Company’s MIS Procedures due to its overall design and ease of use. Speciﬁc instruments have been developed to facilitate the insertion of the M/L Taper through the MIS Anterolateral Technique. Alloclassic˛ (Zweymueller˛) Hip System. The Alloclassic (Zweymueller) Hip System has become the most used, primary, cementless hip in the world. This is one of the few stems available today that is practically unchanged since its introduction in 1979. In 2004, the Company celebrated the 25th anniversary of the Alloclassic Stem with a symposium in Vienna, Austria. A new offset design was added in 2004 and offers the surgeon increased capability to restore the patient’s anatomical joint movement. CLS˛ SpotornoTM Hip System. The CLS Spotorno Stem is one of the Company’s largest selling hip prostheses, especially in the European markets. Since the ﬁrst implantation in 1984, more than 380,000 stems have been implanted. Additions to the product line in 2004 provide the capability for restoration of the physiological center of rotation. The Company believes that more than 20 years of experience and excellent clinical results, conﬁrmed by the 2004 Swedish Hip Registry with a 100 percent survivorship after 11 years, makes the CLS Spotorno Stem one of the most successful uncemented hip prostheses on the market. ZMR˛ and Revitan˛ Revision Hip Systems. The ZMR Revision Hip System, introduced to address the porous modular revision market, and the Revitan Revision Hip System, provide the versatility to accommodate varying ﬁxation and sizing needs. These systems offer straight as well as bowed stems, and cylindrical and spout proximal bodies. Trilogy˛ Acetabular System. The Trilogy Acetabular System, including titanium alloy shells, polyethylene liners, screws and instruments, is a prominent acetabular cup system. The Trilogy Family of products offers patients and surgeons innovative options and versatile component designs and instrumentation. One option, the Longevity˛ Highly Crosslinked Polyethylene Liner, is designed to address the issue of wear in total hip arthroplasty. Polyethylene debris may cause the degeneration of bone surrounding reconstructive implants, a painful condition called osteolysis. The Company has augmented and continues to augment its offerings of porous reconstructive hip implants through the introduction of Trabecular Metal Technology. The Company fully launched the Trabecular Metal Modular Primary Acetabular Shell in 2004. This particular product incorporates design features from the Trilogy family of Acetabular shells augmented with the advanced ﬁxation surface of Trabecular Metal material. In addition to the Trabecular Metal primary system, the Company also offers a Trabecular Metal Revision Acetabular Shell for advanced ﬁxation in acetabulae with insufﬁcient bone. Alternative Bearing Technology. The Company has a broad portfolio of alternative bearing technologies which include Longevity and Durasul˛ Highly Crosslinked Polyethylene, Metasul˛ Metal-on-Metal Tribological Solution and Cerasul˛ and Trilogy AB˛ Ceramic-on-Ceramic Tribological Solutions. Alternative bearings help to minimize wear over time, potentially increasing the longevity of the implant. The Company submitted a pre-market approval application to the United States Food and Drug Administration (‘‘FDA’’) in December 2004 and expects to launch the Trilogy AB System with ceramic-on-ceramic and metal-on-metal bearing surfaces later in 2005. DuromTM Hip Resurfacing System. This product is particularly suited to younger patients since it preserves the patient’s healthy bone stock. A primary objective of this system is to allow the patient to return to an active lifestyle. The Durom System uses the highly wear resistant Metasul Metal-on-Metal Technology as the bearing surface for the implant design. Since 1988, Metasul Technology has been used successfully for total hip replacement. Today’s metal-on- metal technology is the result of over one and a half decades of development, research and clinical evaluation. This has formed the foundation for the latest development – the 7 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Durom Hip Resurfacing System. The option of the large diameter heads, which was introduced in 2004, offers the advantage of a low-wear solution while providing greater joint stability and high range of motion in combination with the wide range of cemented and uncemented femoral implants. This product is not available for commercial distribution in the United States. Elbow and Shoulder Implants Coonrad/Morrey Total Elbow. The Coonrad/Morrey Total Elbow product line is a family of elbow replacement implant products which have helped the Company establish itself in the global elbow implant market. Bigliani/Flatow˛ Complete Shoulder Solution. The Bigliani/Flatow product line gives the Company a signiﬁcant presence in the global shoulder implant market. The system is designed to treat arthritic conditions and fractures as well as to enhance the outcome of primary or revision surgery. New Bigliani/Flatow Shoulder Instrumentation for fracture treatment was released in February 2004. Anatomical ShoulderTM System. The Anatomical Shoulder system can be tailored to each patient’s individual anatomy. In March 2004, the functionality was increased by adding modular rasp instrumentation. This provides the surgeon more versatility in orienting the head of the humerus for optimal clinical results. Dental Products The Company’s Dental Division manufactures and distributes (i) dental reconstructive implants – for individuals who are totally without teeth or are missing one or more teeth; (ii) dental restorative products – aimed at providing a more natural restoration to mimic the original teeth; and (iii) dental regenerative products – for bone grafting applications. Zimmer Dental also develops and offers a variety of educational material and courses to support the clinician in his or her practice. In 2004, Zimmer Dental relocated its manufacturing operations to Carlsbad, California, and began construction of a state-of-the-art training facility designed to provide various educational opportunities for its global customers. Dental Reconstructive Implants The Company’s dental reconstructive implant products and surgical and restorative techniques include, among others: Tapered Screw-Vent˛ Implant System. The Company’s largest selling dental product line provides the clinician a tapered geometry which mimics the natural shape of a tooth root. The Tapered Screw-Vent System, with its two-stage design, was developed and designed to minimize valuable chair time for restorations even in the most challenging locations. Featuring a patented internal hex 1 Trademark of Atlantis Components, Inc. 2 Registered Trademark of Tutogen Medical, Inc. 8 connection, multiple lead threads for reduced insertion time and selective surface coatings, the Tapered Screw-Vent Product is a technologically advanced dental implant offering features which allow the clinician to meet the needs of patients even in the most demanding circumstances. AdVent˛ Implant System. Utilizing many features of the Tapered Screw-Vent System, the AdVent Product is a transgingival, one stage design that utilizes the same surgical system as the Tapered Screw-Vent System, allowing the clinician to use both design concepts without incurring the added cost of a second surgical system. Tapered SwissPlus˛ Implant System. Designed to meet the needs of clinicians who prefer a transgingival, one stage, dental implant design, the Tapered SwissPlus System incorporates innovative multiple lead threads for faster insertion time, and a tapered body to allow it to be placed in tight interdental spaces. The Tapered SwissPlus System also incorporates a unique internal connection. Dental Restorative Products In 2004, the Company continued development efforts concerning products for the aesthetic restorative market aimed at providing a more natural restoration. The following are the primary restorative dental products of the Company: AtlantisTM1 Abutment. The Atlantis Abutment System is marketed by the Company through an agreement with Atlantis Components, Inc. This product allows for a custom made restoration improving aesthetic results in dental implant procedures. PureFormTM Ceramic System. Utilizing patented designs, the PureForm System is a ceramic system which allows clinicians to provide to their patients a more natural looking restoration. This easy-to-use concept provides the clinician a product to custom fabricate and color the crown to each patient’s individual needs. Dental Regenerative Products The Company markets the following product lines for use in regenerative techniques in oral surgery: Puros˛ Allograft. The Puros Material is an allograft bone grafting material which utilizes the Tutoplast˛2 Tissue Processing Technique that provides exceptional bone grafting material for use in oral surgery. The Puros Allograft material is recognized as an excellent bone grafting material by clinicians throughout the world. Biomend˛3 and Biomend˛ Extend Absorbable Collagen Membrane Products. Periodontal and oral surgery often require the use of a membrane to cover the surgical site. The Biomend Family of collagen based membranes offer the surgeon excellent handling characteristics while typically reducing the patient’s surgery to one visit. 3 Registered Trademark of Integra LifeSciences Corporation. Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Spine Implants Trauma The primary focus of the Company’s Spine division in 2004 was the establishment of an increased presence in the spinal market. Zimmer Spine has created a new global infrastructure that will further focus on introducing products internationally and it implemented a new U.S. sales distribution system in 2004. Zimmer Spine is planning to launch key product offerings in 2005 and initiate or continue a variety of research and development projects. The Company’s spine product offerings include, among others: Dynesys˛4 Dynamic Stabilization System. The Dynesys Dynamic Stabilization System uses ﬂexible materials to stabilize the affected lower spine while preserving the natural anatomy of the spine. The Dynesys System is indicated as an adjunct to fusion. NeuGraft˛5 Strip Bone Graft Mix. The NeuGraft Strip Bone Graft Matrix is a mixture of puriﬁed ﬁbrillar collagen (PFC) and hydroxyapatite/tricalcium phosphate ceramic (HA/TCP). The NeuGraft Strip, when coated with autogenous bone marrow, is indicated for use in bony voids or gaps that are not intrinsic to the stability of the bony structure. Current distribution rights from NeuColl, Inc. allow the Company to market this product in the United States. Trinica˛ Select Anterior Cervical Plate System. The Trinica Select Anterior Cervical Plate System and All- Through-One instrumentation is designed to simplify the surgical procedure while requiring less retraction and reducing the risk of soft-tissue damage. The Trinica Select Self-Drilling Screws seek to provide the surgeon with the option to reduce the amount of instruments, thereby potentially reducing the amount of retraction and surgical time to implant the Trinica Select Plate. Trabecular Metal Technology. Trabecular Metal Technology has a wide range of spinal applications. In the United States, Trabecular Metal Materials are cleared for both Thoracolumbar and Vertebral Body Replacement procedures as well as bone void ﬁllers. Puros Allograft Products. The Company continues to sell traditional and specialty Puros Allograft bone products through its exclusive U.S. distribution agreement with Tutogen Medical, GmbH. Puros Products consist of traditional and specialty grafts which are donated human tissues, preserved with Tutogen’s patented Tutoplast Process of tissue preservation and viral inactivation. The Tutoplast Process is a proprietary tissue processing system designed to signiﬁcantly reduce the amount of cells, bone marrow and lipid components from processed allograft bone and connective tissue while preserving the extra-cellular matrix (collagen and mineral components). 4 The Dynesys Dynamic Stabilization Spinal System is cleared in the United States for use as an adjunct to fusion. The Dynesys Dynamic Stabilization Spinal System is also currently in an investigational device study for a non-fusion application and is limited by U.S. federal law to investigational use only. Trauma products include devices used primarily to stabilize damaged bone and tissue to support the body’s natural healing process. The most common surgical stabilization of bone fracture involves the internal ﬁxation of bone fragments. This stabilization can involve the use of a wide assortment of plates, screws, rods, wires and pins. In addition, external ﬁxation devices may be used to stabilize fractures or correct deformities by applying them externally to the limb. The Company offers a comprehensive line of cost-effective quality products, including, among others: M/DN˛ Intramedullary Fixation, ITSTTM Intertrochanteric/Subtrochanteric Fixation System, and Sirus˛ Nail System. The M/DN, ITST, and Sirus Intramedullary Nailing Systems are utilized for the internal ﬁxation of long bone fractures. Both stainless steel and titanium are used to accommodate various market philosophies. Zimmer˛ Periarticular Plating System. The periarticular plating system, used to stabilize fractures near joints, includes recently released locking plates, which are pre-contoured to closely follow the shape of the bone and create a ﬁt that requires little or no additional bending. Zimmer˛ Plates and Screws. The Zimmer Plates and Screws System is a comprehensive system of stainless steel plates, screws and instruments for internal fracture ﬁxation. Because this system is compatible with major competitive systems, it affords surgeons added ﬂexibility and value. WristoreTM6 Distal Radius Fracture Fixator. In early 2003, the Company acquired the design of this new all polymer external ﬁxator for special application to more common wrist fractures. The Wristore Fixator was launched in late 2004 in a sterile pack that provides all of the necessary instruments and device components in one convenient package. TransFxTM External Fixation System. In December 2004, the Company completed the integration of the TransFx External Fixation System product line that was acquired from Immedica, Inc. in 2003. The innovative design of the TransFx Product Line provides excellent fracture reduction and stability while contributing to efﬁcient inventory management within the hospital. The TransFx System is comprehensive with a broad range of sizes capable of treating most any fracture where external ﬁxation is utilized. Orthopaedic Surgical Products The Company manufactures and markets non-implant surgical products, including tourniquets, blood management systems, wound debridement products, traction devices and 5 Registered Trademark of NeuColl, Inc. 6 Trademark of Millenium Medical Technologies, Inc. 9 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K orthopaedic softgoods. The Company develops and markets surgical products to support its reconstructive, trauma, spinal and dental product systems in the operating room environment with a focus on blood, surgical wound management, pain management and patient management products. The Company’s orthopaedic surgical products include, among others: A.T.S.˛ Tourniquet Systems. The A.T.S. Product Line represents a complete family of tourniquet machines and cuffs. The family of three machines is designed to meet the demands of a wide variety of health care facilities and clinical applications. The range of cuffs which complement the machines provides the ﬂexibility to occlude blood ﬂow safely with convenience and accuracy for adult limbs of virtually every size and shape. OrthoPAT˛7 Orthopedic Perioperative Autotransfusion System. This autotransfusion system, which includes patented disposable components, has been speciﬁcally designed to collect, wash and prepare a patient’s own blood for re-infusion during and following an orthopaedic surgical procedure. The Company markets OrthoPAT Autotransfusion Systems through an exclusive distribution arrangement in the United States. Zimmer˛ Blood Reinfusion System (ZBRS). This new addition to the Company’s portfolio of blood management products salvages, ﬁlters and then reinfuses the patient’s own blood following surgery. Pulsavac˛ Plus and Pulsavac Plus LP Wound Debridement Systems. These Pulsavac Systems are used for cleaning and debridement of contaminants and foreign matter from wounds using simultaneous irrigation and suction. Both Pulsavac systems are completely disposable to reduce the risk of cross contamination. Palacos˛8 Bone Cements. Recently, the Company executed a distribution agreement with Heraeus Kulzer GmbH, giving Zimmer the U.S. distribution rights to a variety of Heraeus Kulzer bone cement brands. Included in these brands are Palacos R and Palacos R G Bone Cements. Palacos R G Product is a bone cement with the antibiotic gentamicin pre-mixed in the formulation which is used by the orthopaedic surgeon to reduce the risk of postoperative infection. The multi-year agreement is for nonexclusive distribution rights in 2005, and Zimmer will assume exclusive U.S. distribution rights in 2006. Zimmer expects to launch the Palacos Bone Cements in the ﬁrst half of 2005. Zimmer˛ Ambulatory Pump. In 2004, the Company executed a supply agreement with Baxter Healthcare Corporation, which allows Zimmer to incorporate Baxter’s MULTIRATE INFUSOR9 Elastomeric Mechanical Device in a kit10 that will be used for post-surgical pain management. 7 Trademark of Haemonetics Corporation 8 Registered Trademark of Heraeus Kulzer GmbH. 9 MULTIRATE and INFUSOR are Trademarks of Baxter International Inc. 10 Not yet available for commercial distribution. 10 Zimmer expects to launch this product in the United States in the ﬁrst half of 2005. Sports Medicine The Company markets a limited product line in the area of sports medicine which is focused on products for the ﬁxation and repair of soft tissues, including: Sysorb˛ Bioresorbable Interference Screw System. The unique design of the Sysorb Bioresorbable Interference Screws and associated instrumentation accommodate the use of an amorphous polymer. The beneﬁts of an amorphous polymer are that it has an excellent biocompatibility and degrades completely within approximately one year. It maintains a strong ﬁxation during the entire healing process. The patented turbine-like drive of the Sysorb Screw distributes the torque equally over the whole screw length during its insertion, which helps to prevent screw failure during screw placement. In addition, various projects are underway at the Company to address the repair of cartilage as an early stage treatment. PRODUCT DEVELOPMENT The Company has extensive research and development activities underway to introduce new surgical techniques, materials, biologics and product designs intended to advance the ﬁeld of orthopaedics. The product development function works closely with the strategic brand marketing function to understand and respond quickly to our customers’ needs on a global basis, and with the research function to incorporate new technologies in our product pipeline. The rapid commercialization of innovative new materials, biologics products, implant and instrument designs, and surgical techniques remains one of the Company’s core strategies and continues to be an important driver of sales growth. Key new products, surgical techniques and instruments introduced or developed by the Company in 2004 include, among others: ) MIS Implants, Surgical Techniques and Instrumentation for knee, hip and trauma: ) MIS THA Instruments and Techniques: MIS Mini- Incision and MIS 2-Incision Instrument Enhancements, as well as launch of new Single Anterolateral Incision Technique and Instruments ) MIS TKA Instruments and Techniques: General releases for MIS Quad-Sparing Technique and Instruments and MIS Mini-Incision (Intramedullary and 4-in-1) Technique and Instruments for NexGen Knee System, as well as MIS Mini-Incision Technique and Instruments for the Natural-Knee II System ) MIS TKA Implants: NexGen Mini Keel Tibial Plate Implants and Instruments (outside U.S. only until FDA clearance) Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K ) Zimmer Unicompartmental Knee (Fixed Bearing) – Implant and MIS Instrumentation Systems ) Zimmer˛ Computer Assisted Solutions: Imageless NexGen Open Knee developed in conjunction with partner, Medtronic, Inc.; in addition to the applications released in 2003, the MIS 2-Incision Hip software and instrumentation have been improved ) New Materials: ) Trabecular Metal Augments for the knee, including traditional augment blocks and tibial cones for revision surgery with substantial bone loss ) NexGen LPS-Flex Prolong Highly Crosslinked Polyethylene and Molded Polyethylene Tibial Articular Surfaces (Fixed Bearing) ) New Implant Systems: ) Natural Knee II Patello-Femoral Joint ) Wristore External Fixator – New external ﬁxation system for the wrist; sold in a sterilized kit ) Zimmer Periarticular Locking Plates, starting with Distal Lateral Volar Plates for the wrist and a limited release to developers on the Distal Femoral Plates. Plates for other anatomical sites will be released throughout 2005. ) Elogenics Finger (Europe only) ) Anatomic Hip Stem ) Constrained Acetabular Cup Liners for the Converge˛ Porous Acetabular Cup System ) Expansions to existing systems: ) NexGen CR-Flex Knee ) NexGen LPS-Flex Trabecular Metal Monoblock Tibial ) VerSys Revision Stems ) TransFx External Fixation System ) VariallTM Cups Line Extension ) AllegrettoTM Unicompartmental Knee ) Sirus Nail System ) CLS Hip Stems ) NexGen Rotating Hinge Knee ) NexGen LPS-Flex Knee ) M/DN Intramedullary Fixation System These and other new products introduced in the last 3 years accounted for approximately 18 percent of 2004 total sales, consistent with the Company’s new products sales goal of 15 to 20 percent of total sales on an annual basis. The Company is actively broadening its product offerings in each of the product areas and exploring new technologies that have applications in multiple areas. For the years ended December 31, 2004, 2003 and 2002, the Company spent $166.7 million, $105.8 million, and $80.7 million, respectively, on research and development. The substantial increases in research and development expenditures have accelerated the output of new orthopaedic and dental reconstructive implants, spine and trauma products, including advanced new materials, product designs and surgical techniques. The Company’s primary research and development facility is located in Warsaw, Indiana, but the Company also has other research and development personnel based in, among other places, Dover, Ohio; Austin, Texas; Carlsbad, California; Minneapolis, Minnesota; Cedar Knolls, New Jersey; and Winterthur, Switzerland. As of December 31, 2004, the Company employed more than 540 research and development employees worldwide. The Company will continue to identify innovative technologies and consider acquiring complementary products or businesses, or establishing technology licensing arrangements or strategic alliances. The Zimmer Institute, and the Company’s afﬁliations with medical teaching institutions, will continue to play an integral role in facilitating training for surgeons, sales associates and other medical professionals on the procedures for applying MIS Techniques to orthopaedic surgery. In addition, the Company has developed and maintains close relationships with a number of orthopaedic surgeons who assist in product research and development. ORTHOBIOLOGICS As part of its focused research and development efforts and desire to create new orthopaedic treatments, the Company has established an Orthobiologics group based in Austin, Texas, with its own full-time staff and dedicated projects. The Company is actively involved in the ﬁeld of biologics and is committed to investing in biologics research activities. The Company is working on biological solutions to repair and regenerate damaged or degenerated orthopaedic tissues. These materials potentially could transform treatment of damaged joints by biological regeneration rather than replacement with inert materials. In 2004, the Company, working with Tissue Science Laboratories, prepared for the launch of the Zimmer˛ Collagen Repair Patch to treat rotator cuff tears, which is planned for release in 2005. The Company also continued collaborating with ISTO Technologies on a project to develop a chondral and osteochondral cartilage graft for cartilage tissue repair. The Company continued in 2004 to plan the release of the Denovo˛-T Autologous Chrondrocyte Transplantation Graft, which is an autologous cell implantation service for articular cartilage repair. Moreover, in the orthobiologics area, the Company has other ongoing programs and technology survey activities in the areas of soft tissue repair and regeneration, including tendon, ligament and meniscus and in bone regeneration, spine and dental areas. GOVERNMENT REGULATIONS AND QUALITY SYSTEMS The Company is subject to government regulation with regard to its products and operations in the countries in which it conducts business. It is the policy of the Company to comply with all regulatory requirements governing its operations and products, and the Company believes that the research, development, manufacturing and quality control procedures that it employs are in material compliance with all applicable regulations. 11 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K In the United States, numerous regulations govern the development, testing, manufacturing, marketing and distribution of medical devices, including, among others, the Federal Food, Drug and Cosmetic Act and regulations issued or promulgated thereunder. The FDA regulates product safety and efﬁcacy, laboratory, clinical and manufacturing practices, labeling and record keeping for medical devices and post market surveillance to identify potential problems with marketed medical devices. A few of the devices developed and marketed by the Company are in a category for which the FDA has implemented stringent clinical investigation and pre-market approval requirements. The FDA has the authority to halt the distribution of certain medical devices; detain or seize adulterated or misbranded medical devices; or order the repair, replacement or refund of the costs of such devices. There are also certain requirements of state, local and foreign governments that must be complied with in the manufacture and marketing of the Company’s products. In many of the foreign countries in which the Company markets its products, the Company is subject to local regulations affecting, among other things, clinical efﬁcacy, product standards, packaging requirements and labeling requirements. Many of the regulations applicable to the Company’s devices and products in these countries are similar to those of the FDA. The member countries of the European Union have adopted the European Medical Device Directives, which create a single set of medical device regulations for all member countries. These regulations require companies that wish to manufacture and distribute medical devices in European Union member countries to obtain CE Marks for their products. The Company maintains a certiﬁed status with the European and Canadian Notiﬁed Bodies, which provides for CE marking of products for these markets. The Company is subject to various government regulations pertaining to healthcare fraud and abuse, including anti-kickback laws and physician self-referral laws. Violations of these laws are punishable by criminal and/or civil sanctions, including, in some instances, ﬁnes, imprisonment and, within the United States, exclusion from participation in government healthcare programs, including Medicare, Medicaid, Veterans Administration (VA) health programs and Civilian Health and Medical Program Uniformed Service (CHAMPUS). The scope and enforcement of these laws and regulations are uncertain and subject to rapid change, especially in light of the lack of applicable precedent and regulations. The Company believes that its operations are in material compliance with these laws. The Company is committed to providing high quality products to its customers. To meet this commitment, the Company has implemented modern quality systems and concepts throughout the organization. The quality assurance department supervises the Company’s quality systems. Senior management is actively involved in setting quality policies and managing internal and external quality performance. The Company’s regulatory affairs and compliance department is 12 responsible for assuring compliance with all applicable regulations, standards and internal policies. The Company has initiated numerous quality improvement programs and all of the Company’s manufacturing operations are ISO 9000 and/or ISO 13485/13488 series certiﬁed. The Company’s facilities and operations are also subject to various government environmental and occupational health and safety requirements of the United States and foreign countries, including those relating to discharges of substances in the air, water and land, the handling, storage and disposal of wastes and the cleanup of properties by pollutants. The Company believes it is currently in material compliance with such requirements. COMPETITION The orthopaedics industry is highly competitive. In the global markets for reconstructive implants, trauma and orthopaedic surgical products, major competitors include: DePuy Orthopaedics, Inc. (a subsidiary of Johnson & Johnson), Stryker Corporation, Biomet, Inc., Synthes, Inc. and Smith & Nephew plc. In the Americas geographic segment, DePuy Orthopaedics, Inc., Stryker Corporation, Biomet, Inc. and Smith & Nephew, Inc. (a subsidiary of Smith & Nephew plc), along with the Company, account for a large majority of the total reconstructive implant sales. In the Asia Paciﬁc market for reconstructive implant and trauma products, the Company competes primarily with DePuy Orthopaedics, Inc. and Stryker Corporation, as well as regional companies, including Japan Medical Materials Corporation and Japan Medical Dynamic Marketing, Inc. Factors, such as the dealer system, complex regulatory environments and the accompanying inability to compete on price, make it difﬁcult for smaller companies, particularly those that are non-regional, to compete effectively with the market leaders in the Asia Paciﬁc region. In Europe, the reconstructive implant and trauma product markets are more fragmented than the Americas or the Asia Paciﬁc segments. The variety of philosophies held by European surgeons regarding hip reconstruction, for example, has fostered the existence of many small, niche European companies. Today most hip implants sold in Europe are products developed speciﬁcally for Europe, although global products are gaining acceptance. Therefore, the Company, in addition to its global products, will continue to develop and produce specially tailored products to meet speciﬁc European needs. In the spinal implant area, the Company competes globally primarily with Medtronic Sofamor Danek, Inc. (a subsidiary of Medtronic, Inc.), Synthes, Inc., DePuy Spine (a subsidiary of Johnson & Johnson), Stryker Corporation and EBI, L.P. (a subsidiary of Biomet, Inc.). In the dental reconstructive implant area, the Company competes primarily with Nobel Biocare Holding AG, Straumann Holding AG, and Implant Innovations, Inc. (a subsidiary of Biomet, Inc.). Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Competition within the industry is primarily based on technology, innovation, quality, reputation, customer relationships and service. A key factor in the Company’s continuing success in the future will continue to be its ability to develop new products and improve upon existing products and technologies. Where possible, the Company will continue to seek patent, trademark and other intellectual property protection concerning the surgical techniques, materials, technologies and products it designs and develops. suppliers could require signiﬁcant effort or investment by the Company in circumstances where the items supplied are integral to the performance of the Company’s products or incorporate unique technology, the Company does not believe that the loss of any existing supply contract would have a material adverse effect on its ﬁnancial and operational performance. To date, the Company has not experienced any signiﬁcant difﬁculty in locating and obtaining the materials necessary to fulﬁll its production schedules. MANUFACTURING AND RAW MATERIALS INTELLECTUAL PROPERTY The Company manufactures substantially all of its products at eight locations in the United States, Puerto Rico, Switzerland and France. Speciﬁcally, the Company presently conducts manufacturing operations for various product areas in Warsaw, Indiana; Winterthur, Switzerland; Ponce, Puerto Rico; Dover, Ohio; Austin, Texas11; Statesville, North Carolina; Carlsbad, California; and Etupes, France. In 2004, as part of the execution of the Centerpulse integration plan, the Company transferred some of its production operations among its facilities in order to optimize its manufacturing capacity. The Company believes that its manufacturing facilities set industry standards in terms of automation and have the ﬂexibility to accommodate future growth. The manufacturing operations at these facilities are designed to incorporate the cellular concept for production and to implement tenets of a manufacturing philosophy focused on continuous operational improvement. In addition, at certain of the Company’s manufacturing facilities, many of the employees are cross-trained. The Company generally operates its manufacturing facilities at its targeted goal of approximately 90 percent of total capacity. The Company continually evaluates the potential to in-source products currently purchased from outside vendors to on-site production. The Company is currently in the process of expanding certain of its facilities. Improving manufacturing productivity has been a major contributor to the Company’s proﬁtability improvements in recent years. Major areas of improvement have included utilization of computer-assisted robots to precision polish medical devices, automation of certain manufacturing processes, in-sourcing of core products, such as castings and forgings, high-speed machining, and negotiated reductions in raw materials costs. The Company uses a diverse and broad range of raw materials in the design, development and manufacturing of its products. The Company purchases all of its raw materials and select components used in manufacturing its products from external suppliers. In addition, the Company purchases some supplies from single sources for reasons of quality assurance, sole source availability, cost effectiveness or constraints resulting from regulatory requirements. The Company works closely with its suppliers to assure continuity of supply while maintaining high quality and reliability. Although a change in 11 The Company has announced plans to phase-out this facility by the end of 2005. The Company believes that patents and other proprietary rights are important to the continued success of its business and the Company also relies upon trade secrets, know-how, continuing technological innovation and licensing opportunities to develop and maintain its competitive position. The Company protects its proprietary rights through a variety of methods, including conﬁdentiality agreements and proprietary information agreements with vendors, employees, consultants and others who may have access to proprietary information. The Company owns or controls through licensing arrangements more than 2,130 issued patents and more than 2,106 patent applications throughout the world that relate to aspects of the technology incorporated in many of the Company’s products. EMPLOYEES The Company employs more than 6,600 employees worldwide, including more than 540 employees dedicated to research and development. Approximately 4,100 employees are located within the United States and more than 2,500 employees are located outside of the United States, primarily in Japan and throughout Europe. The Company has over 2,400 employees dedicated to the manufacture of its products worldwide. The Warsaw, Indiana, production facility employs more than 900 employees. Nearly 200 North American employees are members of a trade union covered by a collective bargaining agreement. In May 2000, the Company renewed a collective bargaining agreement with the United Steelworkers of America covering employees at the Dover, Ohio, facility. This agreement will continue in effect until May 15, 2007. The agreement automatically renews thereafter on a year-to-year basis until either party gives written notice of its intent to terminate the agreement, 60 days prior to a termination date. The Company believes that its relationship with its employees and the union that represents them is good. AVAILABLE INFORMATION The Company’s Internet website address is www.zimmer.com. Its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and 13 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K amendments to those reports ﬁled or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available or may be accessed free of charge through the Investor Relations section of the Company’s Internet website as soon as reasonably practicable after the Company electronically ﬁles such material with, or furnishes it to, the SEC. The Company’s Internet website and the information contained therein or connected thereto are not intended to be incorporated by reference into this Annual Report on Form 10-K. The following corporate governance and related documents are available through the Company’s website or may be obtained in print form, without charge, by request to the Company’s Investor Relations Department: Corporate Governance Guidelines, Code of Business Conduct, Code of Ethics for Chief Executive Ofﬁcer and Senior Financial Ofﬁcers, Audit Committee Charter, Compensation and Management Development Committee Charter, Corporate Governance Committee Charter, and Science and Technology Committee Charter. The Company intends to post on its website any amendment to, or waiver from, a provision of its Code of Ethics for Chief Executive Ofﬁcer and Senior Financial Ofﬁcers. 14 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S Executive Ofﬁcers of the Company 2 0 0 4 F O R M 1 0 - K The following table sets forth certain information with respect to the executive officers of the Company as of January 31, 2005. Name J. Raymond Elliott Sheryl L. Conley James T. Crines David C. Dvorak Richard Fritschi Jon E. Kramer Sam R. Leno Bruno A. Melzi Age 55 44 45 41 44 58 59 57 Position Chairman, President and Chief Executive Ofﬁcer President, Global Products Group Senior Vice President, Finance/Controller and Information Technology Executive Vice President, Corporate Services, Chief Counsel and Secretary President, Zimmer Europe and Australasia President, Americas Executive Vice President, Corporate Finance and Operations and Chief Financial Ofﬁcer Chairman, Zimmer International J. Raymond Elliott was appointed Chairman on August 6, 2001 and President and Chief Executive Ofﬁcer of the Company on March 20, 2001. Mr. Elliott was appointed President of Zimmer, Inc., the Company’s predecessor, in November 1997. Mr. Elliott has more than 30 years of experience in orthopaedics, medical devices and consumer products. He has served as a director on more than 20 business-related boards in the U.S., Canada, Japan and Europe and has served on ﬁve occasions as Chairman. He has served as a member of the board of directors and chair of the orthopaedic sector of the Advanced Medical Technology Association (AdvaMed) and is currently a director of the State of Indiana Workplace Development Board, the Indiana Chamber of Commerce, the American Swiss Foundation, and represents the State of Indiana on the President’s State Scholars Program. Mr. Elliott has served as a trustee of the Orthopaedic Research and Education Foundation (OREF). Sheryl L. Conley was appointed President, Global Products Group in October 2003 and she oversees the Company’s Global Development and Global Brand Management groups, the Orthopaedic Surgical Products Division and the Dental Products Division. Ms. Conley has responsibility for, among other things, strategic planning and market research. From September 2002 to October 2003, Ms. Conley served as President, Zimmer Reconstructive and from May 2000 to August 2002, she served as Vice President, Global Brand Management and Commercialization, where she was responsible for the Company’s worldwide branding, marketing and new product development efforts. Ms. Conley was General Manager, Zimmer Canada, from 1998 to 2000. Ms. Conley joined Zimmer, Inc. in 1983 and has held various management positions in marketing, operations and clinical research. James T. Crines was appointed Senior Vice President, Finance/ Controller and Information Technology in October 2003 and he is responsible for a variety of ﬁnancial functions, including accounting, corporate reporting, investments and treasury, as well as for the Company’s worldwide Information Technology function. From July 2001 to October 2003, Mr. Crines served as Vice President, Finance/Controller and from September 2000 to July 2001, he served as Vice President, Finance and Information Technology. Mr. Crines served Zimmer, Inc. as Director of Finance and Logistics, Japan from May 1999 until September 2000. Mr. Crines served as Associate Director, Accounting at Bristol-Myers Squibb, the Company’s former parent, from September 1995 until he joined Zimmer, Inc. in 1997 as Director of Finance. Mr. Crines has over 20 years of experience in corporate and operations ﬁnance and accounting, including ﬁve years as an auditor. David C. Dvorak was appointed Executive Vice President, Corporate Services, Chief Counsel and Secretary in October 2003 and he is responsible for, among other things, legal affairs, corporate business development, corporate communications and corporate human resources. Mr. Dvorak also serves as the Company’s Compliance Officer. From December 2001 to October 2003, Mr. Dvorak served as Senior Vice President, Corporate Affairs and General Counsel of the Company. He has served as Corporate Secretary since February 2003. Prior to his appointment with the Company, Mr. Dvorak served as Senior Vice President, General Counsel and Corporate Secretary and was a member of the Executive Committee of STERIS Corporation. Prior to joining STERIS in June 1996, Mr. Dvorak practiced corporate law at two large Cleveland, Ohio law firms, focusing on mergers and acquisitions and on securities law. Richard Fritschi was appointed President, Zimmer Europe and Australasia in October 2003 and he is responsible for sales in the European market as well as all European marketing and the European and Australasia operations group, including the Winterthur, Switzerland manufacturing facility. From July 2001 to October 2003, Mr. Fritschi served as President of Centerpulse Orthopedics Europe/Asia/Latin America. He joined Allo Pro AG (subsequently known as Sulzer Medica Company) as Controller in 1991 and was promoted to Chief Financial Ofﬁcer of Allo Pro AG in 1992 before becoming General Manager of Sulzer Orthopedics Ltd. in 1999. Jon E. Kramer was appointed President, Americas in August 2004 and he has responsibilities with respect to the Company’s business in the United States, Canada and Latin America. From October 2003 to August 2004, Mr. Kramer served as Vice President, U.S. Sales, and from 2001 to October 2003, he was the Company’s Area Vice President for the Southeast region of the United States. Prior to joining the Company, Mr. Kramer served as Vice President of Sales for Implex Corp. The Company acquired Implex on April 23, 15 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K 2004, and the company formerly known as Implex now is a wholly-owned subsidiary of Zimmer. Mr. Kramer has over 20 years of sales experience in the orthopaedics industry. Sam R. Leno was appointed Executive Vice President, Corporate Finance and Operations, and Chief Financial Ofﬁcer in October 2003 and, in addition to his Chief Financial Ofﬁcer role, he is responsible for the Company’s equity investment portfolio, global operations, which include the Company’s information technology group, Puerto Rico operations, global sourcing, global planning and logistics, global inventory oversight, facilities and facilities planning, and productivity. From July 2001 to October 2003, Mr. Leno served as Senior Vice President and Chief Financial Ofﬁcer of the Company. Prior to his appointment with the Company, Mr. Leno served as Senior Vice President and Chief Financial Ofﬁcer of Arrow Electronics, Inc., a global distributor of electronic components, a position he held from March 1999 until he joined the Company. Between 1971 and March 1999, Mr. Leno held various chief ﬁnancial ofﬁcer and other ﬁnancial positions with several U.S. based companies and he previously served as a U.S. Naval Ofﬁcer. Bruno A. Melzi was appointed Chairman, Zimmer International in October 2003 and he is responsible for the Company’s operations in Europe and Japan, as well as the international staff functions of ﬁnance, human resources, legal and communications. He joined Zimmer, Inc. in 1990 as Managing Director, Italy. In March 2000, Mr. Melzi was promoted from Vice President and Managing Director of Italy, Germany and Switzerland, a position he held since October of 1997, to the role of President, Europe/MEA. Mr. Melzi has over 28 years of experience in the orthopaedics and medical products industry, including serving as General Manager and member of the Board of Directors of Johnson & Johnson Italy from 1983 to 1990. 16 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K ITEM 2. Properties The Company has the following properties: Location Warsaw, Indiana Warsaw, Indiana Warsaw, Indiana Statesville, North Carolina Dover, Ohio Austin, Texas Carlsbad, California Minneapolis, Minnesota Minneapolis, Minnesota Cedar Knolls, New Jersey Memphis, Tennessee Sydney, Australia Wemmel, Belgium Shanghai, China Etupes, France Freiburg, Germany Kiel, Germany Treviso, Italy Milan, Italy Fukuoka, Japan Gotemba, Japan Tokyo, Japan Seoul, Korea Utrecht, Netherlands Mississauga, Canada Ponce, Puerto Rico Ponce, Puerto Rico Singapore Barcelona, Spain Baar, Switzerland Winterthur, Switzerland M ¨unsingen, Switzerland Swindon, United Kingdom Use Owned/Leased Square Feet Research & Development, Manufacturing, Warehousing, Marketing and Administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Owned Corporate Headquarters and The Zimmer Institute . . . . . . . . . . . . . . . . . . . . . Owned Ofﬁces, Manufacturing & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Manufacturing & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Owned Research & Development, Manufacturing & Warehousing . . . . . . . . . . . . . . . . Owned Ofﬁces, Research & Development & Manufacturing . . . . . . . . . . . . . . . . . . . . . Owned Ofﬁces, Research & Development & Manufacturing . . . . . . . . . . . . . . . . . . . . . Leased Ofﬁces & Research & Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Owned Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Manufacturing & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Ofﬁces & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Ofﬁces & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Ofﬁces & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Leased Ofﬁces & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Ofﬁces, Manufacturing & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Owned Ofﬁces & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Ofﬁces & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Ofﬁces & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Ofﬁces & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Ofﬁces, Service Center & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Owned Ofﬁces & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Ofﬁces & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Ofﬁces & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Ofﬁces & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Manufacturing & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Owned Ofﬁces & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Ofﬁces & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Ofﬁces & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased Ofﬁces, Research & Development & Manufacturing . . . . . . . . . . . . . . . . . . . . . Leased Ofﬁces . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Owned Ofﬁces & Warehousing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leased 796,000 115,000 125,000 156,000 140,000 227,000 85,000 42,000 16,000 25,000 30,000 36,000 15,000 10,000 90,000 44,000 21,000 11,000 36,000 22,000 87,000 24,000 38,000 16,000 52,000 113,000 12,000 10,000 67,000 40,000 251,000 76,000 68,000 The Company has begun to phase-out production in its Austin facility and intends to close the facility in 2005. To compensate, additions to the facilities in Warsaw, Indiana and Ponce, Puerto Rico of approximately 132,000 and 110,000 square feet, respectively, have begun and are expected to be completed in 2005. In addition to the above, the Company maintains more than 100 other ofﬁces and warehouse facilities in more than 24 countries around the world, including the United States, Japan, Australia, France, Russia, India, Germany, Italy, Switzerland and China. The Company believes that all of the facilities and equipment are in good condition, well maintained and able to operate at present levels. ITEM 3. Legal Proceedings Information pertaining to legal proceedings can be found in Note 16 to the Consolidated Financial Statements, which are included herein under Item 8. ITEM 4. Submission of Matters to a Vote of Security Holders Not Applicable. 17 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Part II ITEM 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The Company’s common stock is traded on the New York Stock Exchange and the SWX Swiss Exchange under the symbol ‘‘ZMH.’’ The high and low sales prices for the Company’s common stock on the New York Stock Exchange for the calendar quarters of ﬁscal years 2004 and 2003 are set forth as follows: Quarterly High-Low Share Prices Year Ended December 31, 2004: First Quarter Second Quarter Third Quarter Fourth Quarter Year Ended December 31, 2003: First Quarter Second Quarter Third Quarter Fourth Quarter High Low $81.68 $88.95 $89.44 $84.99 $49.90 $49.58 $57.00 $71.85 $68.24 $73.66 $64.40 $67.00 $38.02 $41.20 $43.69 $54.84 The Company has not declared or paid dividends on the common stock since becoming a public company on August 6, 2001. Currently, the Company does not anticipate paying any cash dividends on the common stock in the foreseeable future. The Company’s credit facility also restricts the payment of dividends under certain circumstances. The number of beneﬁcial owners of common stock on February 18, 2005 was approximately 594,000. On February 18, 2005, the closing price of the common stock, as reported on the New York Stock Exchange, was $85.76 per share. The information required by this Item concerning equity compensation plans is incorporated by reference to Item 12 of this report. 18 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S ITEM 6. Selected Financial Data 2 0 0 4 F O R M 1 0 - K The ﬁnancial information for each of the past ﬁve years ended December 31, is set forth below (in millions, except per share amounts): Summary of Operations Net sales Net earnings Pro forma net earnings assuming change in accounting principle for instruments is applied retroactively(2) Earnings per common share Basic Diluted Pro forma earnings per common share assuming change in accounting principle for instruments is applied retroactively(2) Basic Diluted Average common shares outstanding(3) Basic Diluted Balance Sheet Data Total assets Due to former parent Short-term debt Long-term debt Other long-term obligations Stockholders’ equity 2004 2003(1) 2002 2001 2000 $2,980.9 541.8 $1,901.0 346.3 $1,372.4 257.8 $1,178.6 149.8 $1,040.6 176.0 541.8 291.2 260.8 156.2 177.1 $ $ 2.22 2.19 2.22 2.19 244.4 247.8 $5,695.5 – 27.5 624.0 420.9 3,942.5 $ $ 1.67 1.64 1.40 1.38 207.7 211.2 $5,156.0 – 101.3 1,007.8 352.6 3,143.3 $ $ 1.33 1.31 1.34 1.33 194.5 196.8 $ 858.9 – 156.7 – 91.8 366.3 $ $ 0.77 0.77 0.81 0.80 193.7 194.3 $ 745.0 – 150.0 213.9 79.3 78.7 $ $ 0.91 0.91 0.91 0.91 193.6 193.6 $ 597.4 144.0 – – 5.5 N/A (1) Includes the results of Centerpulse subsequent to October 2, 2003 and Centerpulse balance sheet data as of December 31, 2003. See Note 3 to the audited ﬁnancial statements for more information on the Centerpulse acquisition. (2) Pro forma net earnings for the year ended December 31, 2003 are before the cumulative effect of an accounting change of $55.1 million. The years ended December 31, 2002, 2001 and 2000 reﬂect the retroactive application of a new accounting method for instruments. Effective January 1, 2003, Zimmer changed its method of accounting for instruments which are owned by Zimmer and used by orthopaedic surgeons during total joint replacement and other surgical procedures. Instruments are recognized as long-lived assets and are included in property, plant and equipment and are depreciated using the straight-line method based on estimated useful lives, determined principally in reference to associated product life cycles, primarily ﬁve years. In prior periods, undeployed instruments were carried as a prepaid cost and recognized in selling, general and administrative expense in the year in which the instruments were placed into service. (3) For periods ended prior to August 6, 2001, average common shares reﬂect the number of shares of Company common stock outstanding on August 6, 2001, the date all of the shares of Company common stock were distributed to the stockholders of the Company’s former parent. For periods subsequent to August 6, 2001, average common shares reﬂect any new issuances of common stock and the dilutive effect of outstanding stock options, where appropriate. 19 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the consolidated ﬁnancial statements and the corresponding notes included elsewhere in this Form 10-K. This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements. OVERVIEW Zimmer Holdings, Inc. is a global leader in the design, development, manufacture and marketing of reconstructive orthopaedic implants, including joint and dental, spinal implants, and trauma products and related orthopaedic surgical products (‘‘OSP’’). Orthopaedic reconstructive implants restore joint function lost due to disease or trauma in joints such as knees, hips, shoulders and elbows. Dental reconstructive implants restore function and aesthetics in patients that have lost teeth due to trauma or disease. Spinal implants are utilized by orthopaedic surgeons and neurosurgeons in the treatment of degenerative diseases, deformities and trauma in all regions of the spine. Trauma products are devices used primarily to reattach or stabilize damaged bone and tissue to support the body’s natural healing process. The Company’s related orthopaedic surgical products include supplies and instruments designed to aid in orthopaedic surgical procedures. With operations in more than 24 countries and products marketed in more than 100 countries, operations are managed through three reportable geographic segments – the Americas, Europe and Asia Paciﬁc. As used in this discussion, the ‘‘Company’’ means Zimmer Holdings, Inc. and its subsidiaries. The Company believes that the following developments or trends are important to understanding the Company’s ﬁnancial condition, results of operations and cash ﬂows for the year ended December 31, 2004. Acquisitions of Centerpulse and Implex The Centerpulse acquisition, completed in the fourth quarter of 2003, had a signiﬁcant impact on ﬁnancial results for the year ended December 31, 2004. Centerpulse accounted for 37 percentage points of the Company’s 57 percent sales growth for the year ended December 31, 2004. In addition, for the year ended December 31, 2004, the Company incurred $81.1 million of Centerpulse and Implex acquisition and integration expenses. The Company’s gross proﬁt margin for the year ended December 31, 2004 was also impacted by the Centerpulse and Implex acquisitions, as an inventory step-up charge reduced reported gross proﬁt by $59.4 million (2.0 percent of sales). ‘‘Inventory step-up’’ as used herein represents the difference between the cost basis and the fair value of acquired Centerpulse and Implex inventories. SFAS No. 141 requires the recorded values for acquired inventories to be adjusted from cost to fair value at the date of acquisition based upon estimated sales price less distribution costs and a proﬁt allowance. ‘‘Inventory step-up charge(s)’’ as used herein represents the amount of non-cash 20 expense that is recorded upon the sale of acquired inventories. Net synergies associated with the acquisition and integration of Centerpulse were approximately $16 million for the year ended December 31, 2004 compared to an original estimate of $1 million. As anticipated, only modest synergies were recognized in cost of goods sold during 2004. More signiﬁcant cost of goods synergies are expected to be recognized in 2005 and 2006 upon depletion of acquired inventories, upon completion of the transfer of production from Centerpulse’s U.S. manufacturing facility in Austin, Texas to other Company manufacturing facilities in Warsaw, Indiana, Winterthur, Switzerland and Ponce, Puerto Rico and upon completion of the manufacturing portion of the integration plan including, for example, in-sourcing forgings and castings. Operating expense synergies, principally in selling, general and administrative expenses, have exceeded the Company’s original expectations, reﬂecting more rapid than expected execution and achievement of operational efﬁciencies. However, these cost synergies were partially offset by negative sales synergies (losses), also anticipated, and increases in other expenses. Estimated sales losses, including distributor buy backs (accounted for as sales returns) related to distribution restructuring, were $51 million for the year ended December 31, 2004. Increases in other expenses during 2004 include higher distributor commissions, professional fees connected with corporate compliance and training programs and relocation and recruiting to ﬁll open positions. Net synergies for 2005 are expected to approximate $63 million compared to the Company’s original estimate of $56 million. Net synergies for 2006 are expected to be in excess of $100 million compared to the Company’s original estimate of $70 to $90 million. The Company continues to manage the integration of Centerpulse. As of December 31, 2004, the Company has completed over 60 percent of the 3,364 scheduled milestones required to execute the entire integration. The Company has made substantial progress in developing global combined product strategies, in integrating the sales and business organizations, and in melding essential activities as diverse as global accounting policies and procedures, manufacturing processes and E-mail systems. During 2004, the Company, among other things: ) combined and trained sales organizations ) created common branding worldwide ) created common worldwide ﬁnancial consolidation and quality systems ) implemented a global product development system to improve speed-to-market ) consolidated its orthobiologics research activities in Austin, Texas ) in-sourced a variety of formerly out-sourced manufacturing functions ) initiated a worldwide supply chain strategic plan for manufacturing and distribution networks ) uniﬁed professional medical education initiatives Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K ) completed the closure of Centerpulse’s former headquarters in Zurich, Switzerland ) began the transfer of production from Centerpulse’s U.S. manufacturing facility in Austin, Texas to Warsaw, Indiana, Winterthur, Switzerland and Ponce, Puerto Rico ) implemented a more tax efﬁcient global business structure ) completed approximately 75 percent of the Warsaw, Indiana and Ponce, Puerto Rico plant expansions, with Winterthur, Switzerland expansion plans initiated ) consolidated North American distribution and customer service functions Remaining integration milestones relate primarily to the completion of the manufacturing integration plan, including the shut-down of manufacturing operations in Austin, Texas and the in-sourcing of a variety of formerly out-sourced manufacturing functions, including forging and casting production. In addition to the remaining manufacturing integration milestones, other integration activities still to be completed include the establishment of common information technology systems and certain warehouse consolidations. The Company expects to incur approximately $45 million of integration expenses during 2005 to complete the remaining integration milestones. The Company completed the acquisition of Implex on April 23, 2004. During 2004, the Company paid approximately $153.1 million in initial Implex acquisition costs, net of cash acquired. The acquisition was a culmination of a distribution and strategic alliance agreement relating to the development and distribution of reconstructive implant and trauma products incorporating Trabecular Metal Technology. Pursuant to the former distribution and strategic alliance agreement, the Company sold products incorporating Trabecular Metal Technology. Prior to the acquisition, over 90 percent of Implex sales were Trabecular Metal Technology sales to the Company. Therefore, the acquisition did not result in the immediate addition of signiﬁcant new customers or sales for the Company. Post acquisition proﬁt margins on Company products incorporating Trabecular Metal Technology also did not immediately improve as these sales consisted primarily of inventory that the Company already had on hand at the acquisition date. In addition, during 2004 the Company recorded amortization expense of approximately $4 million related to acquired technology intangible assets. Therefore, the acquisition reduced diluted EPS by an estimated $0.02 for the year ended December 31, 2004. The Company expects to realize signiﬁcantly improved future proﬁt margins on Trabecular Metal Technology product sales as it sells inventory manufactured after the acquisition date. In addition, due to continued strong demand for products incorporating Trabecular Metal Technology, the Company expects to triple its Trabecular Metal Technology manufacturing capacity, which will lead to future sales increases and improved proﬁt margins as a result of manufacturing efﬁciencies. Demand (Volume and Mix) Trends On a pro forma11 basis, volume and mix improvements contributed 9 percentage points of sales growth during the year ended December 31, 2004. Orthopaedic procedure volume on a global basis continues to rise at mid to high single digit rates driven by an aging global population, proven clinical beneﬁts, new material technologies, advances in surgical techniques (such as the Company’s MIS Procedures and Technologies) and more active lifestyles, among other factors. In addition, the continued shift in demand to premium products, such as Longevity and Durasul Highly Crosslinked Polyethylene Liners, Trabecular Metal Technology products, high ﬂex knees, knee and hip revision products and porous hip stems, continue to positively impact sales growth. For the year ended December 31, 2004, primary porous hip stems accounted for 63 percent of all Zimmer standalone primary hip stem units sold, compared to 46 percent, 53 percent and 59 percent of total primary hip stem units sold for Zimmer standalone in 2001, 2002 and 2003, respectively. ‘‘Zimmer standalone sales’’ as used herein refers to sales for the period less sales from acquired Centerpulse businesses. The Company believes innovative surgical approaches will continue to signiﬁcantly impact the orthopaedics industry. The Company has made signiﬁcant progress in the development and introduction of MIS Procedures and Technologies. During the year ended December 31, 2004, the Company trained more than 1,400 surgeons at The Zimmer Institute and its satellite locations in MIS Techniques, including the MIS 2-Incision Hip Replacement Technique and MIS Quad-Sparing Knee Replacement Technique. During the fourth quarter of 2004, the Company estimates that 50 percent and 36 percent of all Zimmer standalone U.S. hip and knee sales, respectively, utilized an MIS Procedure and/or Technology. Pricing Trends In the Americas, the Company’s largest operating segment, the Company realized pro forma average selling price growth of 4 percent for the year ended December 31, 2004. In Europe, pro forma sales growth reﬂected ﬂat average selling prices during the year. However, during the fourth quarter of 2004, European average selling prices decreased approximately 1 percent, primarily due to a 6 percent price decrease in Germany, principally the result of a revised reimbursement system implemented by the German government. In the Asia Paciﬁc operating segment on a pro forma basis, the Company experienced an average selling price reduction of 2 percent during the year ended December 31, 2004, principally the result of the Japanese 11 The unaudited pro forma net sales information, including comparisons to 2004 net sales, contained in this Form 10-K and presented in accordance with U.S. generally accepted accounting principles has been derived from the audited ﬁnancial statements of the Company for the year ended December 31, 2003 and the ﬁnancial statements of Centerpulse for the nine months ended September 30, 2003 to give effect to the Centerpulse acquisition as if it had occurred on January 1, 2003. 21 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K government’s bi-annual change in reimbursement rates. Pressure from governmental healthcare cost containment efforts, group purchasing organizations and potential gain sharing arrangements between surgeons and hospitals may negatively affect the Company’s ability to realize global price increases of 2-3 percent. Foreign Currency Exchange Rates A weakened U.S. dollar during the year ended December 31, 2004 compared to last year contributed 4 percentage points sales growth, on a pro forma basis. The Company addresses currency risk management through regular operating and ﬁnancing activities, and under appropriate circumstances and subject to proper authorization, through the use of simple forward contracts solely for managing foreign currency volatility and risk. The use of derivative ﬁnancial instruments for trading or speculative purposes is prohibited. RESULTS OF OPERATIONS New Product Sales New products, which management deﬁnes as products introduced within the prior 36-month period, accounted for 18 percent, or $541 million, of the Company’s sales during the year ended December 31, 2004. Adoption rates for new technologies are a key indicator of industry performance. Sales have grown with the introduction of new products such as Prolong Highly Crosslinked Polyethylene for the knee, which was introduced in 2002, and represented approximately 49 percent of all cruciate retaining articulating surface product sales and 12 percent of all knee articulating surfaces for the year ended December 31, 2004. Adoption rates for the Company’s new products should continue to favorably affect the Company’s operating performance. Year Ended December 31, 2004 Compared to Year Ended December 31, 2003 Net Sales by Operating Segment The following table presents net sales by operating segment and the components of the percentage changes (dollars in millions): Americas Europe Asia Paciﬁc Year Ended December 31, 2004 2003 % Inc Zimmer Standalone Volume/ Mix Price Foreign Exchange Impact of Centerpulse Acquisition $1,741.3 808.3 431.3 $1,208.3 366.0 326.7 $2,980.9 $1,901.0 44% 121 32 57 16% 9 10 14 5% 2 (3) 3 –% 23% 10 8 3 100 17 37 ‘‘Foreign Exchange’’ as used in the tables herein represents the effect of changes in foreign exchange rates on sales growth. ‘‘Impact of Centerpulse Acquisition’’ as used in the tables herein represents the impact of the Centerpulse acquisition on sales growth. The following table presents 2004 net sales by operating segment and 2003 unaudited pro forma net sales by operating segment and the components of the percentage changes (dollars in millions): Year Ended December 31, Reported 2004 $1,741.3 808.3 431.3 $2,980.9 Pro forma 2003 $1,499.1 707.1 383.4 $2,589.6 % Inc 16% 14 13 15 Volume/ Mix 12% 5 7 9 Price 4% – (2) 2 Foreign Exchange –% 9 8 4 Americas Europe Asia Paciﬁc 22 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Net Sales by Product Category The following table presents net sales by product category and the components of the percentage changes (dollars in millions): Reconstructive Knees Hips Dental Extremities Total Trauma Spine OSP Total Year Ended December 31, 2004 2003 % Inc Zimmer Standalone Volume/ Mix Price Foreign Exchange Impact of Centerpulse Acquisition $1,194.5 1,079.0 124.7 58.1 $ 800.6 645.5 29.8 45.1 2,456.3 1,521.0 172.9 134.2 217.5 150.1 35.1 194.8 $2,980.9 $1,901.0 49% 67 319 28 62 15 281 12 57 18% 16 – 9 17 2 – 5 14 3% 2 – 5 3 3 – 2 3 3% 3 – 3 3 3 – 2 3 25% 46 319 11 39 7 281 3 37 Knee sales were led by the NexGen Complete Knee Solution product line including the NexGen LPS-Flex Knee, NexGen Trabecular Metal Tibial Components and the NexGen CR-Flex Knee. In addition, the NexGen Rotating Hinge Knee and the Innex Total Knee System exhibited strong growth. Hip sales were led by growth in porous stems, including signiﬁcant growth of the VerSys Fiber Metal and Zimmer M/L Taper Stems (the stems of choice for MIS Procedures), Trabecular Metal Acetabular Cups, Trilogy Acetabular Cups, Durom Hip Resurfacing Products, and Longevity and Durasul Highly Crosslinked Polyethylene Liners. The Alloclassic Hip System and AlloﬁtTM Acetabular Shell also had strong growth. Dental sales were led by sales of biologicals, surgical products and prosthetic implants, including strong growth of the SwissPlus˛ Implant System and Tapered Screw-Vent Internal Hex Implant System. Extremities sales were led by the Bigliani/Flatow Shoulder. Trauma sales were led by sales of Zimmer Periarticular Plates, Cable-Ready˛ Cable Products, Zimmer Plates and Screws System, ITST and Sirius Intramedullary Nails, TransFx External Fixation System and the Trabecular Metal AVN Rod. Spine sales were led by the Dynesys Dynamic Stabilization System and Trinica Select Anterior Cervical Plate System. OSP sales were primarily driven by the continued growth of the OrthoPAT Autotransfusion System and wound management and drainage products. The following table presents 2004 net sales by product category and 2003 unaudited pro forma net sales by product category and the components of the percentage changes (dollars in millions): Reconstructive Knees Hips Dental Extremities Total Trauma Spine OSP Total Year Ended December 31, Reported 2004 Pro forma 2003 $1,194.5 1,079.0 124.7 58.1 $1,007.8 937.6 99.9 52.2 2,456.3 2,097.5 172.9 134.2 217.5 161.4 130.9 199.8 $2,980.9 $2,589.6 % Inc Volume/ Mix Price Foreign Exchange 19% 15 25 11 17 7 3 9 15 12% 9 19 3 11 1 (3) 5 9 3% 1 3 5 2 3 4 1 2 4% 5 3 3 4 3 2 3 4 23 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K The following table presents estimated* 2004 global market size and market share information (dollars in billions): Reconstructive Knees Hips Dental Extremities Total Trauma Spine*** Global Market Size $ 4.2 3.9 1.3 0.3 $ 9.7 $ 2.4 $ 3.9 Global Market % Growth** Zimmer Market Share Zimmer Market Position 15% 10 20 15 14 11 24 28% 28 9 18 25 7 3 1 1 4 2 1 4 6 * Estimates based on company annual ﬁlings, Wall Street equity research and Zimmer management ** Excludes the effect of changes in foreign exchange rates on sales growth *** Spine includes related orthobiologics Growth in the Americas was led by strong knee and hip sales. Knee sales were led by the NexGen Complete Knee Solution product line, including the NexGen LPS-Flex Knee, NexGen Trabecular Metal Tibial Components, the NexGen LCCK Revision Knee, the NexGen CR-Flex Knee and Prolong Highly Crosslinked Polyethylene. The Natural-Knee System also made a strong contribution. Hip sales were led by growth in porous stems, including signiﬁcant growth of the VerSys Fiber Metal and Zimmer M/L Taper Stems (the stems of choice for MIS Procedures), beaded stems, Trabecular Metal Acetabular Cups and Longevity and Durasul Highly Crosslinked Polyethylene Liners. The following table presents 2004 Americas net sales and 2003 Americas unaudited pro forma net sales (dollars in millions): Reconstructive Knees Hips Dental Extremities Total Trauma Spine OSP Total Year Ended December 31, Reported 2004 Pro forma % Inc (Dec) 2003 $ 762.0 499.5 75.3 41.1 $ 625.9 425.1 61.0 37.3 1,377.9 1,149.3 105.7 111.0 146.7 100.9 112.0 136.9 $1,741.3 $1,499.1 22% 18 23 10 20 5 (1) 7 16 Pro forma sales growth of 15 percent (12 percent volume/mix and 3 percent price) and 10 percent (9 percent volume/mix and 1 percent price) for knees and hips, respectively, during 2004 was in line with market growth, despite Centerpulse acquisition sales dis-synergies and inventory buy backs (accounted for as sales returns) due to changes in the Company’s distribution network resulting from the Centerpulse acquisition. Pro forma dental sales growth of 22 percent (19 percent volume/mix and 3 percent price), outpaced the market due to strong sales of biologicals, surgical products and prosthetic implants; the continued rebranding to Zimmer also was a positive factor. The Company’s pro forma 2004 sales growth rates for extremities, trauma and spine were below the corresponding estimated market growth rates, reﬂecting market share loss. Extremities and spine lagged the overall market growth rate due to the fact that the Company does not have a complete product offering to compete effectively with the product category market leaders. Trauma is lagging the overall market growth rate due to delays in new product introductions. Comparison of the OSP pro forma growth rate to a market growth rate is not meaningful due to the fragmented nature of the market. Americas Net Sales The following table presents Americas net sales (dollars Year Ended December 31, 2004 2003 % Inc Impact of Centerpulse Acquisition $ 762.0 499.5 75.3 41.1 1,377.9 105.7 111.0 146.7 $ 523.6 365.6 18.2 34.0 941.4 100.3 29.5 137.1 $1,741.3 $1,208.3 46% 37 314 21 46 5 276 7 44 18% 16 314 5 21 – 249 – 23 in millions): Reconstructive Knees Hips Dental Extremities Total Trauma Spine OSP Total 24 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Europe Net Sales Asia Paciﬁc Net Sales The following table presents Europe net sales (dollars The following table presents Asia Paciﬁc net sales in millions): (dollars in millions): Year Ended December 31, 2004 2003 % Inc Impact of Centerpulse Acquisition Year Ended December 31, 2004 2003 % Inc Impact of Centerpulse Acquisition Reconstructive Knees Hips Dental Extremities Total Trauma Spine OSP Total $ 292.0 398.4 34.8 11.6 $ 162.8 151.7 8.2 7.1 736.8 329.8 29.5 19.8 22.2 16.3 4.6 15.3 $ 808.3 $ 366.0 79% 61% 163 323 62 124 81 330 45 121 137 323 44 103 59 330 29 100 Reconstructive Knees Hips Dental Extremities Total Trauma Spine OSP Total $ 140.5 181.0 14.6 5.4 $ 114.2 128.3 3.4 4.0 341.5 249.9 37.7 3.4 48.7 33.4 1.0 42.4 $ 431.3 $ 326.7 23% 41 333 34 37 13 213 15 32 9% 25 333 8 22 2 213 – 17 Growth in Europe was led by strong knee and hips sales. Knee sales were driven by strong sales of the NexGen Complete Knee Solution product line, including the NexGen CR Knee, NexGen Trabecular Metal Tibial Components and the NexGen Rotating Hinge Knee. Hip sales were driven by strong sales of Longevity and Durasul Highly Crosslinked Polyethylene Liners, VerSys Porous Stems and Trabecular Metal Acetabular Cups. The Alloclassic Hip System and Alloﬁt Acetabular Shell also had strong growth. The following table presents 2004 Europe net sales and 2003 Europe unaudited pro forma net sales (dollars in millions): Growth in Asia Paciﬁc was led by strong knee and hip sales. Knee sales were driven by the NexGen LPS-Flex Knee, NexGen Trabecular Metal Tibial Components and the NexGen CR Knee. The Natural-Knee System also made a strong contribution. Hip sales were driven primarily by the continued conversion to porous stems, including VerSys Porous Stems, and sales of Longevity Highly Crosslinked Polyethylene Liners. The following table presents 2004 Asia Paciﬁc net sales and 2003 Asia Paciﬁc unaudited pro forma net sales (dollars in millions): Reconstructive Knees Hips Dental Extremities Total Trauma Spine OSP Total Year Ended December 31, Reported 2004 Pro forma 2003 % Inc $ 292.0 398.4 34.8 11.6 $ 254.4 351.5 27.9 10.3 736.8 644.1 29.5 19.8 22.2 26.0 16.7 20.3 $ 808.3 $ 707.1 15% 13 25 11 14 14 19 9 14 Reconstructive Knees Hips Dental Extremities Total Trauma Spine OSP Total Year Ended December 31, Reported 2004 Pro forma 2003 % Inc $ 140.5 181.0 14.6 5.4 $ 127.5 161.0 11.0 4.6 341.5 304.1 37.7 3.4 48.7 34.5 2.2 42.6 $ 431.3 $ 383.4 10% 12 33 17 12 9 51 15 13 25 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Gross Proﬁt Gross proﬁt as a percentage of net sales was 73.8 percent in 2004, compared to 72.8 percent in 2003 and 68.1 percent for the three month period ended December 31, 2003 (the ﬁrst quarter of combined Zimmer and Centerpulse operations). The following table reconciles the gross margin for the year ended December 31, 2004 and for the three month period ended December 31, 2003. Three month period ended December 31, 2003 gross margin Inventory step-up charge Increased average selling prices Operating segment and product category mix Other Year ended December 31, 2004 gross margin 68.1% 4.1 1.8 0.2 (0.4) 73.8% Decreased Centerpulse and Implex inventory step-up charges as a percentage of net sales during 2004 ($59.4 million, or 2.0 percent of net sales) compared to the three month period ended December 31, 2003 ($42.7 million, or 6.1 percent of net sales) and increases in average selling prices were the primary contributors to improved gross margins. In addition, operating segment mix and product category mix both had a positive impact on gross margins due to higher sales growth in the more proﬁtable Americas segment compared to Europe and Asia Paciﬁc, higher sales growth of reconstructive implants and the continued shift to premium products. Offsetting these favorable impacts were a variety of other items, including increased royalty expenses and higher losses on foreign exchange contracts included in cost of products sold, partially offset by reduced manufacturing costs due to automation, vertical integration and process improvements. Operating Expenses R&D as a percentage of net sales was 5.6 percent for years ended December 31, 2004 and 2003. R&D increased to $166.7 million from $105.8 million reﬂecting a full year of Centerpulse research and development expenses and increased spending on active projects focused on areas of strategic signiﬁcance. The Company’s pipeline includes 146 projects with a total investment equal to or greater than $1 million. Of the 146 projects, approximately two-thirds involve new platforms, MIS or other technologies. For example, the Company’s orthobiological research group in Austin, Texas is developing innovative solutions for hip fracture and cartilage regeneration. During 2004, the Company delivered more than 40 major development projects to market. The Company has strategically targeted R&D spending to be at the high end of what management believes to be an average of 4-6 percent for the industry. The Company expects over the next few years to invest in research and development at approximately 5.5 percent to 6 percent of sales. SG&A as a percentage of net sales was 39.9 percent for the year ended December 31, 2004 compared to 38.8 percent 26 for the same 2003 period. Amortization expense increased to $39.1 million, or 1.3 percent of sales, during the year ended December 31, 2004 compared to $10.9 million, or less than 1 percent of sales, during the year ended December 31, 2003. The increase was primarily due to amortization expense related to Centerpulse and Implex ﬁnite lived intangible assets. In addition, during 2004 the Company continued to introduce or expand strategic programs and activities. In 2004, The Zimmer Institute and its satellite locations were well utilized with over 1,400 surgeons trained, compared to 500 surgeons trained in 2003. These surgeon training costs are recognized in SG&A. The Company also recognized approximately $5 million of Sarbanes-Oxley compliance expenses, including consultant fees and increased audit fees. These increases were partially offset by expense synergies realized from the Centerpulse acquisition and controlled spending. The Company has begun to realize synergies from the Centerpulse acquisition and expects to pursue additional synergy opportunities. The Company estimates that over the next two years it will be able to reduce annual SG&A as a percentage of net sales to 38.9 percent or lower, representing a 200 basis point improvement over the fourth quarter of 2003 (the ﬁrst quarter of combined Zimmer and Centerpulse operations). Acquisition and integration expenses related to the acquisitions of Centerpulse and Implex were $81.1 million compared to $79.6 million for the same 2003 period and included $24.4 million of sales agent and lease contract termination expenses, $24.2 million of integration consulting expenses, $9.4 million of employee severance and retention expenses, $7.8 million of professional fees, $5.2 million of personnel expenses and travel for full-time integration team members, $4.3 million of costs related to integrating the Company’s information technology systems, $2.9 million of costs related to relocation of facilities, and $2.9 million of other miscellaneous acquisition and integration expenses. Operating Proﬁt, Income Taxes and Net Earnings Operating proﬁt for the year ended December 31, 2004 increased 69 percent to $763.2 million from $450.7 million in the comparable 2003 period. Operating proﬁt growth was driven by Zimmer standalone sales growth, operating proﬁt contributed by Centerpulse, effectively controlled operating expenses and the absence of in-process research and development expense in 2004 compared to $11.2 million in 2003. These favorable items were partially offset by Centerpulse and Implex inventory step-up of $59.4 million in 2004 compared to $42.7 million in 2003 and intangible asset amortization of $39.1 million in 2004 versus $10.9 million in 2003. The effective tax rate on earnings before income taxes, minority interest and cumulative effect of change in accounting principle decreased to 25.9 percent for the year ended December 31, 2004 from 33.6 percent for the same period in 2003. A major component of the decrease (4.7 percent, or $34.5 million) was the result of revaluing deferred taxes of acquired Centerpulse operations due to a reduction in the ongoing Swiss tax rate. The major reasons Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K for the remaining decrease in the effective tax rate were the ongoing European restructuring initiatives, the successful negotiation of a lower ongoing Swiss tax rate (from approximately 24 percent to 12.5 percent) and continued expansion of operations in lower tax jurisdictions. Net earnings increased 57 percent to $541.8 million for the year ended December 31, 2004 compared to $346.3 million in the same 2003 period. The increase was due to higher operating proﬁt offset partially by increased interest expense, $31.7 million in 2004 compared to $13.2 million in 2003. Net earnings for 2003 also included a one-time, $55.1 million (net of tax), non-cash cumulative effect of a change in accounting principle for instruments. Net earnings in 2004 also beneﬁted from the decreased effective income tax rate. Basic and diluted earnings per share increased 33 percent and 34 percent to $2.22 and $2.19, respectively, from $1.67 and $1.64 in 2003. Year Ended December 31, 2003 Compared to Year Ended December 31, 2002 The following table presents the components of the 2003 over 2002 percentage changes in net sales by geographic segment: Zimmer Standalone Volume/ Mix Foreign Exchange Sub- Total Price Impact of Centerpulse Acquisition Americas Europe Asia Paciﬁc Consolidated 15% 4% 19 4 13 2 1 3 –% 19% 17 9 4 38 14 20 11% 77 7 19 Net Change 30% 115 21 39 Net sales for the year ended December 31, 2003 increased 39 percent to $1,901.0 million. Sales growth was driven by strong demand for the Company’s reconstructive implants and additional sales from the October 2, 2003 Centerpulse acquisition. The 39 percent increase was comprised of a 20 percent increase in Zimmer standalone sales and a 19 percent increase due to the Centerpulse acquisition. Favorable demographics, including an aging population and a continued shift to premium priced products, contributed to the favorable volume and mix growth. Higher average selling prices were realized in all three geographic segments. The continued weakening of the U.S. dollar versus the Euro and the Japanese yen were the main contributors to the favorable impact of foreign currency exchange rates on net sales. Net sales in the Americas for the year ended December 31, 2003 increased 30 percent to $1,208.3 million. Sales growth was driven by strong demand for the Company’s reconstructive implants and additional sales from the Centerpulse acquisition. The 30 percent increase was comprised of a 19 percent increase in Zimmer standalone sales plus an 11 percent increase due to the Centerpulse acquisition. Net sales of reconstructive implants increased 33 percent to $941.4 million, 22 percent due to increased Zimmer standalone sales and 11 percent related to the Centerpulse acquisition. Knee sales increased 32 percent to $523.6 million, 24 percent related to increased Zimmer standalone sales and 8 percent due to the Centerpulse acquisition. Hip sales increased 27 percent to $365.6 million, 21 percent due to increased Zimmer standalone sales and 6 percent due to the Centerpulse acquisition. Knee sales growth was led by the NexGen Legacy Knee-Posterior Stabilized product line, including the LPS-Flex Knee, the NexGen Trabecular Metal Technology Tibial Components, the NexGen CR Knee with Prolong Highly Crosslinked Polyethylene and the NexGen Rotating Hinge Knee. Hip sales growth was driven by the continued conversion to porous stems including signiﬁcant growth of the VerSys Fiber Metal Taper Stem, which is often used in MIS Hip Replacement Procedures; Trabecular Metal Acetabular Cups; and increased sales of Trilogy Acetabular Cups incorporating Longevity Highly Crosslinked Polyethylene Liners. Net sales in Europe for the year ended December 31, 2003 increased 115 percent to $366.0 million. Sales growth was driven by additional sales from the Centerpulse acquisition and strong demand for the Company’s reconstructive implants. The 115 percent increase was comprised of a 77 percent increase due to the Centerpulse acquisition and a 38 percent increase in Zimmer standalone sales. Net sales of reconstructive implants increased 119 percent to $329.8 million, 81 percent due to the Centerpulse acquisition and 38 percent due to increased Zimmer standalone sales, including 18 percent due to changes in foreign exchange rates. Knee sales increased 72 percent to $162.8 million, 37 percent due to the Centerpulse acquisition and 35 percent due to increased Zimmer standalone sales, including 18 percent due to changes in foreign exchange rates. Hip sales increased 196 percent to $151.7 million, 152 percent due to the Centerpulse acquisition and 44 percent due to increased Zimmer standalone sales, including 17 percent due to changes in foreign exchange rates. Knee sales were driven by strong sales of the NexGen Legacy system of knee prostheses, the NexGen CR Knee, NexGen Trabecular Metal Components and the NexGen Rotating Hinge Knee. Hip sales were driven by strong sales of Trilogy Acetabular Cups incorporating Longevity Highly Crosslinked Polyethylene Liners, VerSys Porous Stems and Trabecular Metal Acetabular Cups. Net sales in Asia Paciﬁc for the year ended December 31, 2003 increased 21 percent to $326.7 million. Sales growth was driven by strong demand for the Company’s reconstructive implants and additional sales from the Centerpulse acquisition. The 21 percent increase was comprised of a 14 percent increase in Zimmer standalone sales and a 7 percent increase due to the Centerpulse acquisition. Net sales of reconstructive implants increased 25 percent to $249.8 million, 14 percent due to increased Zimmer standalone sales, including 9 percent due to changes in foreign exchange rates, and 11 percent due to the Centerpulse acquisition. Knee sales increased 21 percent to $114.2 million, 16 percent due to increased Zimmer standalone sales, including 10 percent due to changes in foreign exchange rates, and 5 percent due to the Centerpulse acquisition. Hip sales increased 25 percent to $128.2 million, 13 percent due to increased Zimmer standalone sales, 27 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K including 9 percent due to changes in foreign exchange rates, and 12 percent due to the Centerpulse acquisition. Knee sales were driven by the NexGen LPS-Flex Knee, NexGen Trabecular Metal Technology Tibial Components and the NexGen CR Knee. Hip sales were driven primarily by the continued conversion to porous stems and sales of Trilogy Acetabular Cups incorporating Longevity Highly Crosslinked Polyethylene Liners. The following table presents the components of the 2003 over 2002 percentage changes in net sales by product category: Zimmer Standalone Volume/ Mix Foreign Exchange Sub- Total Price Impact of Centerpulse Acquisition Net Change Reconstructive implants Trauma Spine(1) Orthopaedic surgical products Consolidated 16% 3% 4 – 5 13 3 – 2 3 4% 23% 3 – 10 – 20% 3 N/A 43% 13 N/A 3 4 10 20 – 19 10 39 Overall, worldwide reconstructive implant sales increased 43 percent to $1,521.0 million. The 43 percent increase was comprised of a 23 percent increase in Zimmer standalone sales and a 20 percent increase due to the Centerpulse acquisition. Knee sales increased 37 percent to $800.5 million, 24 percent due to increased Zimmer standalone sales, including 4 percent due to changes in foreign exchange rates and 13 percent due to the Centerpulse acquisition. Knee sales were led by the NexGen Legacy Knee Posterior Stabilized product line including the LPS-Flex Knee, NexGen Trabecular Metal Tibial Components and the NexGen CR Knee with Prolong Highly Crosslinked Polyethylene. Hip sales increased 46 percent to $645.6 million, 24 percent due to the Centerpulse acquisition and 22 percent due to increased Zimmer standalone sales, including 5 percent due to changes in foreign exchange rates. Hip sales were driven by continued conversion to porous stems, Trabecular Metal Acetabular Cups, and increased sales of Trilogy Acetabular Cups incorporating Longevity Highly Crosslinked Polyethylene Liners. Dental sales were $29.8 million, reﬂecting solid growth in both standard and tapered SwissPlus Implants. Trauma sales increased 13 percent to $151.6 million, 10 percent due to increased Zimmer standalone sales, including 3 percent due to changes in foreign exchange rates, and 3 percent due to the Centerpulse acquisition. Trauma sales were led by sales of the Zimmer Periarticular Plating System. Spine sales were $33.6 million due to sales from Centerpulse. OSP sales increased 10 percent, including 3 percent due to changes in foreign currency, to $194.8 million, primarily driven by the continued growth of the OrthoPAT Orthopedic Perioperative Autotransfusion System. Gross proﬁt as a percentage of net sales was 72.8 percent in 2003 compared to 74.9 percent in 2002. (1) Spine was a new product category as a result of the Centerpulse acquisition. 28 Gross proﬁt for 2003 was reduced $42.7 million, or 2.2 percent of net sales, as a result of an inventory step-up charge recognized in connection with the Centerpulse acquisition. Sales and gross proﬁt from Centerpulse also reduced reported gross margins as Centerpulse has a greater percentage of sales based in Europe, where gross margins are historically lower than the U.S. and Japan. Increased Zimmer standalone average selling prices in all geographic segments, the continued conversion from cemented implants to higher margin porous implants and the ongoing efforts to reduce manufacturing costs through automation, in-sourcing and process improvements had positive impacts on gross proﬁt. The Company’s operating plans annually call for reductions in unit manufacturing cost of its products as a direct result of a number of factors, including but not limited to, increased volume, improvements in material technology, replacement of used machinery and equipment with higher speed equipment, changes in the conﬁguration of manufacturing cells designed to increase throughput, labor automation as well as in- sourcing. Focus on inventory cost reduction is a strategic imperative. The Company will continue to direct efforts on driving down costs of products sold, general and administrative expenses and holding costs associated with working capital. Research and development as a percentage of net sales was 5.6 percent in 2003 compared to 5.9 percent in 2002, as research and development expenses increased 31 percent from the prior year compared to a 39 percent increase in sales. Research and development expense increased to $105.8 million from $80.7 million reﬂecting research and development expenses from Centerpulse and increased spending on active projects focused on areas of strategic signiﬁcance, including MIS Technologies, innovative materials such as Trabecular Metal Technology and Highly Crosslinked Polyethylene, lifestyle designs, revision implants and biological solutions. The Company has strategically targeted R&D spending to be at the high end of what management believes to be an average of 4-6 percent for the industry. Maintaining a robust product development pipeline has enabled Zimmer to achieve signiﬁcant contributions in revenue from new products, which management deﬁnes as products introduced within the prior 36 month period. For example, in the fourth quarter, new product revenue, excluding Centerpulse, represented 18.9 percent of sales, at the high end of the Company’s stated quarterly and annual goal of 15-20 percent, in place since 1999. Management expects over the next year or two to continue to invest in R&D at almost 6 percent of sales on a higher revenue base as investments in spine, biologics and new technology increase. Selling, general and administrative expenses (‘‘SG&A’’) as a percentage of net sales were 38.8 percent in 2003 compared to 39.8 percent (39.4 percent assuming the change in accounting principle for instruments is applied retroactively) in 2002. Low cost inﬂation accompanied with double digit revenue growth has driven the overall expense Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K ratio lower for the year. Detailed planning, monitoring and control over these expenses have also contributed to the improvement. While well managed, the Company introduced programs and activities in 2003 that involved signiﬁcant investments, which, in part, are reﬂected in SG&A. As an example, The Zimmer Institute saw very active use in 2003. The Zimmer Institute, which is used for surgeon training, product development activities such as prototype evaluations and product and instrument training for independent ﬁeld sales representatives, provided training for over 500 surgeons, physician assistants and nurses on the MIS 2-Incision Hip Replacement Procedure and the MIS Quad-Sparing Total Knee Procedure over the course of 2003. The cost of training is borne by the Company and reported in SG&A. The acquisition of Centerpulse resulted in higher SG&A as a percentage of sales in the fourth quarter of 2003. The change in accounting principle for instruments favorably impacted SG&A by $26.8 million, or 1.4 percent of net sales, in 2003. Acquisition and integration expenses related to the acquisition of Centerpulse and InCentive were $79.6 million, including $36.1 million of sales agent and lease contract termination expenses, $15.4 million of integration consulting expenses, $10.2 million of employee severance and retention expenses, $6.4 million of professional fees, $5.3 million of costs for meetings and activities associated with the initial cross-training of employees and independent sales representatives, $2.4 million of investment banking fees incurred by Centerpulse, $2.0 million of personnel expenses and travel for full-time integration team members, $0.6 million of employee relocation expenses and $1.2 million of other miscellaneous acquisition and integration expenses. Operating proﬁt increased 12 percent to $450.7 million. Operating proﬁt growth was driven by strong organic sales growth, operating proﬁt contributed by Centerpulse and effectively controlled operating expenses. In addition, the change in accounting principle for instruments favorably impacted operating proﬁt by $26.8 million. These favorable items were offset by Centerpulse inventory step-up of $42.7 million, Centerpulse in-process research and development write-offs of $11.2 million and Centerpulse acquisition and integration expenses of $79.6 million. The Company’s effective tax rate for the year ended December 31, 2003 was 33.6 percent, compared to 33.7 percent in 2002. The decrease from 33.7 percent to 33.6 percent was due to expanded operations in Puerto Rico and the implementation of certain business strategies in 2002 which resulted in reducing taxes in certain jurisdictions and increased credits, offset by non-deductible in-process research and development charges. Net earnings increased 34 percent to $346.3 million from $257.8 million in 2002, driven by strong organic sales growth, earnings contributed by Centerpulse, leveraged operating expenses and the one-time, non-cash cumulative effect of change in accounting principle for instruments of $55.1 million (net of tax), offset by Centerpulse inventory step-up of $28.0 million (net of tax), Centerpulse in-process research and development write-offs of $11.2 million and Centerpulse acquisition and integration expenses of $51.1 million (net of tax). Basic and diluted earnings per share increased 26 percent and 25 percent to $1.67 and $1.64, respectively, from $1.33 and $1.31 in 2002. OPERATING PROFIT BY SEGMENT Company management evaluates operating segment performance based upon segment operating proﬁt exclusive of operating expenses pertaining to global operations and corporate expenses, acquisition and integration expenses, inventory step-up, in-process research and development write-offs and intangible asset amortization expense. Global operations include research, development engineering, medical education, brand management, corporate legal, ﬁnance, human resource functions and the Americas operations and logistics functions. For more information regarding the Company’s segments, see Note 14 to the consolidated ﬁnancial statements included elsewhere in this Form 10-K. The following table sets forth the operating proﬁt as a percentage of sales by segment for the years ended December 31, 2004, 2003 and 2002: Percent of net sales Year Ended December 31, Americas Europe Asia Paciﬁc 2004 2003 2002 51.3% 34.6 42.3 51.2% 26.3 45.3 48.3% 24.4 46.1 Year Ended December 31, 2004 Compared to Year Ended December 31, 2003 In the Americas, operating proﬁt as a percentage of sales improved slightly due to improved gross margins and controlled operating expenses. Gross proﬁt margins increased as a result of improved average selling prices, lower royalty expenses as a percentage of net sales and the impact of a more favorable product sales mix. Product sales mix made favorable contributions as the Company sold a higher concentration of more proﬁtable reconstructive implants and spinal implants, while less proﬁtable trauma and OSP products became a smaller percentage of net sales. Royalties as a percentage of net sales declined as certain royalty contracts have ﬁxed components and caps, or ceilings, on payments. In addition to improved gross margins, the Company effectively controlled operating expenses, including general and administrative expenses. These improvements were offset primarily by increased selling expenses as a percentage of net sales due to the restructuring of certain distributor contracts. In Europe, operating proﬁt as a percentage of net sales improved due to improved gross margins, controlled operating expenses and the favorable impact of the Centerpulse acquisition. Gross proﬁt margins increased principally due to improved average selling prices, a more favorable product and country sales mix and the favorable impact of the Centerpulse acquisition. Product sales mix made favorable contributions as the Company sold a higher concentration of more proﬁtable reconstructive implants and 29 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K spinal implants, while less proﬁtable trauma and OSP products became a smaller percentage of net sales. Country sales mix made favorable contributions as the proﬁtable German market represented a greater percentage of total Europe sales. Asia Paciﬁc operating proﬁt as a percentage of net sales declined primarily due to decreased average selling prices, principally the result of the 4.9 percent decrease in government reimbursement rates in Japan, and increased selling expenses as a percentage of net sales due to the restructuring of certain dealer contracts in Japan. Year Ended December 31, 2003 Compared to Year Ended December 31, 2002 Operating proﬁt for the Americas as a percentage of net sales increased due to improved gross margins driven by higher average selling prices and increased sales of higher margin products, leveraged operating expenses and the favorable impact of the change in accounting principle for instruments. The change in accounting principle for instruments increased operating proﬁt by 1.7 percentage points. With respect to sales growth, increased Zimmer standalone average selling prices of 4 percent in 2003 and favorable effects of volume and mix, 15 percent increase in 2003, represent the most signiﬁcant factors in improved operating proﬁt in the Americas. As reconstructive implant sales grow at a higher rate than trauma and OSP, operating proﬁt margins generally tend to improve since reconstructive product sales generally earn higher gross margins. This was the case in 2003, with Zimmer standalone reconstructive implant sales growth of 22 percent as compared with total Zimmer standalone sales growth of 19 percent. In the fourth quarter, the Company reported operating proﬁt as a percent of net sales of 50.4 percent for the Americas. Operating proﬁt for Europe as a percentage of net sales increased due to improved gross proﬁt margins driven by higher Zimmer standalone average selling prices and favorable product and country mix, leveraged operating expenses and the favorable impact of the change in accounting principle for instruments. The change in accounting for instruments increased operating proﬁt by 1.4 percentage points. Increases in Zimmer standalone average selling prices in Europe of 2 percent in 2003 and the effect of volume and mix, 19 percent increase in 2003, were the key factors in improved operating proﬁt. Also contributing to the improvement was signiﬁcantly lower growth in operating expenses. In the fourth quarter of 2003, the Company reported operating proﬁt as a percent of net sales of 24.7 percent for Europe. Operating proﬁt for Asia Paciﬁc as a percentage of net sales decreased primarily due to less favorable rates on hedge contracts during the year compared to the prior year, partially offset by increased Zimmer standalone average selling prices and leveraged operating expenses. The change in accounting for instruments had an immaterial effect on operating proﬁt for Asia Paciﬁc. Increases in Zimmer standalone average selling prices in Asia Paciﬁc of 1 percent and volume and mix improvements of 4 percent in 2003 30 contributed modest improvement but was offset by higher cost of products sold. Included in cost of product sold are losses on foreign exchange hedge contracts, which increased in 2003 relative to 2002. In the fourth quarter, the Company reported operating proﬁt as a percent of net sales of 47.1 percent for Asia Paciﬁc. LIQUIDITY AND CAPITAL RESOURCES Cash ﬂows provided by operating activities were $862.2 million in 2004 compared to $494.8 million in 2003. The principal source of cash was net earnings of $541.8 million. Non-cash expenses for the period included depreciation and amortization expense of $181.3 million and Centerpulse and Implex inventory step-up of $59.4 million. Included in operating cash ﬂow is approximately $112 million of payments related to the Centerpulse and Implex integration. Income taxes generated $139.2 million of operating cash ﬂow, primarily due to reduced U.S. federal income tax payments resulting from the utilization of acquired Centerpulse net operating losses and exercises of stock options by Company employees, which are deductible expenses in the U.S. In addition, during 2004 the Company received a $55 million tax refund related to the overpayment of U.S. federal income taxes during 2003. Working capital, including the management of inventory and accounts receivable, continues to be a key management focus. At December 31, 2004, the Company had 59 days of sales outstanding in accounts receivable, favorable to December 31, 2003 by 3 days and unfavorable to December 31, 2002 by 7 days. Acquired Centerpulse businesses accounted for the decline from December 31, 2002, as Centerpulse’s business mix has a greater proportion of European sales with payment terms generally longer than those in the U.S. The improvement from the prior year is due to the Europe operating segment reducing its days of sales outstanding by 6 days due to improved collections in larger markets, such as Germany and France, and the factoring of receivables in Italy. At December 31, 2004, the Company had 258 days of inventory on hand, unfavorable to the prior year by 26 days. Inventory balances have increased due to the acquisition of Implex and to support new product launches. The 258 days of inventory on hand at December 31, 2004 is in line with the Company’s anticipated levels of 250-260 days. Cash ﬂows used in investing activities declined to $388.3 million in 2004 compared to $1,102.7 million in 2003. During 2003 the Company made $927.7 million of cash payments, net of acquired cash, for the Centerpulse and InCentive Capital acquisitions, compared to $18.2 million during 2004 to complete the compulsory acquisition process. During 2004 the Company also completed the acquisition of Implex for cash consideration of $153.1 million, comprised of $98.6 million of initial cash consideration, earn-out payments of $51.9 million and direct acquisition costs of $2.6 million. Additions to other property, plant and equipment during 2004 were $100.8 million compared to $44.9 million in 2003. Increases were primarily to support the acquired Centerpulse businesses, to support sales growth and new product Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K launches and to fund the facility expansions in Warsaw, Indiana, Ponce, Puerto Rico, and Parsippany, New Jersey. Additions to instruments during 2004 were $139.6 million compared to $113.6 million in 2003. Increases in instrument purchases were primarily to support acquired Centerpulse businesses and to support new product launches. Also, additional instrument purchases were made during 2004 to support MIS Procedure growth, including the placement of over 2,000 MIS Quad-Sparing Knee Replacement and Mini- Incision Knee Replacement instrument sets in the ﬁeld. During 2005 the Company expects purchases of other property, plant and equipment to increase to approximately $125 million to $135 million, as a result of ongoing facility expansions in Warsaw, Indiana, Ponce, Puerto Rico, Winterthur, Switzerland and Parsippany, New Jersey. Facility expansions are due to increased demand, the closure of the Austin, Texas, facility and the tripling of Trabecular Metal Technology production capacity. During 2005 the Company expects purchases of instruments to be approximately $145 million to $150 million as the Company continues to invest in instruments to support new products, sales growth and MIS procedures. plus an applicable margin determined by reference to the Company’s senior unsecured long-term credit rating and the amounts drawn under the Senior Credit Facility. The Senior Credit Facility contains customary afﬁrmative and negative covenants and events of default for an unsecured ﬁnancing arrangement, including, among other things, limitations on consolidations, mergers and sales of assets, as deﬁned in the Senior Credit Facility. Financial covenants include a maximum leverage ratio of 3.0 to 1.0 and a minimum interest coverage ratio of 3.5 to 1.0. If the Company falls below an investment grade credit rating, additional restrictions would result, including restrictions on investments and payment of dividends, as deﬁned in the Senior Credit Facility. The Company intends to maintain a capital structure that is consistent with an investment grade credit rating. The Company was in compliance with all covenants under the Senior Credit Facility as of December 31, 2004. Commitments under the $400 million 364-day revolving credit facility and the $800 million three-year revolving credit facility are subject to certain fees, including a facility and a utilization fee. The Company also has available uncommitted credit Cash ﬂows used in ﬁnancing activities were facilities totaling $50 million. $402.0 million in 2004 compared to $664.8 million provided by ﬁnancing activities in 2003. The Company repaid $461.4 million of debt in 2004 utilizing cash on hand, cash generated from operating activities and $65.0 million in cash proceeds received from the exercise of Company stock options. As of December 31, 2004, the Company has the following committed ﬁnancing arrangements: (i) $400 million 364-day revolving credit facility maturing May 2005, (ii) $800 million three-year revolving credit facility maturing June 2006 and (iii) $550 million ﬁve-year term loan facility maturing June 2008 (collectively, the ‘‘Senior Credit Facility’’). Available borrowings under the Senior Credit Facility at December 31, 2004, were approximately $1.1 billion. On May 24, 2004, the Company renewed its $400 million 364-day revolving credit facility and amended its ﬁve-year term loan facility to $550 million and reduced its term loan pricing by 25 basis points. The Company and certain of its wholly owned foreign and domestic subsidiaries are the borrowers and its wholly owned domestic subsidiaries are the guarantors of the Senior Credit Facility. Borrowings may bear interest at the appropriate LIBOR-based rate, or an alternative base rate, The terms of the Implex acquisition include additional cash earn-out payments that are contingent on the year-over- year growth of Implex product sales through 2006. The Company estimates total earn-out payments, including payments already made, to be in a range from $120 to $160 million. The Company expects to pay future earn-out payments, if any, with cash ﬂows from operations and borrowings available under its Senior Credit Facility. The Company had $154.6 million in cash and equivalents, $18.9 million in restricted cash and total debt of $651.5 million as of December 31, 2004. At December 31, 2004, $70.2 million of cash and equivalents was held at Company locations outside the U.S. The Company expects cash on hand to be in excess of total outstanding debt by June 30, 2006, absent any cash requirements for acquisitions. Management believes that cash ﬂows from operations, together with available borrowings under the Senior Credit Facility, will be sufﬁcient to meet the Company’s working capital, capital expenditure and debt service needs. Should investment opportunities arise, the Company believes that its earnings, balance sheet and cash ﬂows will allow the Company to obtain additional capital, if necessary. 31 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K CONTRACTUAL OBLIGATIONS The Company has entered into contracts with various third parties in the normal course of business which will require future payments. The following table illustrates the Company’s contractual obligations: Total 2005 $ 651.5 103.0 16.1 420.9 $27.5 23.5 15.5 – 2006 and 2007 $449.0 34.2 0.6 135.7 2008 and 2009 2010 and Thereafter $175.0 17.7 – 30.5 $ – 27.6 – 254.7 $1,191.5 $66.5 $619.5 $223.2 $282.3 adequate provisions exist for income taxes for all periods and jurisdictions subject to review or audit. Commitments and Contingencies – Accruals for product liability and other claims are established with internal and external legal counsel based on current information and historical settlement information for claims, related fees and for claims incurred but not reported. An actuarial model is used by the Company to assist management in determining an appropriate level of accruals for product liability claims. Historical patterns of claim loss development over time are statistically analyzed to arrive at factors which are then applied to loss estimates in the actuarial model. The amounts established represent management’s best estimate of the ultimate costs that it will incur under the various contingencies. Goodwill and Intangible Assets – The Company evaluates the carrying value of goodwill and indeﬁnite life intangible assets annually, or whenever events or circumstances indicate the carrying value may not be recoverable. The Company evaluates the carrying value of ﬁnite life intangible assets whenever events or circumstances indicate the carrying value may not be recoverable. Signiﬁcant assumptions are required to estimate the fair value of goodwill and intangible assets, most notably estimated future cash ﬂows generated by these assets. Changes to these assumptions could result in the Company being required to record impairment charges on these assets. RECENT ACCOUNTING PRONOUNCEMENTS Information about recent accounting pronouncements is included in Note 2 to the Consolidated Financial Statements, which are included herein under Item 8. Contractual Obligations Debt obligations Operating leases Purchase obligations Other long-term liabilities Total contractual obligations CRITICAL ACCOUNTING ESTIMATES The ﬁnancial results of the Company are affected by the selection and application of accounting policies and methods. Signiﬁcant accounting policies which require management’s judgment are discussed below. Excess Inventory and Instruments – The Company must determine as of each balance sheet date how much, if any, of its inventory may ultimately prove to be unsaleable or unsaleable at its carrying cost. Similarly, the Company must also determine if instruments on hand will be put to productive use or remain undeployed as a result of excess supply. Reserves are established to effectively adjust inventory and instruments to net realizable value. To determine the appropriate level of reserves, the Company evaluates current stock levels in relation to historical and expected patterns of demand for all of its products and instrument systems and components. The basis for the determination is generally the same for all inventory and instrument items and categories except for work-in-progress inventory, which is recorded at cost. Obsolete or discontinued items are generally destroyed and completely written off. Management evaluates the need for changes to valuation reserves based on market conditions, competitive offerings and other factors on a regular basis. Income Taxes – The Company estimates income tax expense and income tax liabilities and assets by taxable jurisdiction. Realization of deferred tax assets in each taxable jurisdiction is dependent on the Company’s ability to generate future taxable income sufﬁcient to realize the beneﬁts. The Company evaluates deferred tax assets on an ongoing basis and provides valuation allowances if it is determined to be ‘‘more likely than not’’ that the deferred tax beneﬁt will not be realized. Federal income taxes are provided on the portion of the income of foreign subsidiaries that is expected to be remitted to the U.S. The Company operates within numerous taxing jurisdictions. The Company is subject to regulatory review or audit in virtually all of those jurisdictions and those reviews and audits may require extended periods of time to resolve. The Company makes use of all available information and makes reasoned judgments regarding matters requiring interpretation in establishing tax expense, liabilities and reserves. The Company believes 32 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk MARKET RISK The Company is exposed to certain market risks as part of its ongoing business operations, including risks from changes in foreign currency exchange rates, interest rates and commodity prices that could impact its ﬁnancial condition, results of operations and cash ﬂows. The Company manages its exposure to these and other market risks through regular operating and ﬁnancing activities, and on a limited basis, through the use of derivative ﬁnancial instruments. Derivative ﬁnancial instruments are used solely as risk management tools and not for speculative investment purposes. FOREIGN CURRENCY EXCHANGE RISK The Company operates on a global basis and is exposed to the risk that its ﬁnancial condition, results of operations and cash ﬂows could be adversely affected by changes in foreign currency exchange rates. The Company is primarily exposed to foreign currency exchange rate risk with respect to its transactions and net assets denominated in Euros, Swiss Francs, Japanese Yen, British Pounds, Canadian Dollars and Australian Dollars. The Company manages the foreign currency exposure centrally, on a combined basis, which allows the Company to net exposures and to take advantage of any natural offsets. In order to reduce the uncertainty of foreign exchange rate movements on transactions denominated in foreign currencies, the Company enters into derivative ﬁnancial instruments in the form of foreign exchange forward contracts with major ﬁnancial institutions. These forward contracts are designed to hedge anticipated foreign currency transactions, primarily intercompany sale and purchase transactions, for periods consistent with commitments. Realized and unrealized gains and losses on these contracts that qualify as cash ﬂow hedges are temporarily recorded in other comprehensive income, then recognized in cost of products sold when the hedged item affects net earnings. The notional amounts of outstanding foreign exchange forward contracts, principally Euros, Swiss Francs, Japanese Yen, British Pounds, Canadian Dollars and Australian Dollars, entered into with third parties, at December 31, 2004 and 2003, were $1,052 million and $506 million, respectively. For contracts outstanding at December 31, 2004, the Company has an obligation to purchase U.S. Dollars and sell Euros, Swiss Francs, Japanese Yen, British Pounds, Canadian Dollars and Australian Dollars or purchase Swiss Francs and sell U.S. Dollars at set maturity dates ranging from January 2005 through December 2006. The weighted average contract rates outstanding are Euro: USD 1.20, USD: Swiss Franc 1.25, USD: Yen 110, British Pound: USD 1.76, USD: Canadian Dollar 1.37 and Australian Dollar: USD 0.65. The Company maintains written policies and procedures governing its risk management activities. The Company’s policy requires that critical terms of hedging instruments are the same as hedged forecasted transactions. On this basis, with respect to cash ﬂow hedges, changes in cash ﬂows attributable to hedged transactions are generally expected to be completely offset by changes in the fair value of hedge instruments. As part of its risk management program, the Company also performs sensitivity analyses to assess potential changes in revenue, operating results, cash ﬂows and ﬁnancial position relating to hypothetical movements in currency exchange rates. A sensitivity analysis of changes in the fair value of foreign exchange forward contracts outstanding at December 31, 2004, indicated that, if the U.S. Dollar uniformly changed in value by 10 percent relative to the Euro, Swiss Franc, Japanese Yen, British Pound, Canadian Dollar and Australian Dollar, with no change in the interest differentials, the fair value of those contracts would increase or decrease earnings before income taxes in periods through 2007, depending on the direction of the change, by an average approximate amount of $62.1 million, $21.8 million, $20.3 million, $6.3 million, $4.4 million and $3.7 million for the Euro, Swiss Franc, Japanese Yen, British Pound, Canadian Dollar and Australian Dollar contracts, respectively. Any change in the fair value of foreign exchange forward contracts as a result of a ﬂuctuation in a currency exchange rate is expected to be largely offset by a change in the value of the hedged transaction. Consequently, foreign exchange contracts would not subject the Company to material risk due to exchange rate movements because gains and losses on these contracts offset gains and losses on the assets, liabilities, and transactions being hedged. The Company had net investment exposures to net foreign currency denominated assets and liabilities of approximately $1,860 million at December 31, 2004, primarily in Swiss Francs, Japanese Yen and Euros. Approximately $1,140 million of the net asset exposure at December 31, 2004 relates to goodwill recorded in the Europe and Asia Paciﬁc geographic segments. The Company enters into foreign currency forward exchange contracts with terms of one month to manage currency exposures for assets and liabilities denominated in a currency other than an entity’s functional currency. As a result, foreign currency translation gains/losses recognized in earnings under SFAS No. 52, ‘‘Foreign Currency Translation’’ are generally offset with gain/losses on the foreign currency forward exchange contracts in the same reporting period. COMMODITY PRICE RISK The Company purchases raw material commodities such as cobalt chrome, titanium, tantalum, polymer and sterile packaging. The Company enters into 12 to 24 month supply contracts, where available, on these commodities to alleviate the impact of market fluctuation in prices. As part of the Company’s risk management program, sensitivity analyses related to potential commodity price changes are performed. A 10 percent price change across all these commodities would not have a material impact on the Company’s consolidated financial position, results of operations or cash flows. 33 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K customers and their dispersion across a number of geographic areas and by frequent monitoring of the creditworthiness of the customers to whom credit is granted in the normal course of business. However, essentially all of the Company’s trade receivables are concentrated in the public and private hospital and healthcare industry in the U.S. and internationally or with distributors or dealers who operate in international markets and, accordingly, are exposed to their respective business, economic and country speciﬁc variables. Repayment is dependent upon the ﬁnancial stability of these industry sectors and the respective countries’ national economic and health care systems. Exposure to credit risk is controlled through credit approvals, credit limits and monitoring procedures and the Company believes that reserves for losses are adequate. There is no signiﬁcant net exposure due to any individual customer or other major concentration of credit risk. INTEREST RATE RISK In the normal course of business, the Company is exposed to market risk from changes in interest rates that could impact its results of operations and ﬁnancial condition. The Company manages its exposure to interest rate risks through its regular operations and ﬁnancing activities. Presently, the Company invests its cash and equivalents in money market and investment-grade short-term debt instruments. The primary investment objective is to ensure capital preservation of its invested principal funds by limiting default and market risk. Currently, the Company does not use derivative ﬁnancial instruments in its investment portfolio. The Company’s exposure to interest rate risk arises principally from the variable rates associated with its credit facilities. The Company is subject to interest rate risk through movements in interest rates on the committed Senior Credit Facility and its uncommitted credit facilities. Presently, all of its debt outstanding bears interest at short- term rates. The Company currently does not hedge its interest rate exposure, but may do so in the future. Based upon the Company’s overall interest rate exposure as of December 31, 2004, a change of 10 percent in interest rates (or 25 basis points), assuming the amount outstanding remains constant, would result in an annual increase of interest expense of approximately $1.0 million. However, due to the uncertainty of the actions that would be taken and their possible effects, this analysis assumes no such action, nor management actions to mitigate interest rate changes. Further, this analysis does not consider the effect of the change in the level of overall economic activity that could exist in such an environment. CREDIT RISK Financial instruments, which potentially subject the Company to concentrations of credit risk, are primarily cash, cash equivalents, counterparty transactions, and accounts receivable. The Company places its investments in highly rated ﬁnancial institutions and money market instruments, and limits the amount of credit exposure to any one entity. The Company does not believe it is exposed to any signiﬁcant credit risk on its cash and equivalents and investments. The Company is exposed to credit loss in the event of nonperformance by the ﬁnancial institutions with which it conducts business. However, this loss is limited to the amounts, if any, by which the obligations of the counterparty to the ﬁnancial instrument contract exceed the obligation of the Company. The Company also minimizes exposure to credit risk by dealing with a diversiﬁed group of major ﬁnancial institutions. Credit risk is managed through the monitoring of counterparty ﬁnancial condition and by the use of standard credit guidelines. The Company does not anticipate any nonperformance by any of the counterparties. Concentration of credit risk with respect to trade accounts receivable is limited due to the large number of 34 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Management’s Report on Internal Control Over Financial Reporting The management of Zimmer Holdings, Inc. is responsible for establishing and maintaining adequate internal control over ﬁnancial reporting. Internal control over ﬁnancial reporting is deﬁned in Rules 13a-15(f) or 15d-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, the Company’s principal executive and principal ﬁnancial ofﬁcers and effected by the Company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of ﬁnancial reporting and the preparation of ﬁnancial statements for external purposes in accordance with U.S. generally accepted accounting principles and includes those policies and procedures that: ) Pertain to the maintenance of records that in reasonable detail accurately and fairly reﬂect the transactions and dispositions of the assets of the Company; ) Provide reasonable assurance that transactions are recorded as necessary to permit preparation of ﬁnancial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and ) Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the ﬁnancial statements. Because of its inherent limitations, the Company’s internal control over ﬁnancial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The Company’s management assessed the effectiveness of the Company’s internal control over ﬁnancial reporting as of December 31, 2004. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on our assessment, management has concluded that, as of December 31, 2004, the Company’s internal control over ﬁnancial reporting is effective based on those criteria. The Company’s independent auditors have audited our assessment of the effectiveness of the Company’s internal control over ﬁnancial reporting as of December 31, 2004, as stated in their report which appears in Item 8 of this Annual Report on Form 10-K. 35 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K ITEM 8. Financial Statements and Supplementary Data Zimmer Holdings, Inc. Index to Consolidated Financial Statements FINANCIAL STATEMENTS: Report of Independent Registered Public Accounting Firm Consolidated Statements of Earnings for the Years Ended December 31, 2004, 2003 and 2002 Consolidated Balance Sheets as of December 31, 2004 and 2003 Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2004, 2003 and 2002 Consolidated Statements of Cash Flows for the Years Ended December 31, 2004, 2003 and 2002 Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2004, 2003 and 2002 Notes to Consolidated Financial Statements Page 37 39 40 41 42 43 44 36 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Report of Independent Registered Public Accounting Firm To the Stockholders and Board of Directors of Zimmer Holdings, Inc.: We have completed an integrated audit of Zimmer Holdings, Inc.’s 2004 consolidated ﬁnancial statements and of its internal control over ﬁnancial reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated ﬁnancial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below. Consolidated ﬁnancial statements In our opinion, the consolidated ﬁnancial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the ﬁnancial position of Zimmer Holdings, Inc. and its subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash ﬂows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the ﬁnancial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated ﬁnancial statements. These ﬁnancial statements and ﬁnancial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these ﬁnancial statements and ﬁnancial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the ﬁnancial statements are free of material misstatement. An audit of ﬁnancial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the ﬁnancial statements, assessing the accounting principles used and signiﬁcant estimates made by management, and evaluating the overall ﬁnancial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As described in Note 4, the Company changed its method of accounting for instruments effective January 1, 2003. Internal control over ﬁnancial reporting Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing at the conclusion of Item 7A, that the Company maintained effective internal control over ﬁnancial reporting as of December 31, 2004 based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over ﬁnancial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over ﬁnancial reporting and for its assessment of the effectiveness of internal control over ﬁnancial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over ﬁnancial reporting based on our audit. We conducted our audit of internal control over ﬁnancial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over ﬁnancial reporting was maintained in all material respects. An audit of internal control over ﬁnancial reporting includes obtaining an understanding of internal control over ﬁnancial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. A company’s internal control over ﬁnancial reporting is a process designed to provide reasonable assurance regarding the reliability of ﬁnancial reporting and the preparation of ﬁnancial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over ﬁnancial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reﬂect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of ﬁnancial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the ﬁnancial statements. 37 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Because of its inherent limitations, internal control over ﬁnancial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. PricewaterhouseCoopers LLP Chicago, IL March 9, 2005 38 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S Consolidated Statements of Earnings For the Years Ended December 31, Net Sales Cost of products sold Gross Proﬁt Research and development Selling, general and administrative In-process research and development Acquisition and integration Operating expenses Operating Proﬁt Interest expense Earnings before income taxes, minority interest and cumulative effect of change in accounting principle Provision for income taxes Minority interest Earnings before cumulative effect of change in accounting principle Cumulative effect of change in accounting principle, net of tax Net Earnings Earnings Per Common Share – Basic Earnings before cumulative effect of change in accounting principle Cumulative effect of change in accounting principle, net of tax Earnings Per Common Share – Basic Earnings Per Common Share – Diluted Earnings before cumulative effect of change in accounting principle Cumulative effect of change in accounting principle, net of tax Earnings Per Common Share – Diluted Pro Forma Amounts Assuming the New Accounting Principle is Applied Retroactively Net Earnings Earnings Per Common Share – Basic Earnings Per Common Share – Diluted Weighted Average Common Shares Outstanding Basic Diluted The accompanying notes are an integral part of these consolidated ﬁnancial statements. 2 0 0 4 F O R M 1 0 - K (in millions, except per share amounts) 2004 2003 2002 $2,980.9 779.9 $1,901.0 516.2 $1,372.4 344.8 2,201.0 1,384.8 1,027.6 166.7 1,190.0 – 81.1 1,437.8 763.2 31.7 731.5 189.6 (0.1) 541.8 – 105.8 737.5 11.2 79.6 934.1 450.7 13.2 437.5 146.8 0.5 291.2 55.1 80.7 546.0 – – 626.7 400.9 12.0 388.9 131.1 – 257.8 – $ 541.8 $ 346.3 $ 257.8 $ $ $ $ 2.22 – 2.22 2.19 – 2.19 $ $ $ $ 1.40 0.27 1.67 1.38 0.26 1.64 $ $ $ $ 1.33 – 1.33 1.31 – 1.31 $ 541.8 2.22 $ 2.19 $ $ 291.2 1.40 $ 1.38 $ $ 260.8 1.34 $ 1.33 $ 244.4 247.8 207.7 211.2 194.5 196.8 39 2 0 0 4 F O R M 1 0 - K (in millions, except share amounts) 2004 2003 $ 154.6 18.9 524.8 536.0 54.0 272.6 1,560.9 628.5 2,528.9 794.8 182.4 $ 77.5 14.5 486.4 527.7 43.5 189.1 1,338.7 525.2 2,291.8 760.5 239.8 $5,695.5 $5,156.0 $ 131.6 34.2 507.7 27.5 701.0 420.9 624.0 $ 127.6 (59.0) 475.4 101.3 645.3 352.6 1,007.8 1,745.9 2,005.7 7.1 7.0 2.5 2,485.2 1,201.5 253.3 2.4 2,342.5 659.7 138.7 3,942.5 3,143.3 $5,695.5 $5,156.0 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S Consolidated Balance Sheets December 31, ASSETS Current Assets: Cash and equivalents Restricted cash Accounts receivable, less allowance for doubtful accounts Inventories, net Prepaid expenses Deferred income taxes Total Current Assets Property, plant and equipment, net Goodwill Intangible assets, net Other assets Total Assets LIABILITIES AND STOCKHOLDERS’ EQUITY Current Liabilities: Accounts payable Income taxes payable (receivable) Other current liabilities Short-term debt Total Current Liabilities Other long-term liabilities Long-term debt Total Liabilities Commitments and Contingencies (Note 16) Minority Interest Stockholders’ Equity: Common stock, $0.01 par value, one billion shares authorized, 245.5 million (242.4 million in 2003) issued and outstanding Paid-in capital Retained earnings Accumulated other comprehensive income Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity The accompanying notes are an integral part of these consolidated ﬁnancial statements. 40 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Consolidated Statements of Stockholders’ Equity Balance January 1, 2002 Net earnings Other comprehensive income Stock option exercises Other Balance December 31, 2002 Net earnings Other comprehensive income Centerpulse and InCentive Exchange Offers net of $(11.9) million equity issuance costs Stock option exercises Other Balance December 31, 2003 Net earnings Other comprehensive income Centerpulse and InCentive compulsory acquisition Stock option exercises Other Common Shares Number Amount Paid-in Capital Retained Earnings 193.9 – – 1.3 – 195.2 – – 44.5 2.7 – 242.4 – – 0.6 2.5 – $1.9 – – 0.1 – 2.0 – – 0.4 – – 2.4 – – – 0.1 – $ 4.4 – – 30.9 1.6 36.9 – – 2,211.6 88.1 5.9 2,342.5 – – 28.1 104.3 10.3 $ 55.6 257.8 – – – 313.4 346.3 – – – – 659.7 541.8 – – – – Accumulated Other Comprehensive Income (in millions) Total Stockholders’ Equity $ 16.8 – (2.8) – – 14.0 – 124.7 – – – 138.7 – 114.6 – – – $ 78.7 257.8 (2.8) 31.0 1.6 366.3 346.3 124.7 2,212.0 88.1 5.9 3,143.3 541.8 114.6 28.1 104.4 10.3 Balance December 31, 2004 245.5 $2.5 $2,485.2 $1,201.5 $253.3 $3,942.5 The accompanying notes are an integral part of these consolidated ﬁnancial statements. 41 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Consolidated Statements of Cash Flows For the Years Ended December 31, Cash ﬂows provided by (used in) operating activities: Net earnings Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization Inventory step-up Write off of in-process research and development Cumulative effect of change in accounting principle Changes in operating assets and liabilities, net of acquired assets and liabilities Income taxes Receivables Inventories Accounts payable and accrued liabilities Other assets and liabilities (in millions) 2004 2003 2002 $ 541.8 $ 346.3 $ 257.8 181.3 59.4 – – 139.2 (10.6) (44.7) (3.1) (1.1) 103.3 42.7 11.2 (89.1) 117.8 (39.0) (53.0) 75.9 (21.3) 25.3 – – – 29.9 (25.0) (59.7) (12.2) 4.1 Net cash provided by operating activities 862.2 494.8 220.2 Cash ﬂows provided by (used in) investing activities: Additions to instruments Additions to other property, plant and equipment Centerpulse and InCentive acquisitions, net of acquired cash Implex acquisition, net of acquired cash Proceeds from note receivable Investments in other assets Net cash used in investing activities Cash ﬂows provided by (used in) ﬁnancing activities: Net proceeds/(payments) on lines of credit Proceeds from term loans Payments on term loans Proceeds from exercise of stock options Debt issuance costs Equity issuance costs Net cash provided by (used in) ﬁnancing activities Effect of exchange rates on cash and equivalents Increase (decrease) in cash and equivalents Cash and equivalents, beginning of year Cash and equivalents, end of year The accompanying notes are an integral part of these consolidated ﬁnancial statements. (139.6) (100.8) (18.2) (153.1) 25.0 (1.6) (113.6) (44.9) (927.7) – – (16.5) – (33.7) – – – (2.0) (388.3) (1,102.7) (35.7) (561.4) 100.0 – 65.0 (0.6) (5.0) 170.6 550.0 (100.0) 70.5 (19.4) (6.9) (212.8) – – 23.9 – – (402.0) 664.8 (188.9) 5.2 77.1 77.5 4.9 61.8 15.7 1.7 (2.7) 18.4 $ 154.6 $ 77.5 $ 15.7 42 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Consolidated Statements of Comprehensive Income For the Years Ended December 31, Net Earnings Other Comprehensive Income (Loss): Foreign currency cumulative translation adjustments Unrealized foreign currency hedge losses, net of tax effects of $10.0 in 2004, $21.6 in 2003 and $7.5 in 2002 Reclassiﬁcation adjustments on foreign currency hedges, net of tax effects of $(9.6) in 2004, $(2.1) in 2003 and $2.1 in 2002 Unrealized gains on securities, net of tax effect of $(1.5) Minimum pension liability, net of tax effects of $0.2 in 2004 and $0.4 in 2002 Other comprehensive income (loss) Comprehensive Income The accompanying notes are an integral part of these consolidated ﬁnancial statements. (in millions) 2004 2003 2002 $541.8 $346.3 $257.8 145.5 156.6 13.5 (48.7) (35.3) (12.2) 15.7 2.4 (0.3) 3.4 – – 114.6 124.7 (3.5) – (0.6) (2.8) $656.4 $471.0 $255.0 43 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Notes to Consolidated Financial Statements 1. BUSINESS Zimmer Holdings, Inc. and its subsidiaries (individually and collectively the ‘‘Company’’) design, develop, manufacture and market reconstructive orthopaedic implants, including joint and dental, spinal implants, and trauma products. Joint reconstructive implants restore function lost due to disease or trauma in joints such as knees, hips, shoulders and elbows. Dental reconstructive implants restore function and aesthetics in patients that have lost teeth due to trauma or disease. Spinal implants are utilized by orthopaedic surgeons and neurosurgeons in the treatment of degenerative diseases, deformities and trauma in all regions of the spine. Trauma products are devices used primarily to reattach or stabilize damaged bone and tissue to support the body’s natural healing process. The Company’s related orthopaedic surgical products include surgical supplies and instruments designed to aid in orthopedic surgical procedures. The Company also has a limited array of sports medicine products. The Company has operations in more than 24 countries and markets its products in more than 100 countries. The Company operates in a single industry but has three reportable geographic segments, the Americas, Europe and Asia Paciﬁc. 2. SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation – The consolidated ﬁnancial statements include the accounts of Zimmer Holdings, Inc. and its subsidiaries in which it holds a controlling equity position. Investments in companies in which the Company exercises signiﬁcant inﬂuence over the operating and ﬁnancial affairs, but does not control, are accounted for under the equity method. Under the equity method, the Company records the investment at cost and adjusts the carrying amount of the investment by its proportionate share of the investee’s net earnings or losses. All signiﬁcant intercompany accounts and transactions are eliminated. Certain amounts in the 2003 and 2002 consolidated ﬁnancial statements have been reclassiﬁed to conform to the 2004 presentation. Use of Estimates – The consolidated ﬁnancial statements are prepared in conformity with accounting principles generally accepted in the United States and, accordingly, include amounts that are based on management’s best estimates and judgments. Actual results could differ from those estimates. Foreign Currency Translation – The ﬁnancial statements of the Company’s 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. Foreign currency transaction gains and losses included in net earnings are not material. 44 Revenue Recognition – The Company sells product through three principal channels: 1) direct to health care institutions, 2) through stocking distributors and healthcare dealers and 3) directly to dental practices and dental laboratories. The direct channel accounts for greater than 80 percent of the Company’s revenue. 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 the Company retains title and maintains the inventory on the Company’s balance sheet. Upon use, the Company issues 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 health care institutions within a speciﬁed group. At negotiated thresholds within a contract buying period, price discounts increase. The Company tracks sales volumes by contract and as contractual volume thresholds are achieved, the higher discounts are applied at an item level on customer invoices. As such, discounts are reﬂected in revenue as earned. The Company also accrues for anticipated price adjustments, which can occur subsequent to invoicing, based on reasonable estimates derived from past experience. Revenue is recognized on sales to stocking distributors, healthcare dealers, dental practices and dental laboratories, which account for less than 20 percent of the Company’s revenue, when title to product passes to the distributor, healthcare dealer, dental practice or dental laboratory, generally upon shipment. Product is generally sold to distributors on secured credit terms at ﬁxed prices for speciﬁed periods. A distributor may return product in the event that the Company terminates the relationship. Under those circumstances, the Company records an estimated sales return in the period in which constructive notice of termination is given to a distributor. The reserves for doubtful accounts were $28.4 million and $29.5 million as of December 31, 2004 and 2003, respectively. 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. Acquisition and Integration – The Company recognizes incremental expenses resulting directly from the acquisitions of Centerpulse and Implex as ‘‘Acquisition and integration’’ Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Notes to Consolidated Financial Statements (Continued) expenses. Acquisition and integration expenses for the years ended December 31, 2004 and 2003, included (in millions): For the Years Ended December 31, 2004 2003 Sales agent and lease contract terminations Integration consulting Employee severance and retention Professional fees Integration personnel Information technology integration Other $24.4 24.2 9.4 7.8 5.2 4.3 5.8 $36.1 15.4 10.2 6.4 2.0 – 9.5 $81.1 $79.6 Cash and Equivalents – The Company considers 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 equivalents are valued at cost, which approximates their fair value. The Company has restricted cash primarily composed of cash held in escrow related to certain insurance coverage. Inventories – Inventories, net of allowances for obsolete and slow-moving goods, 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 on a straight-line method based on the estimated useful lives of ten to forty years for buildings and improvements, three to eight years for machinery and equipment and generally ﬁve years for instruments. Maintenance and repairs are expensed as incurred. In accordance with Statement of Financial Accounting Standards (‘‘SFAS’’) No. 144, ‘‘Accounting for the Impairment or Disposal of Long-Lived Assets,’’ the Company reviews 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. Goodwill – The Company accounts for goodwill in accordance with SFAS No. 142, ‘‘Goodwill and Other Intangible Assets’’. Under SFAS 142, goodwill is not amortized but is subject to annual impairment tests. Goodwill has been assigned to reporting units, which are consistent with the Company’s reportable operating segments. The Company performs annual impairment tests in accordance with SFAS No. 142 by comparing each reporting unit’s fair value to its carrying amount to determine if there is potential impairment. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the reporting unit goodwill is less than the carrying value of the reporting unit goodwill. The fair value of the reporting unit and the implied fair value of goodwill are determined based upon discounted cash ﬂows, market multiples or appraised values as appropriate. Intangible Assets – The Company accounts for intangible assets in accordance with SFAS No. 142. Intangible assets with an indeﬁnite life, including certain trademarks and trade names, are not amortized. The useful lives of 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 and patents and licenses are amortized over their estimated useful life, ranging from seven to thirty years. 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. Intangible assets with a ﬁnite life are tested for impairment whenever events or circumstances indicate that the carrying amount may not be recoverable. Research and Development – The Company expenses all research and development costs as incurred. Research and development costs include salaries, prototypes, depreciation of equipment used in research and development, consultant fees and amounts paid to collaborative partners. Income Taxes – The Company accounts for income taxes in accordance with SFAS No. 109, ‘‘Accounting for Income Taxes.’’ Under this method, deferred tax assets and liabilities are determined based on differences between ﬁnancial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates in effect for the years in which the differences are expected to reverse. Federal income taxes are provided on the portion of the income of foreign subsidiaries that is expected to be remitted to the U.S. Derivative Financial Instruments – The Company accounts for all derivative ﬁnancial instruments in accordance with SFAS No. 133, ‘‘Accounting for Derivative Instruments and Hedging Activities,’’ as amended by SFAS No. 138, ‘‘Accounting for Certain Derivative Instruments and Certain Hedging Activities (an amendment of FASB Statement No. 133)’’ and SFAS No. 149, ‘‘Amendment of Statement 133 on Derivative Instruments and Hedging Activities’’. SFAS No. 133 requires that all derivative instruments be reported as assets or liabilities on the balance sheet and measured at fair value. The Company maintains written policies and procedures that permit, under appropriate circumstances and subject to proper authorization, the use of derivative ﬁnancial instruments solely for hedging purposes. The use of derivative ﬁnancial instruments for trading or speculative purposes is prohibited. The Company is exposed to market risk due to changes in currency exchange rates. As a result, the Company utilizes foreign exchange forward contracts to offset the effect of exchange rate ﬂuctuations on anticipated foreign currency transactions, generally intercompany sales 45 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Notes to Consolidated Financial Statements (Continued) and purchases expected to occur within the next twelve to twenty-four months. Derivative instruments that qualify as cash ﬂow hedges are designated as such from inception. Formal documentation is maintained of the Company’s objectives, the nature of the risk being hedged, identiﬁcation of the instrument, the hedged transaction, the hedging relationship and how effectiveness of the hedging instrument will be assessed. The Company’s policy requires that critical terms of a hedging instrument are essentially the same as a hedged forecasted transaction. On this basis, with respect to a cash ﬂow hedge, changes in cash ﬂows attributable to the hedged transaction are generally expected to be completely offset by the cash ﬂows attributable to hedge instruments. The Company, therefore, performs quarterly assessments of hedge effectiveness by verifying and documenting those critical terms of the hedge instrument and that forecasted transactions have not changed. The Company also assesses 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 reported in cost of products sold immediately. The net amount recognized in earnings during the years ended December 31, 2004, 2003 and 2002, due to ineffectiveness and amounts excluded from the assessment of hedge effectiveness, was not signiﬁcant. The notional amounts of outstanding foreign exchange forward contracts, principally Euros, Swiss Francs, Japanese Yen, British Pounds, Canadian Dollars and Australian Dollars, entered into with third parties, at December 31, 2004, were $1,052.3 million. The fair value of outstanding derivative instruments recorded on the balance sheet at December 31, 2004, together with settled derivatives where the hedged item has not yet affected earnings, was a net unrealized loss of $97.3 million, or $73.4 million net of taxes, which is deferred in other comprehensive income, of which, $57.9 million, or $46.2 million, net of taxes, is expected to be reclassiﬁed to earnings over the next twelve months. The Company also enters into foreign currency forward exchange contracts with terms of one month to manage currency exposures for assets and liabilities denominated in a currency other than an entity’s functional currency. As a result, any foreign currency translation gains/losses recognized in earnings under SFAS No. 52, ‘‘Foreign Currency Translation’’ are generally offset with gains/losses on the foreign currency forward exchange contracts in the same reporting period. Stock Compensation – At December 31, 2004, the Company had three stock-option compensation plans for employees, which are described more fully in Note 13, an employee stock purchase plan and a restricted stock plan for certain key members of management. The Company accounts 46 for those plans under the recognition and measurement principles of APB Opinion No. 25, ‘‘Accounting for Stock Issued to Employees,’’ and related Interpretations. No compensation cost is reflected in net income for the stock- option compensation plans, as all options granted under those plans had exercise prices equal to the market value of the underlying common stock on the date of grant. No compensation cost is reflected in net income for the employee stock purchase plan under the provisions of APB 25, which allows a discounted purchase price under Section 423 of the Internal Revenue Code. Compensation cost related to restricted stock is recognized in earnings over the vesting period of the stock, which is generally five years. Compensation cost related to restricted stock was not significant for the years ended December 31, 2004, 2003 and 2002. The following table illustrates the effect on net earnings and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, ‘‘Accounting for Stock Based Compensation,’’ to the above plans. For the Years Ended December 31, 2004 2003 2002 (in millions, except per share amounts) Net earnings, as reported Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax Pro forma net earnings Earnings per share: Basic – as reported Basic – pro forma Diluted – as reported Diluted – pro forma Weighted average shares outstanding: Basic Diluted $541.8 $346.3 $257.8 (26.0) (14.3) (12.7) $515.8 $332.0 $245.1 $ 2.22 2.11 2.19 2.08 $ 1.67 1.60 1.64 1.57 $ 1.33 1.26 1.31 1.25 244.4 247.8 207.7 211.2 194.5 196.8 The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: 2004 2003 2002 Dividend Yield Volatility Risk-free interest rate Expected life (years) –% –% –% 28.0% 27.1% 30.3% 4.6% 3.1% 5 5 3.4% 5 The weighted average fair value for options granted during 2004, 2003 and 2002 was $21.85, $12.85 and $10.63, respectively. Comprehensive Income – Other comprehensive income 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. The Company’s other comprehensive income is comprised of unrealized foreign currency hedge gains and losses, minimum pension liability adjustments, unrealized gains (losses) on available-for-sale securities, and foreign currency translation adjustments. Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Notes to Consolidated Financial Statements (Continued) The components of accumulated other comprehensive income are as follows (in millions): Beginning balance at January 1, 2004 Other comprehensive income (loss) Balance at December 31, 2004 Accounting Pronouncements – In November 2004, the FASB issued FASB Staff Position (‘‘FSP’’) 109-1, ‘‘Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualiﬁed Production Activities Provided by the American Jobs Creation Act of 2004’’ and FSP 109-2, ‘‘Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004’’. FSP 109-1 states that a company’s deduction under the American Jobs Creation Act of 2004 (the ‘‘Act’’) should be accounted for as a special deduction in accordance with SFAS No. 109 and not as a tax rate reduction. FSP 109-2 provides accounting and disclosure guidance for repatriation provisions included under the Act. FSP 109-1 and FSP 109-2 were both effective upon issuance. The adoption of these FSP’s did not have a material impact on the Company’s ﬁnancial position, results of operations or cash ﬂows in 2004. In November 2004, the FASB issued SFAS No. 151, ‘‘Inventory Costs’’ to clarify the accounting for abnormal amounts of idle facility expense. SFAS No. 151 requires that ﬁxed overhead production costs be applied to inventory at ‘‘normal capacity’’ and any excess ﬁxed overhead production costs be charged to expense in the period in which they were incurred. SFAS No. 151 is effective for ﬁscal years beginning after June 15, 2005. The company does not expect SFAS No. 151 to have a material impact on its ﬁnancial position, results of operations, or cash ﬂows. In December 2004, the FASB issued SFAS No. 153, ‘‘Exchanges of Nonmonetary Assets’’, which is effective for ﬁscal years beginning after June 15, 2004. The Company does not routinely engage in exchanges of nonmonetary assets; as such, SFAS No. 153 is not expected to have a material impact on the Company’s ﬁnancial position, results of operations or cash ﬂows. In May 2004, the FASB issued FSP 106-2 ‘‘Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003’’, which is effective for the ﬁrst interim or annual period beginning after June 15, 2004. The Company does not expect to be eligible for the federal subsidy available pursuant to the Medicare Prescription Drug Improvement and Modernization Act of 2003; therefore, this staff position did not have a material impact on the Company’s results of operations, ﬁnancial position or cash ﬂow. In December 2004, the FASB issued SFAS No. 123(R), ‘‘Share-Based Payment’’, which is a revision to SFAS No. 123, ‘‘Accounting for Stock Based Compensation’’. SFAS Foreign Currency Translation $179.7 145.5 $325.2 Foreign Currency Hedges $(40.4) (33.0) $(73.4) Minimum Pension Liability $(0.6) (0.3) $(0.9) Unrealized Gains on Securities $ – 2.4 $2.4 Accumulated Other Comprehensive Income $138.7 114.6 $253.3 No. 123(R) requires all share-based payments to employees, including stock options, to be expensed based on their fair values. The Company has disclosed the effect on net earnings and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123. SFAS 123(R) contains three methodologies for adoption: 1) adopt SFAS 123(R) on the effective date for interim periods thereafter, 2) adopt SFAS 123(R) on the effective date for interim periods thereafter and restate prior interim periods included in the ﬁscal year of adoption under the provisions of SFAS 123, or 3) adopt SFAS 123(R) on the effective date for interim periods thereafter and restate all prior interim periods under the provisions of SFAS 123. The Company has not determined an adoption methodology. The Company is in the process of assessing the impact that SFAS 123(R) will have on its ﬁnancial position, results of operations and cash ﬂows. SFAS 123(R) is effective for the Company on July 1, 2005. 3. ACQUISITIONS Centerpulse AG and InCentive Capital AG On October 2, 2003 (the ‘‘Closing Date’’), the Company closed its exchange offer for Centerpulse, a global orthopaedic medical device company headquartered in Switzerland that services the reconstructive joint, spine and dental implant markets. The Company also closed its exchange offer for InCentive, a company that, at the Closing Date, owned only cash and beneﬁcially owned 18.3 percent of the issued Centerpulse shares. The primary reason for making the Centerpulse and InCentive exchange offers (the ‘‘Exchange Offers’’) was to create a global leader in the design, development, manufacture and marketing of orthopaedic reconstructive implants, including joint and dental, spine implants, and trauma products. The strategic compatibility of the products and technologies of the Company and Centerpulse is expected to provide signiﬁcant earnings power and a strong platform from which it can actively pursue growth opportunities in the industry. For the Company, Centerpulse provides a unique platform for growth and diversiﬁcation in Europe as well as in the spine and dental areas of the medical device industry. As a result of the Exchange Offers, the Company beneﬁcially owned 98.7 percent of the issued Centerpulse shares (including the Centerpulse shares owned by InCentive) and 99.9 percent of the issued InCentive shares on the Closing Date. 47 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Notes to Consolidated Financial Statements (Continued) Pursuant to Swiss law, the Company initiated the The following table summarizes the fair values of the compulsory acquisition process to acquire all of the shares of Centerpulse and InCentive that remained outstanding following the Exchange Offers, and completed this process on April 29, 2004. The aggregate consideration paid by the Company for shares acquired pursuant to the compulsory acquisition process was $42.3 million, consisting of Company common stock valued at $28.1 million (562,870 shares exchanged) and $14.2 million of cash. In accordance with EITF 99-12, ‘‘Determination of the Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business Combination’’, the fair value of the Company’s common stock issued pursuant to the compulsory acquisition process was determined to be $49.93 per share based upon the average closing price of the Company’s common stock two days before and after the date when sufﬁcient Centerpulse and InCentive shares had been tendered to make the Exchange Offers binding (August 27, 2003). The aggregate consideration paid by the Company in the Exchange Offers, including amounts paid pursuant to the compulsory acquisition process, was $3,495.7 million, consisting of Company common stock valued at $2,252.0 million (45,101,640 shares exchanged), $1,201.3 million of cash and $42.4 million of direct acquisition costs. The Exchange Offers were accounted for under the purchase method of accounting pursuant to SFAS No. 141, ‘‘Business Combinations’’. Accordingly, Centerpulse and InCentive results of operations have been included in the Company’s consolidated results of operations subsequent to the Closing Date, and their respective assets and liabilities were recorded at their estimated fair values in the Company’s consolidated statement of ﬁnancial position as of the Closing Date, with the excess purchase price being allocated to goodwill. The Company ﬁnalized the purchase price allocation in 2004 in accordance with U.S. generally accepted accounting principles. During the year ended December 31, 2004, the Company adjusted certain estimates included in the preliminary purchase price allocation, including estimated fair values of certain acquired investments, intangible assets, inventory, ﬁxed assets, income tax liabilities, product liabilities and other legal liabilities. In accordance with SFAS No. 141, all adjustments to the purchase price allocation have been reﬂected as changes to goodwill. See Note 7 for the changes in the carrying amount of goodwill during the year ended December 31, 2004. The purchase price allocation was based on information available to the Company, and expectations and assumptions deemed reasonable by the Company’s management. No assurance can be given, however, that the underlying assumptions used to estimate expected technology based product revenues, development costs or proﬁtability, or the events associated with such technology, will occur as projected. 48 assets acquired and liabilities assumed at the Closing Date. Current assets Property, plant and equipment Intangible assets not subject to amortization: Trademarks and trade names Intangible assets subject to amortization: Core technology Developed technology Trademarks and trade names Customer relationships In-process research and development Deferred taxes Other assets Goodwill Total assets acquired Short-term debt Deferred taxes Other current liabilities Integration liability Long-term liabilities Total liabilities assumed Net assets acquired (in millions) As of October 2, 2003 $ 793.6 179.3 207.4 110.6 303.0 30.4 44.0 11.2 579.5 75.7 2,293.5 4,628.2 306.3 250.3 299.7 67.6 208.6 1,132.5 $3,495.7 In 2003, the Company recorded a $75.7 million integration liability consisting of $49.7 million of employee termination beneﬁts, $22.6 million of sales agent and lease contract termination costs and $3.4 million of employee relocation costs. In accordance with EITF 95-3 ‘‘Recognition of Liabilities Assumed in a Purchase Business Combination’’, these liabilities were included in the allocation of the purchase price. Reductions to the integration liability of $8.1 million during the purchase price allocation period were recorded as adjustments to goodwill. Increases to the liability subsequent to the completion of the allocation period are expensed in the ﬁnancial statements, and were not signiﬁcant. Reductions in the liability subsequent to the completion of the allocation period are recorded as adjustments to goodwill. The Company’s integration plan covers all functional business areas, including sales force, research and development, manufacturing and administrative. Approximately 830 Centerpulse employees have been or will be involuntarily terminated through the Company’s integration plan. The Company began phasing-out production at its Austin, Texas manufacturing facility in 2004. The phase-out will result in the involuntary termination of approximately 550 employees, including 390 employees involved in manufacturing. Products previously manufactured at the Austin facility will be sourced from the Company’s other manufacturing facilities. The Company has begun to hire additional manufacturing employees at its other manufacturing facilities to handle increased production schedules. The Austin phase-out is expected to be completed Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Notes to Consolidated Financial Statements (Continued) in 2005. As of December 31, 2004, approximately 420 Centerpulse employees had been involuntarily terminated. With a few exceptions, the Company’s integration plan is expected to be completed by the end of 2005. Reconciliation of the integration liability, as of December 31, 2004, is as follow (in millions): Employee Termination Employee Contract Beneﬁts Terminations Relocation Total Balance, Closing Date Cash Payments $ 49.7 (20.7) $ 22.6 (0.2) $ 3.4 $ 75.7 (20.9) – Balance, December 31, 2003 Cash Payments Additions /(Reductions) 29.0 (19.2) 2.1 22.4 (2.3) (11.8) 3.4 54.8 (1.3) (22.8) (8.1) 1.6 Balance, December 31, 2004 $ 11.9 $ 8.3 $ 3.7 $ 23.9 The $11.8 million reduction in contract terminations during the year ended December 31, 2004 primarily resulted due to the assignment of $5.2 million of lease obligations related to closed Centerpulse facilities and a $7.9 million reduction in estimated Centerpulse distributor contract termination payments, offset by $1.3 million of miscellaneous adjustments related to the restructuring or termination of certain Centerpulse contractual obligations. The $2.1 million and $1.6 million increases in employee termination beneﬁts and employee relocation, respectively, during the year ended December 31, 2004 is a result of the ﬁnalization of the integration plan, including decisions on management structure and consolidation of facilities. The $11.2 million assigned to in-process research and development was written off as of the Closing Date in accordance with FASB Interpretation No. 4, ‘‘Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method’’. The fair value of acquired in- process research and development was determined in accordance with the AICPA practice aid entitled ‘‘Assets Acquired in a Purchase Business Combination to be used in Research and Development Activities’’ and was primarily based upon the estimated present value of future after-tax cash ﬂows of acquired in-process research and development projects. Goodwill of $1,316.2 million, $870.5 million and $106.8 million was assigned to the Americas, Europe and Asia Paciﬁc geographic segments, respectively. None of the goodwill is deductible for tax purposes. See Note 7 for more information related to goodwill and acquired intangible assets. The following sets forth unaudited pro forma ﬁnancial information (i) derived from the ﬁnancial statements of the Company for the years ended December 31, 2003 and 2002 and (ii) derived from the ﬁnancial statements of Centerpulse for the year ended December 31, 2002 and the nine month period ended September 30, 2003. The unaudited pro forma ﬁnancial information is based on the ﬁnancial statements of the Company and the ﬁnancial statements of Centerpulse and has been adjusted to give effect to the Exchange Offers as if they had occurred on January 1 of the respective years: (Unaudited; in millions, except per share amounts) Year Ended December 31, Net Sales Earnings before cumulative effect of change in accounting principle Net Earnings Earnings Per Share, before cumulative effect of change in accounting principle – Diluted Earnings Per Share – Diluted 2003 2002 $2,589.6 $2,167.9 453.5 508.6 312.6 312.6 $ $ 1.85 2.08 $ $ 1.30 1.30 These unaudited pro forma results have been prepared for comparative purposes only and include adjustments such as amortization of acquired intangible assets and interest expense on debt incurred to ﬁnance the Exchange Offers. The unaudited pro forma results for 2003 exclude $11.2 million of in-process research and development write- offs, $170.0 million ($121.3 million net of tax) of investment banking fees, legal and accounting fees, break-up fee, compensation expense related to the accelerated vesting of certain Centerpulse stock options, distributor terminations, integration related consulting and professional fees, severance and other acquisition and integration related expenses, and inventory step-up of $95.3 million ($62.1 million net of tax). The unaudited pro forma results for 2003 include $90.4 million of expense related to Centerpulse hip and knee litigation, $54.4 million of cash income tax beneﬁts as a result of Centerpulse electing to carry back its 2002 U.S. federal net operating loss for 5 years versus 10 years, which resulted in more losses being carried forward to future years and less tax credits going unutilized due to the shorter carry back period and an $8.0 million gain on sale of Orquest Inc., an investment previously held by Centerpulse. The unaudited pro forma results are not necessarily indicative either of the results of operations that actually would have resulted had the Exchange Offers been in effect at the beginning of the respective years or of future results. Implex Corp. On April 23, 2004, the Company acquired Implex, a privately held orthopaedics company based in New Jersey, pursuant to an Amended and Restated Merger Agreement (‘‘Merger Agreement’’). The Company acquired 100 percent of the shares of Implex for an initial cash consideration of approximately $108.0 million, before adjustments for debt repayment, certain payments previously made by Zimmer to Implex pursuant to their existing alliance agreement and other items. The aggregate cash consideration paid by the Company through December 31, 2004 was $153.1 million, consisting of a $98.6 million payment at closing (including $9.8 million delivered to an escrow agent to be held for eighteen months, subject to possible indemniﬁcation claims of the Company), $2.6 million of direct acquisition costs and $51.9 million of earn-out payments made pursuant to the Merger Agreement. The acquisition is a culmination of a distribution and strategic alliance agreement, under which 49 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Notes to Consolidated Financial Statements (Continued) the Company and Implex had been operating since 2000, relating to the development and distribution of reconstructive implant and trauma products incorporating Trabecular Metal Technology. The Merger Agreement contains provisions for additional annual cash earn-out payments that are based on year-over- year sales growth through 2006 of certain products that incorporate Trabecular Metal Technology. The Company estimates total earn-out payments, including payments already made, to be in a range from $120 to $160 million. These earn-out payments represent contingent consideration and, in accordance with SFAS No. 141 and EITF 95-8 ‘‘Accounting for Contingent Consideration Paid to the Shareholders of an Acquired Enterprise in a Purchase Business Combination’’, are recorded as an additional cost of the transaction upon resolution of the contingency and therefore increase goodwill. The Implex acquisition was accounted for under the purchase method of accounting pursuant to SFAS No. 141. Accordingly, Implex results of operations have been included in the Company’s consolidated results of operations subsequent to April 23, 2004, and its respective assets and liabilities have been recorded at their estimated fair values in the Company’s consolidated statement of ﬁnancial position as of April 23, 2004, with the excess purchase price being allocated to goodwill. Pro forma ﬁnancial information has not been included as the acquisition did not have a material impact upon the Company’s ﬁnancial position, results of operations or cash ﬂows. The Company completed the preliminary purchase price allocation in accordance with U.S. generally accepted accounting principles. The process included interviews with management, review of the economic and competitive environment and examination of assets including historical performance and future prospects. The preliminary purchase price allocation was based on information currently available to the Company, and expectations and assumptions deemed reasonable by the Company’s management. No assurance can be given, however, that the underlying assumptions used to estimate expected technology based product revenues, development costs or proﬁtability, or the events associated with such technology, will occur as projected. The ﬁnal purchase price allocation may vary from the preliminary purchase price allocation. The ﬁnal valuation and associated purchase price allocation is expected to be completed as soon as possible, but no later than one year from the date of acquisition. To the extent that the estimates need to be adjusted, the Company will do so. 50 The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of the Implex acquisition: Current assets Property, plant and equipment Intangible assets subject to amortization: Core technology (30 year useful life) Developed technology (30 year useful life) Other assets Goodwill Total assets acquired Current liabilities Deferred taxes Total liabilities assumed Net assets acquired (in millions) As of April 23, 2004 $ 23.1 4.5 3.6 103.9 14.4 61.0 210.5 14.1 43.3 57.4 $153.1 4. CHANGE IN ACCOUNTING PRINCIPLE Instruments are hand held devices used by orthopaedic surgeons during total joint replacement and other surgical procedures. Effective January 1, 2003, instruments are recognized as long-lived assets and are included in property, plant and equipment. Undeployed instruments are carried at cost, net of allowances for obsolescence. 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. In accordance with SFAS No. 144, the Company reviews instruments 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 cash ﬂows relating to the asset are less than its carrying amount. Depreciation of instruments is recognized as selling, general and administrative expense, consistent with the classiﬁcation of instrument cost in periods prior to January 1, 2003. Prior to January 1, 2003, undeployed instruments were carried as a prepaid expense at cost, net of allowances for obsolescence ($54.8 million, net, at December 31, 2002), and recognized in selling, general and administrative expense in the year in which the instruments were placed into service. The new method of accounting for instruments was adopted to recognize the cost of these important assets of the Company’s business within the consolidated balance sheet and meaningfully allocate the cost of these assets over the periods beneﬁted, typically ﬁve years. The effect of the change during the year ended December 31, 2003 was to increase earnings before cumulative effect of change in accounting principle by $26.8 million ($17.8 million net of tax), or $0.08 per diluted share. The cumulative effect adjustment of $55.1 million (net of income taxes of $34.0 million) to retroactively apply the Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Notes to Consolidated Financial Statements (Continued) new capitalization method as if applied in years prior to 2003 is included in earnings during the year ended December 31, 2003. The pro forma amounts shown on the consolidated statement of earnings have been adjusted for the effect of the retroactive application on depreciation and related income taxes. 5. INVENTORIES Inventories at December 31, 2004 and 2003, consist of the following (in millions): Finished goods Raw materials and work in progress Inventory step-up (primarily ﬁnished goods) Inventories, net 2004 $420.5 112.2 3.3 $536.0 2003 $384.3 90.8 52.6 $527.7 Reserves for obsolete and slow-moving inventory were $124.1 million and $129.1 million at December 31, 2004 and 2003, respectively. Inventory step-up includes $3.3 million from the Implex acquisition at December 31, 2004 and $52.6 million from the Centerpulse acquisition at December 31, 2003. Both the Centerpulse step-up and Implex step-up values were based upon estimated sales prices less distribution costs and a proﬁt allowance. 6. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment at December 31, 2004 and 2003, was as follows (in millions): Land Building and equipment Instruments Construction in progress Accumulated depreciation $ 2004 20.0 677.1 557.8 57.9 $ 2003 22.0 600.3 431.4 20.1 1,312.8 (684.3) 1,073.8 (548.6) Depreciation expense was $142.2 million, $92.4 million and $25.3 million for the years ended December 31, 2004, 2003 and 2002, respectively. 7. GOODWILL AND OTHER INTANGIBLE ASSETS The following table summarizes the changes in the carrying amount of goodwill for the years ended December 31, 2004 and 2003 (in millions): Americas Europe Asia Paciﬁc Balance at January 1, 2003 $ – $ – $ – $ Total – Acquisition of Centerpulse and InCentive Acquisition of TransFx Currency translation Balance at December 31, 1,263.6 11.9 – 836.3 104.8 69.7 5.5 2,204.7 11.9 75.2 2003 1,275.5 906.0 110.3 2,291.8 Completion of Centerpulse and InCentive compulsory acquisition process Acquisition of Implex Change in preliminary fair value estimates of Centerpulse related to: Intangible assets Income taxes Property, plant and equipment Inventories Integration liability Other assets Preacquisition contingencies Other Currency translation Balance at December 31, 24.3 61.0 16.0 – 10.7 (33.7) 26.5 6.6 (5.3) 6.5 4.9 10.3 37.9 (3.0) – (3.1) 1.8 (12.8) – – (0.8) 83.0 2.0 – – 0.3 – – (0.2) – – (0.1) 4.3 42.3 61.0 37.2 (26.8) (8.4) 8.3 (8.1) 10.3 37.9 (3.9) 87.3 2004 $1,389.1 $1,023.2 $116.6 $2,528.9 Property, plant and equipment, net $ 628.5 $ 525.2 The components of identiﬁable intangible assets are as follows (in millions): As of December 31, 2004: Intangible assets subject to amortization: Gross carrying amount Accumulated amortization Intangible assets not subject to amortization: Gross carrying amount Total identiﬁable intangible assets As of December 31, 2003: Intangible assets subject to amortization: Gross carrying amount Accumulated amortization Intangible assets not subject to amortization: Gross carrying amount Total identiﬁable intangible assets Core Technology Developed Technology Trademarks and Trade Names Customer Relationships Other Total $117.9 (8.0) $417.3 (31.9) – – $109.9 $385.4 $118.9 (1.6) $318.8 (5.5) – – $117.3 $313.3 $ 31.7 (3.8) 218.1 $246.0 $ 33.1 (0.8) 251.3 $283.6 $34.4 (1.3) $ 34.1 (13.7) $635.4 (58.7) – – $33.1 $ 20.4 218.1 $794.8 $34.4 (0.3) $ 23.6 (11.4) $528.8 (19.6) – – $34.1 $ 12.2 251.3 $760.5 51 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Notes to Consolidated Financial Statements (Continued) Total amortization expense for ﬁnite-lived intangible assets was $39.1 million and $10.9 million for the years ended December 31, 2004 and 2003, respectively, and was recorded as part of selling, general and administrative. Amortization expense for the year ended December 31, 2002 was not signiﬁcant. Estimated annual amortization expense for the years ending December 31, 2005 through 2009 is $38.2 million, $38.1 million, $37.9 million, $37.9 million and $37.9 million, respectively. The useful lives of intangible assets range from 11 to 30 years. In determining the useful lives of intangible assets, the Company considers 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, the Company considers the expected product 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, the Company assigns useful lives based upon historical levels of customer attrition. 8. OTHER CURRENT AND LONG-TERM LIABILITIES Other current and long-term liabilities at December 31, 2004 and 2003, consist of the following (in millions): Other current liabilities: Service arrangements Fair value of derivatives Salaries, wages and beneﬁts Litigation liability Integration liability Accrued liabilities Total other current liabilities Other long-term liabilities: Long-term income tax payable Other long-term liabilities Total other long-term liabilities 9. DEBT 2004 2003 $114.3 72.8 54.7 38.3 23.9 203.7 $ 92.9 56.4 60.5 59.5 54.8 151.3 $507.7 $475.4 $156.7 264.2 $128.9 223.7 $420.9 $352.6 The Company has the following committed ﬁnancing arrangements: (i) $400 million 364-day revolving credit facility maturing May 2005, (ii) $800 million three-year revolving credit facility maturing June 2006 and (iii) $550 million ﬁve-year term loan facility maturing June 2008 (collectively, the ‘‘Senior Credit Facility’’). There is no prepayment penalty included in the Senior Credit Facility. The $800 million three-year revolving credit facility has a 52 multi-currency option of up to an aggregate principal amount of $350 million. In addition to the Senior Credit Facility, the Company has uncommitted, unsecured revolving lines of credit totaling $50 million. The Company and certain of its wholly owned foreign and domestic subsidiaries are the borrowers and its wholly owned domestic subsidiaries are the guarantors of the Senior Credit Facility. Borrowings may bear interest at the appropriate LIBOR-based rate, or an alternative base rate, plus an applicable margin determined by reference to the Company’s senior unsecured long-term credit rating and the amounts drawn under the Senior Credit Facility. The Senior Credit Facility contains customary afﬁrmative and negative covenants and events of default for an unsecured ﬁnancing arrangement. Financial covenants include a maximum leverage ratio and a minimum interest coverage ratio. The Company was in compliance with all covenants under the Senior Credit Facility as of December 31, 2004. Commitments under the $400 million 364-day revolving credit facility and the $800 million three-year revolving credit facility are subject to certain fees, including a facility and a utilization fee. Outstanding debt as of December 31, 2004 and 2003 consists of the following (in millions): Senior Credit Facility 364-day revolving credit facility Three-year revolving credit facility Five-year term loan Uncommitted credit facilities Other Total debt Less: Current Portion Total Long-Term Debt 2004 2003 $ – 97.8 550.0 1.1 2.6 651.5 27.5 $ 100.0 552.4 450.0 0.6 6.1 1,109.1 101.3 $ 624.0 $1,007.8 The weighted average interest rates for borrowings under the ﬁve year term loan and three-year revolving credit facility were 3.42 percent and 0.58 percent, respectively, at December 31, 2004. Borrowings under the three-year revolving credit facility at December 31, 2004 are Japanese Yen based borrowings. The Company paid $27.9 million, $6.3 million and $13.0 million in interest during 2004, 2003 and 2002, respectively. Maturities of obligations outstanding under the ﬁve-year term loan at December 31, 2004, are $25.0 million, $100.0 million, $250.0 million and $175.0 million for the years ended December 31, 2005 through 2008, respectively. The carrying value of the Company’s borrowings approximates fair value due to their short-term interest rates. Debt issuance costs of $20.5 million were incurred to obtain the Senior Credit Facility arrangement. These costs were capitalized and are amortized to interest expense over the lives of the related facilities. At December 31, 2004, unamortized debt issuance costs were $9.1 million. Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Notes to Consolidated Financial Statements (Continued) 10. RETIREMENT AND POSTRETIREMENT BENEFIT PLANS The Company has deﬁned beneﬁt pension plans covering certain U.S. and Puerto Rico employees who were hired before September 2, 2002. Employees hired after September 2, 2002 are not part of the U.S. and Puerto Rico deﬁned beneﬁt plans, but do receive additional beneﬁts under the Company’s deﬁned contribution plans. Plan beneﬁts are primarily based on years of credited service and the participant’s average eligible compensation or a monthly retirement beneﬁt amount. In addition to the U.S. and Puerto Rico deﬁned beneﬁt pension plans, the Company sponsors various non-U.S. pension arrangements, including retirement and termination beneﬁt plans required by local law or coordinated with government sponsored plans. As a result of the consummation of the Exchange Offers, the Company acquired the obligations and assets of certain Centerpulse deﬁned beneﬁt plans as of the Closing Date. The Company also provides comprehensive medical and group life insurance beneﬁts to certain U.S. and Puerto Rico eligible retirees who elect to participate in the Company’s comprehensive medical and group life plans. The medical plan is contributory, and the life insurance plan is non- contributory. No similar plans exist for employees outside the U.S. and Puerto Rico. Employees hired after September 2, 2002, are not eligible for retiree medical and life insurance beneﬁts. The Company uses a December 31 measurement date for its beneﬁt plans. The components of net pension expense for the years ended December 31 for the Company’s deﬁned beneﬁt retirement plans are as follows (in millions): Service cost Interest cost Expected return on plan assets Amortization of prior service cost Amortization of unrecognized actuarial loss Net periodic beneﬁt cost U.S. and Puerto Rico 2004 $ 9.7 4.2 (4.8) (0.1) 0.9 $ 9.9 2003 $ 8.6 3.1 (2.8) (0.2) 0.5 $ 9.2 2002 $ 7.2 2.0 (1.2) 0.1 0.1 $ 8.2 2004 $13.1 4.8 (5.8) 0.4 0.6 $13.1 Non-U.S. 2003 $ 4.9 2.0 (2.2) 1.9 0.4 $ 7.0 2002 $ 2.0 0.7 (1.0) – 0.2 $ 1.9 The weighted average actuarial assumptions used to determine net pension expense for the Company’s deﬁned beneﬁt retirement plans were as follows: Discount rate Rate of compensation increase Expected long-term return on plan assets U.S. and Puerto Rico 2004 6.75% 3.60% 8.75% 2003 7.00% 3.62% 9.00% 2002 7.25% 3.60% 9.00% 2004 3.81% 1.57% 4.83% Non-U.S. 2003 4.08% 2.27% 4.77% 2002 4.25% 3.17% 5.95% The expected long-term rates of return on plan assets is based on the period expected beneﬁts will be paid and the historical 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. The Company believes that historical asset results approximate expected market returns applicable to the funding of a long-term beneﬁt obligation. 53 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Notes to Consolidated Financial Statements (Continued) Changes in projected beneﬁt obligations and plan assets, for the years ended December 31, 2004 and 2003 for the Company’s pension plans, were (in millions): U.S. and Puerto Rico Non-U.S. 2004 2003 2004 2003 Projected beneﬁt obligation – beginning of year Obligation assumed from Centerpulse Plan amendments Service cost Interest cost Employee contributions Beneﬁts paid Actuarial (gain) loss Translation loss Projected beneﬁt obligation – end of year Plan assets at fair market value – beginning of year Assets contributed by Centerpulse Actual return on plan assets Company contributions Employee contributions Beneﬁts paid Expenses Translation gain Plan assets at fair market value – end of year Funded status Unrecognized prior service cost Unrecognized actuarial (gain) loss Net amount recognized Amounts recognized in consolidated balance sheet: Prepaid pension Accrued beneﬁt liability Accumulated other comprehensive income Net amount recognized $ 63.8 – (0.1) 9.7 4.2 – (0.7) 12.3 – $ 89.2 $ 45.5 – 5.4 16.5 – (0.7) (0.6) – $ 66.1 $(23.1) (0.6) 26.4 $ 2.7 $ 5.8 (4.6) 1.5 $ 2.7 $ 42.5 – 0.7 8.6 3.1 – (0.6) 9.5 – $ 63.8 $ 21.4 – 6.8 18.1 – (0.6) (0.2) – $ 45.5 $(18.3) (0.7) 15.0 $ (4.0) $ 2.1 (7.2) 1.1 $ (4.0) $130.2 – – 13.1 4.8 4.3 (20.9) 0.6 10.9 $ 21.6 101.1 – 4.9 2.0 2.3 (7.8) (6.4) 12.5 $143.0 $130.2 $128.0 – 2.3 9.1 7.8 (20.9) – 10.9 $137.2 $ (5.8) 1.2 0.8 $ 17.3 94.3 4.8 6.3 3.2 (7.8) – 9.9 $128.0 $ (2.2) – (0.6) $ (3.8) $ (2.8) $ 6.1 (9.9) – $ 6.9 (9.7) – $ (3.8) $ (2.8) The weighted average actuarial assumptions used to determine the projected beneﬁt obligation for the Company’s deﬁned beneﬁt retirement plans were as follows: Discount rate Rate of compensation increase U.S. and Puerto Rico 2004 6.25% 3.84% 2003 6.75% 3.62% 2002 7.00% 3.60% 2004 3.75% 2.22% Non-U.S. 2003 4.03% 2.27% 2002 4.17% 3.17% Plans with projected beneﬁt obligations in excess of plan assets as of December 31, 2004 and 2003 were as follows (in millions): Beneﬁt obligation Plan assets at fair market value U.S. and Puerto Rico Non-U.S. 2004 $82.9 58.1 2003 $58.8 39.7 2004 $38.9 30.2 Plans with accumulated beneﬁt obligations in excess of plan assets as of December 31, 2004 and 2003 were as follows (in millions): Accumulated beneﬁt obligation Plan assets at fair market value 54 U.S. and Puerto Rico Non-U.S. 2004 $4.0 – 2003 $ – – 2004 $16.2 12.5 2003 $32.1 24.3 2003 $10.6 9.1 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Notes to Consolidated Financial Statements (Continued) The accumulated beneﬁt obligation for U.S. and Puerto The Company expects that it will have no minimum Rico deﬁned beneﬁt retirement pension plans was $53.0 million and $35.1 million as of December 31, 2004 and 2003, respectively. The accumulated beneﬁt obligation for non-U.S. deﬁned beneﬁt retirement plans was $126.6 million and $115.6 million as of December 31, 2004 and 2003, respectively. 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, 2005 2006 2007 2008 2009 2010 – 2014 U.S. and Puerto Rico $ 0.8 1.1 1.5 2.1 2.9 30.4 Non-U.S. $ 9.1 10.5 13.1 12.6 12.8 54.5 funding requirements by law for the U.S. and Puerto Rico deﬁned beneﬁt retirement plans. However, the Company expects to voluntarily contribute between $10 million to $13 million to these plans during 2005. Contributions to non- U.S. deﬁned beneﬁt are estimated to be approximately $9 million in 2005. The Company also sponsors deﬁned contribution plans for substantially all of the U.S. and Puerto Rico employees and employees in other countries. The beneﬁts of these plans relate to local customs and practices in the countries concerned. The Company expensed $6.4 million, $4.8 million and $3.5 million to these plans for the years ended December 31, 2004, 2003 and 2002, respectively. The components of net periodic expense for the year ended December 31 for the Company’s postretirement beneﬁt plans are as follows (in millions): The Company’s weighted-average asset allocations at December 31, December 31, 2004 and 2003, by asset category are as follows: U.S. and Puerto Rico Non-U.S. Net periodic beneﬁt cost Service cost Interest cost Amortization of unrecognized actuarial loss 2004 2003 2002 $ 1.4 1.7 0.2 $ 3.3 $ 1.3 1.5 0.1 $ 2.9 $ 1.1 1.2 – $ 2.3 Asset Category Equity Securities Debt Securities Real Estate Cash Funds Other Total 2004 2003 2004 2003 65% 35 – – – 65% 35 – – – 37% 35 15 5 8 36% 35 15 5 9 100% 100% 100% 100% 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 avoiding risk. The Company has established target ranges of assets held by the plans of 50 to 75 percent for equity securities and 25 to 50 percent for debt securities. 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. The investments in the plans are rebalanced quarterly based upon the target asset allocation of the plans. The investment strategies of non-U.S. based plans vary according to the plan provisions and local laws. The majority of the assets in non-U.S. 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. As of December 31, 2004 and 2003, the Company’s deﬁned beneﬁt pension plans’ assets did not hold any direct investment in the Company’s common stock. The weighted average actuarial assumptions used in accounting for the Company’s postretirement beneﬁt plans were as follows: December 31, Discount rate – Beneﬁt obligation Discount rate – Net periodic beneﬁt cost Initial health care cost trend rate Ultimate health care cost trend rate First year of ultimate trend rate 2004 2003 2002 6.25% 6.75% 9.50% 5.00% 2014 7.00% 6.75% 7.00% 7.25% 9.00% 10.00% 5.00% 5.00% 2012 2012 Changes in beneﬁt obligations for the Company’s postretirement beneﬁt plans were (in millions): December 31, Beneﬁt obligation – beginning of year Service cost Interest cost Beneﬁts paid Actuarial loss Beneﬁt obligation – end of year Funded status Unrecognized prior service cost Unrecognized actuarial loss Net amount recognized Accrued beneﬁt liability recognized 2004 $ 25.0 1.4 1.7 (0.4) 3.5 $ 31.2 $(31.2) (0.1) 7.0 2003 $ 20.5 1.3 1.5 – 1.7 $ 25.0 $(25.0) (0.1) 3.7 $(24.3) $(21.4) $(24.3) $(21.4) As of December 31, 2004 and 2003, the Company had no assets set aside in a trust for its postretirement beneﬁt plans. A one percentage point change in the assumed health care cost trend rates would have no signiﬁcant effect on the service and interest cost components of net postretirement beneﬁt expense and the accumulated postretirement beneﬁt obligation. The effect of a change in the healthcare cost trend rate is tempered by an annual cap that limits medical costs to be paid by the Company. 55 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Notes to Consolidated Financial Statements (Continued) The beneﬁts expected to be paid out in each of the next The components of deferred income taxes consisted of ﬁve years and for the ﬁve years combined thereafter are as follows (in millions): the following (in millions): For the Years Ending December 31, 2005 2006 2007 2008 2009 2010 – 2014 11. INCOME TAXES $ 0.5 0.8 1.1 1.5 1.9 15.3 Inventory Fixed assets Net operating loss carryover Capital loss carryover Tax credit carryover Accrued liabilities Intangible assets Valuation allowances Other 2004 2003 $ 102.4 (31.8) 297.9 11.5 76.5 158.4 (201.4) (67.6) 22.4 $ 77.6 (12.3) 336.6 11.5 8.2 156.9 (206.3) (58.0) 36.1 $ 368.3 $ 350.3 The components of earnings before taxes consist of the following (in millions): United States operations Foreign operations Total 2004 2003 2002 $385.7 345.8 $307.6 129.9 $292.0 96.9 $731.5 $437.5 $388.9 The provision for income taxes consists of (in millions): Current: Federal State Foreign Deferred: Federal State Foreign $122.7 17.1 114.9 254.7 $(14.3) 3.8 60.6 $ 79.9 12.9 34.4 50.1 127.2 (20.2) (9.6) (35.3) (65.1) 116.0 6.1 (25.4) 96.7 3.3 (1.3) 1.9 3.9 $189.6 $146.8 $131.1 Income taxes paid by the Company during 2004, 2003 and 2002 were $143.3 million, $116.1 million and $114.2 million, respectively. A reconciliation of the U.S. statutory income tax rate to the Company’s effective tax rate is as follows: 2004 2003 2002 U.S. statutory income tax rate State taxes, net of federal deduction Foreign income taxes at rates different from the U.S. statutory rate, net of foreign tax credits Tax beneﬁt from decreased deferred taxes of acquired Centerpulse operations; due to Swiss tax rate reduction Tax beneﬁt relating to operations in Puerto Rico Tax beneﬁt relating to U.S. export sales R&D credit Non-deductible expenses In-process research & development Other 35.0% 35.0% 35.0% 1.5 0.7 3.0 (2.3) (4.7) (1.7) (1.3) (0.7) 0.6 – 0.3 – – (2.7) (0.3) (0.4) 0.1 0.9 (0.5) – – (2.6) (1.1) (0.6) – – – Effective income tax rate 25.9% 33.6% 33.7% 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. 56 At December 31, 2004, the vast majority of the net operating loss is available to reduce future federal and state taxable earnings of the U.S. companies. These losses generally expire within a period of 1 to 19 years. $24.7 million of state losses are subject to valuation allowances and certain restrictions. The tax credits are entirely available to offset future federal and state tax liabilities of the U.S. companies. These credits generally expire within a 1 to 15 year period. $11.1 million of the tax credits are subject to valuation allowances and certain restrictions. The capital loss carryover is also available to reduce future federal taxable earnings of the U.S. companies; however, the entire carryover is subject to a valuation allowance and expires in 2005 and 2006. The Company’s former parent received a ruling from the Internal Revenue Service (‘‘IRS’’), that the spin-off of the Company would qualify as a tax-free transaction. Such a ruling, while generally binding upon the IRS, is subject to certain factual representations and assumptions. The Company has agreed to certain restrictions on its future actions to provide further assurances that the spin-off will qualify as tax-free. If the Company fails to abide by such restrictions and, as a result, the spin-off fails to qualify as a tax-free transaction, the Company will be obligated to indemnify its former parent for any resulting tax liability. During 2004, the Company’s tax provision included a deferred tax beneﬁt of $34.5 million as a result of revaluing deferred taxes of acquired Centerpulse operations due to a reduction in the ongoing Swiss tax rate (from approximately 24 percent to 12.5 percent). The Company has a long-term tax liability of $156.7 million at December 31, 2004 for expected settlement of various U.S. and foreign income tax liabilities. At December 31, 2004, the Company had an aggregate of approximately $270 million of unremitted earnings of foreign subsidiaries that have been, or are intended to be, permanently reinvested for continued use in foreign operations. If the total undistributed earnings of foreign subsidiaries were remitted, a signiﬁcant amount of the additional tax would be offset by the allowable foreign tax credits. It is impractical for the Company to determine the additional tax of remitting these earnings. As a result of recent changes to U.S. tax rules regarding foreign earnings repatriation, the Company may repatriate Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Notes to Consolidated Financial Statements (Continued) earnings of foreign subsidiaries at reduced U.S. tax rates. The Company believes the impact of such repatriation will not be material and expects to complete its evaluation by December 31, 2005. 12. CAPITAL STOCK AND EARNINGS PER SHARE On September 13, 2004, the Company amended its Rights Agreement to have the rights expire on September 16, 2004. The stockholder rights plan had been established in 2001 and was scheduled to expire in 2011. The Company has authorized for issuance 2 million shares of Series A Participating Cumulative Preferred Stock (‘‘Series A Preferred Stock’’). No shares of the Series A Preferred Stock have been issued as of December 31, 2004. 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. The following is a reconciliation of weighted average shares for the basic and diluted share computations for the years ending December 31 (in millions): 2002 2004 2003 Weighted average shares outstanding for basic net earnings per share Effect of dilutive stock options Weighted average shares outstanding for 244.4 3.4 207.7 3.5 194.5 2.3 diluted net earnings per share 247.8 211.2 196.8 13. STOCK OPTION AND COMPENSATION PLANS The Company had three stock option plans in effect at December 31, 2004: the 2001 Stock Incentive Plan, the TeamShare Stock Option Plan, and the Stock Plan for Non- Employee Directors. The Company has reserved the maximum number of shares of common stock available for award under the terms of each of these plans and has registered 34.3 million shares of common stock. Options may be granted under these plans at a price of not less than the fair market value of a share of common stock on the date of grant. The 2001 Stock Incentive Plan provides for the grant of nonqualiﬁed stock options and incentive stock options, long-term performance awards, restricted stock awards and deferred stock units. Options granted under the 2001 Stock Incentive Plan may include stock appreciation rights. The TeamShare Stock Option Plan provides for the grant of non- qualiﬁed stock options and, in certain jurisdictions, stock appreciation rights, while the Stock Plan for Non-Employee Directors provides for awards of stock options, restricted stock and restricted stock units to non-employee directors. Options granted under these plans generally vest over four years, although in no event in less than one year, and expire ten years from the date of grant. In the past, certain options have had price thresholds, which affect exercisability. All such price thresholds have been satisﬁed. Under the 2001 Stock Incentive Plan, the total number of awards which may be granted in a given year pursuant to options and other awards under the plan may not exceed 1.9 percent of the outstanding shares of the Company’s stock on the effective date of the Plan for 2001 or January 1 of each subsequent year, plus the number of shares from the prior year that were available for grant but not granted, that were granted but subsequently terminated, expired, cancelled or surrendered without being exercised or tendered in the prior year to pay for options or satisfy tax withholding requirements. No participant may receive options or awards which in the aggregate exceed 2 million shares of stock over the life of the Plan. A summary of the status of all options granted to employees and non-employee directors for the years ended December 31, 2004, 2003 and 2002 is presented below: Outstanding at January 1, 2002 Options granted Options exercised Options cancelled Outstanding at December 31, 2002 Options granted Options exercised Options cancelled Outstanding at December 31, 2003 Options granted Options exercised Options cancelled Outstanding at December 31, 2004 Options (in thousands) Weighted Average Exercise Price 10,727 1,833 (1,262) (263) 11,035 2,395 (2,688) (272) 10,470 3,407 (2,450) (136) 11,291 $25.01 30.34 18.94 28.73 26.51 43.06 23.80 34.76 30.77 70.41 25.90 50.81 $43.60 57 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Notes to Consolidated Financial Statements (Continued) The following table summarizes information about stock options outstanding at December 31, 2004: Range of Exercise Prices $6.25 – $17.00 $19.50 – $27.50 $27.51 – $37.50 $39.50 – $51.00 $69.00 – $87.50 Options exercisable at December 31, 2004, 2003 and 2002, were 4.8 million, 4.9 million and 4.7 million, respectively, with average exercise prices of $29.30, $25.97 and $22.81, respectively. See Note 2 for the effect on net earnings and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock based employee compensation. 14. SEGMENT DATA The Company designs, develops, manufactures and markets reconstructive orthopaedic implants, including joint and dental, spinal implants, and trauma products and orthopaedic surgical products which include surgical supplies and instruments designed to aid in orthopaedic surgical procedures. Operations are managed through three major geographic segments – the Americas, which is comprised principally of the United States and includes other North, Central and South American markets; Europe, which is comprised principally of Europe and includes the Middle East Outstanding Weighted Average Remaining Contractual Life Exercisable Weighted Average Exercise Price Options (in thousands) Weighted Average Exercise Price 1.22 4.95 6.22 8.22 9.22 7.19 $11.86 24.80 30.70 43.10 70.50 $43.60 259 1,373 2,667 478 3 4,780 $11.86 24.50 30.90 42.70 78.30 $29.30 Options (in thousands) 259 1,583 4,012 2,082 3,355 11,291 and Africa; and Asia Paciﬁc, which is comprised primarily of Japan and includes other Asian and Paciﬁc markets. This structure is the basis for the Company’s reportable segment information discussed below. Company management evaluates operating segment performance based upon segment operating proﬁt exclusive of operating expenses pertaining to global operations and corporate expenses, acquisition and integration expenses, inventory step-up, in-process research and development write-offs and intangible asset amortization expense. Global operations include research, development engineering, medical education, brand management, corporate legal, ﬁnance, human resource functions, and U.S. and Puerto Rico based operations and logistics. Intercompany transactions have been eliminated from segment operating proﬁt. Company management reviews accounts receivable, inventory, property, plant and equipment, goodwill and intangible assets by reportable segment exclusive of U.S. and Puerto Rico based operations and logistics and corporate assets. Net sales, segment operating proﬁt and year-end assets are as follows (in millions): Americas Europe Asia Paciﬁc Net sales Inventory step-up Acquisition and integration In-process research and development Global operations and corporate functions Operating proﬁt Total assets Net Sales Operating Proﬁt Year-End Assets 2004 2003 2002 2004 2003 2002 2004 2003 $1,741.3 808.3 431.3 $1,208.3 366.0 326.7 $ 932.9 169.9 269.6 $ 893.1 279.4 182.3 $ 619.2 96.4 148.1 $ 450.2 41.4 124.3 $2,430.9 1,824.4 310.6 $2,181.1 1,731.7 300.4 $2,980.9 $1,901.0 $1,372.4 (59.4) (81.1) – (451.1) (42.7) (79.6) (11.2) (279.5) – – – (215.0) $ 763.2 $ 450.7 $ 400.9 1,129.6 942.8 $5,695.5 $5,156.0 58 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Notes to Consolidated Financial Statements (Continued) Depreciation and amortization used in determining operating segment proﬁt for the years ended December 31, 2004, 2003 and 2002 was as follows (in millions): Americas Europe Asia Paciﬁc Global operations and corporate 2004 2003 2002 functions 2004 2003 2002 $ 46.1 50.5 17.9 $ 36.8 23.4 16.8 $ 0.1 1.1 1.4 66.8 26.3 22.7 $181.3 $103.3 $25.3 U.S. sales were $1,664.5 million, $1,152.0 million and $892.3 million for the years ended December 31, 2004, 2003 and 2002, respectively. The Company’s sales to any individual country outside of the U.S. were not signiﬁcant. Sales are attributable to a country based upon the customer’s country of domicile. Net sales by product category are as follows (in millions): Reconstructive implants Trauma Spine Orthopaedic surgical products Total $2,456.3 172.9 134.2 217.5 $1,521.0 150.1 35.1 194.8 $1,061.7 133.8 – 176.9 $2,980.9 $1,901.0 $1,372.4 Long-lived tangible assets as of December 31, 2004 and 2003 are as follows: Americas Europe Asia Paciﬁc 2004 2003 $416.8 170.9 40.8 $344.9 143.8 36.5 $628.5 $525.2 The Americas long-lived tangible assets are located primarily in the U.S. Approximately $70 million of Europe long-lived tangible assets are located in Switzerland. Capital expenditures by operating segment for the years ended December 31, 2004, 2003 and 2002 were as follows (in millions): Americas Additions to instruments Additions to other property, plant and equipment Europe Additions to instruments Additions to other property, plant and equipment Asia Paciﬁc Additions to instruments Additions to other property, plant and equipment Global operations and corporate functions Additions to instruments Additions to other property, plant and 0.3 14.0 24.4 1.4 3.2 0.8 4.0 5.4 1.0 3.5 0.1 – 1.4 – 1.3 124.2 107.1 – equipment For segment reporting purposes, deployed instruments 35.2 72.9 30.9 are included in the measurement of operating segment assets while undeployed instruments at U.S. and Puerto Rico based operations and logistics are included in global operations and corporate functions. The majority of instruments are purchased by U.S. and Puerto Rico based operations and logistics and are deployed to the operating segments as needed for the business. 2004 2003 2002 16. COMMITMENTS AND CONTINGENCIES $ – $ 1.5 $ – As a result of the Centerpulse transaction, the Company The increase in deprecation and amortization in 2004 from 2003 was primarily caused by a full year of depreciation and amortization on Centerpulse acquired assets in 2004 versus one quarter of depreciation and amortization in 2003. The increase in depreciation and amortization in 2003 from 2002 was primarily caused by the change in accounting principle for instruments. 15. LEASES Future minimum rental commitments under non- cancelable operating leases in effect as of December 31, 2004 were $23.5 million for 2005, $19.6 million for 2006, $14.6 million for 2007, $9.5 million for 2008, $8.2 million for 2009 and $27.6 million thereafter. Total rent expense for the years ended December 31, 2004, 2003 and 2002 aggregated $24.2 million, $15.7 million and $9.1 million, respectively. acquired the entity involved in Centerpulse’s hip and knee implant litigation matter. The litigation was a result of a voluntary recall of certain hip and knee implants manufactured and sold by Centerpulse. On March 13, 2002, a U.S. Class Action Settlement Agreement (‘‘Settlement Agreement’’) was entered into by Centerpulse that resolved U.S. claims related to the affected products and a settlement trust (‘‘Settlement Trust’’) was established and funded for the most part by Centerpulse. The court approved the settlement arrangement on May 8, 2002. Under the terms of the Settlement Agreement, the Company will reimburse the Settlement Trust a speciﬁed amount for each revision surgery over 4,000 and revisions on reprocessed shells over 64. As of March 4, 2005, the claims administrator has received 4,136 likely valid claims for hips (cut-off date June 5, 2003) and knees (cut-off date November 17, 2003) and 198 claims for reprocessed shells (cut-off date September 8, 2004). The Company believes the litigation liability recorded as of December 31, 2004 is adequate to provide for any future claims regarding the hip and knee implant litigation. On February 6, 2004, BTG International Limited (‘‘BTG’’) ﬁled an action against the Company and two unrelated parties in the United States District Court for the District of Delaware alleging infringement by the defendants of U.S. Patent No. 6,352,559 (the ‘‘559 Patent’’). The Company’s Trilogy˛ Acetabular System is speciﬁcally accused of 59 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Notes to Consolidated Financial Statements (Continued) infringement, as well as Centerpulse’s Converge˛ and AlloﬁtTM Acetabular Systems. BTG’s complaint seeks unspeciﬁed damages and injunctive relief. On March 4, 2004, the Company ﬁled an answer to the complaint denying infringement, and asserting a counterclaim alleging that the ‘‘559 Patent is invalid. The Company believes that its defenses are valid and meritorious and the Company intends to continue to defend the BTG lawsuit vigorously. On February 15, 2005, Howmedica Osteonics Corp. (‘‘Howmedica’’) ﬁled an action against the Company and an unrelated party in the United States District Court for the District of New Jersey alleging infringement by the defendants of U.S. Patent Nos. 6,174,934; 6,372,814; 6,664,308; and 6,818,020. Howmedica’s complaint seeks unspeciﬁed damages and injunctive relief. The Company believes that its defenses are valid and meritorious and the Company intends to defend the Howmedica lawsuit vigorously. The Company is also subject to product liability and other claims and lawsuits arising in the ordinary course of 17. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) (in millions, except per share amounts) business, for which the Company maintains insurance, subject to self-insured retention limits. The Company establishes accruals for product liability and other claims in conjunction with outside counsel based on current information and historical settlement information for open claims, related fees and for claims incurred but not reported. While it is not possible to predict with certainty the outcome of these cases, it is the opinion of management that, upon ultimate resolution, these cases will not have a material adverse effect on the consolidated ﬁnancial position, results of operations or cash ﬂows of the Company. On July 25, 2003, the Staff of the Securities and Exchange Commission informed Centerpulse that it was conducting an informal investigation of Centerpulse relating to certain accounting issues. The Company is continuing to cooperate with the Securities and Exchange Commission in this matter. Net sales Gross proﬁt Earnings before cumulative effect of change in accounting principle(1) Net earnings Earnings per common share before cumulative effect of change in accounting principle Basic Diluted Net earnings per common share(1) Basic Diluted 2004 Quarter Ended 2003 Quarter Ended Mar Jun Sep Dec Mar Jun Sep Dec(2) $742.2 522.7 $737.4 535.5 $700.2 531.1 $801.1 611.7 $390.1 293.2 $411.1 312.7 $398.2 301.4 $701.6 477.5 97.6 97.6 116.3 116.3 127.9 127.9 200.0 200.0 80.2 135.3 89.0 89.0 85.0 85.0 37.0 37.0 0.40 0.40 0.40 0.40 0.48 0.47 0.48 0.47 0.52 0.52 0.52 0.52 0.82 0.81 0.82 0.81 0.41 0.41 0.69 0.68 0.45 0.45 0.45 0.45 0.43 0.43 0.43 0.43 0.15 0.15 0.15 0.15 (1) The three month period ended March 31, 2003 includes a cumulative effect of a change in accounting principle for instruments as discussed in Note 4 of these audited ﬁnancial statements. (2) The three month period ended December 31, 2003 includes the results of Centerpulse subsequent to the Closing Date, as discussed in Note 3 of these audited ﬁnancial statements. 60 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure None ITEM 9A. Controls and Procedures The Company has established disclosure controls and procedures and internal controls over ﬁnancial reporting to provide reasonable assurance that material information relating to the Company, including its consolidated subsidiaries, is made known on a timely basis to management and the Board of Directors. However, any control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. Based on their evaluation, the Company’s principal executive ofﬁcer and principal ﬁnancial ofﬁcer have ITEM 9B. Other Information None concluded that the Company’s disclosure controls and procedures as of the end of the period covered by this report are effective. Management’s report on internal control over ﬁnancial reporting appears in this report at the conclusion of Item 7A. There was no change in the Company’s internal control over ﬁnancial reporting (as deﬁned in Rule 13a-15(f)) that occurred during the fourth quarter of 2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over ﬁnancial reporting. 61 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Part III ITEM 10. Directors and Executive Ofﬁcers of the Registrant The information required by this Item concerning directors and executive ofﬁcers of the Company is incorporated herein by reference from the Company’s deﬁnitive Proxy Statement for its 2005 Annual Meeting of Stockholders which will be ﬁled with the Commission pursuant to Regulation 14A and the information included under the caption ‘‘Executive Ofﬁcers of the Company’’ in Part I hereof. ITEM 11. Executive Compensation The information required by this Item concerning remuneration of the Company’s ofﬁcers and directors and information concerning material transactions involving such ofﬁcers and directors is incorporated herein by reference from the Company’s deﬁnitive Proxy Statement for its 2005 Annual Meeting of Stockholders which will be ﬁled with the Commission pursuant to Regulation 14A within 120 days after the end of the Company’s most recent ﬁscal year. ITEM 12. Security Ownership of Certain Beneﬁcial Owners and Management and Related Stockholder Matters The information required by this Item concerning the stock ownership of management and ﬁve percent beneﬁcial owners and related stockholder matters, including equity compensation plan information, is incorporated herein by reference from the Company’s deﬁnitive Proxy Statement for its 2005 Annual Meeting of Stockholders which will be ﬁled with the Commission pursuant to Regulation 14A within 120 days after the end of the Company’s most recent ﬁscal year. ITEM 13. Certain Relationships and Related Transactions The information required by this Item concerning certain relationships and related transactions is incorporated herein by reference from the Company’s deﬁnitive Proxy Statement for its 2005 Annual Meeting of Stockholders which will be ﬁled with the Commission pursuant to Regulation 14A within 120 days after the end of the Company’s most recent ﬁscal year. ITEM 14. Principal Accounting Fees and Services The information required by this Item concerning principal accounting fees and services is incorporated herein by reference from the Company’s deﬁnitive Proxy Statement for its 2005 Annual Meeting of Stockholders which will be ﬁled with the Commission pursuant to Regulation 14A within 120 days after the end of the Company’s most recent ﬁscal year. 62 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Part IV ITEM 15. Exhibits and Financial Statement Schedules (a) 1. Financial Statements The following consolidated ﬁnancial statements of the Company and its subsidiaries are set forth in Part II, Item 8. Report of Independent Registered Public Accounting Firm Consolidated Statements of Earnings for the Years Ended December 31, 2004, 2003 and 2002 Consolidated Balance Sheets as of December 31, 2004 and 2003 Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2004, 2003 and 2002 Consolidated Statements of Cash Flows for the Years Ended December 31, 2004, 2003 and 2002 Notes to Consolidated Financial Statements 2. Financial Statement Schedules Schedule II. Valuation and Qualifying Accounts Other ﬁnancial statement schedules are omitted because they are not applicable or the required information is shown in the ﬁnancial statements or the notes thereto. 3. Exhibits A list of exhibits required to be ﬁled as part of this report is set forth in the Index to Exhibits, which immediately precedes such exhibits, and is incorporated herein by reference. 63 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Signatures Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ZIMMER HOLDINGS, INC. By: /s / J. RAYMOND ELLIOTT J. Raymond Elliott Chairman of the Board President and Chief Executive Ofﬁcer Dated: March 11, 2005 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date /s/ J. RAYMOND ELLIOTT J. Raymond Elliott Chairman of the Board, President, Chief Executive Ofﬁcer and Director (Principal Executive Ofﬁcer) March 11, 2005 /s/ SAM R. LENO Sam R. Leno Executive Vice President, Corporate Finance and Operations and Chief Financial Ofﬁcer (Principal Financial Ofﬁcer) March 11, 2005 /s/ JAMES T. CRINES James T. Crines Senior Vice President, Finance/Controller and Information Technology (Principal Accounting Ofﬁcer) March 11, 2005 /s/ LARRY C. GLASSCOCK Director March 11, 2005 Larry C. Glasscock /s/ REGINA E. HERZLINGER Director March 11, 2005 Regina E. Herzlinger /s/ JOHN L. MCGOLDRICK Director March 11, 2005 John L. McGoldrick /s/ AUGUSTUS A. WHITE, III Director March 11, 2005 Augustus A. White, III 64 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S 2 0 0 4 F O R M 1 0 - K Index to Exhibits Exhibit No Description 3.1 3.2 3.3 4.1 10.1* 10.2* 10.3* 10.4* 10.5 10.6 10.7 10.8* 10.9* 10.10* 10.11* 10.12* 10.13 10.14 10.15 10.16 10.17 Restated Certiﬁcate of Incorporation of Zimmer Holdings, Inc. (incorporated herein by reference to Exhibit 3.1 to Current Report on Form 8-K dated November 13, 2001) Certiﬁcate of Designations of Series A Participating Cumulative Preferred Stock of Zimmer Holdings, Inc., dated as of August 6, 2001 (incorporated herein by reference to Exhibit 3.2 to Current Report on Form 8-K dated November 13, 2001) Restated By-Laws of Zimmer Holdings, Inc., together with Amendment No. 1 to the Restated By-Laws of Zimmer Holdings, Inc. (incorporated herein by reference to Exhibit 3 to Quarterly Report on Form 10-Q dated November 14, 2003) Specimen Common Stock certiﬁcate (incorporated herein by reference to Exhibit 4.1 to Amendment No. 3 to Registration Statement on Form 10 dated July 6, 2001) Zimmer Holdings, Inc. 2001 Stock Incentive Plan (incorporated herein by reference to Appendix B to the Registrant’s deﬁnitive Proxy Statement on Schedule 14A dated March 24, 2003) Zimmer Holdings, Inc. Executive Performance Incentive Plan, effective August 6, 2001 (incorporated herein by reference to Appendix C to the Registrant’s deﬁnitive Proxy Statement on Schedule 14A dated March 24, 2003) Zimmer Holdings, Inc. Stock Plan for Non-Employee Directors, effective August 6, 2001 (incorporated by reference to Exhibit 10.6 to Current Report on Form 8-K dated August 6, 2001) Zimmer Holdings, Inc. Deferred Compensation Plan for Non-Employee Directors, effective August 6, 2001 (incorporated herein by reference to Exhibit 10.7 to Current Report on Form 8-K dated August 6, 2001) Three Year Competitive Advance and Revolving Credit Facility among Zimmer Holdings, Inc., Zimmer, Inc., Zimmer K.K., Zimmer LTD. and the lenders named therein, dated as of July 31, 2001 (incorporated herein by reference to Exhibit 10.1 to Current Report on Form 8-K dated August 6, 2001) First Amendment to Three Year Competitive Advance and Revolving Credit Facility among Zimmer Holdings, Inc., Zimmer, Inc., Zimmer K.K., Zimmer LTD. and the lenders named therein, dated as of December 10, 2001 (incorporated herein by reference to Exhibit 10.26 to Annual Report on Form 10-K dated March 13, 2002) Guarantee Assumption Agreement, dated as of June 24, 2002, made by each of the signatories thereto in favor of the lenders named in the Three Year Competitive Advance and Revolving Credit Facility Agreement dated as of July 31, 2001 (incorporated herein by reference to Exhibit 10.1 to Quarterly Report on Form 10-Q dated August 9, 2002) Zimmer Holdings, Inc. Long-Term Disability Income Plan for Highly Compensated Employees (incorporated herein by reference to Exhibit 10.15 to Current Report on Form 8-K dated November 13, 2001) Change in Control Severance Agreement with J. Raymond Elliott (incorporated herein by reference to Exhibit 10.2 to Quarterly Report on Form 10-Q dated May 8, 2002) Change in Control Severance Agreement with Sam R. Leno, Bruno A. Melzi, Bruce E. Peterson and David C. Dvorak (incorporated herein by reference to Exhibit 10.3 to Quarterly Report on Form 10-Q dated May 8, 2002) Change in Control Severance Agreement with James T. Crines (incorporated herein by reference to Exhibit 10.4 to Quarterly Report on Form 10-Q dated May 8, 2002) Change in Control Severance Agreement with Sheryl L. Conley (incorporated herein by reference to Exhibit 10.2 to Quarterly Report on Form 10-Q dated August 8, 2003) $26,000,000 Uncommitted Standard Instrument Line of Credit between Zimmer, Inc. and subsidiaries and Bank of America, N.A. and its afﬁliates and subsidiaries dated July 17, 2001 (incorporated herein by reference to Exhibit 10.23 to Annual Report on Form 10-K dated March 13, 2002) Amendment No. 1 to Letter Agreement dated July 17, 2001 between Zimmer, Inc. and Bank of America, N.A. dated July 26, 2001 (incorporated herein by reference to Exhibit 10.24 to Annual Report on Form 10-K dated March 13, 2002) Amendment No. 2 to Letter Agreement dated July 17, 2002 between Zimmer, Inc. and Bank of America, N.A. dated February 5, 2002 (incorporated herein by reference to Exhibit 10.1 to Quarterly Report on Form 10-Q dated May 8, 2002) Amendment No. 3 to Letter Agreement dated as of July 31, 2003 between Zimmer Holdings, Inc. and Bank of America, N.A. (incorporated herein by reference to Exhibit 10.2 to Quarterly Report on Form 10-Q dated November 14, 2003) Uncommitted Credit Agreement between Zimmer, Inc. and Sumitomo Mitsui Banking Corporation dated October 29, 2001 (incorporated herein by reference to Exhibit 10.25 to Annual Report on Form 10-K dated March 13, 2002) 65 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S Index to Exhibits (Continued) Exhibit No Description 2 0 0 4 F O R M 1 0 - K 10.18 10.19 10.20 10.21 10.22 10.23* 10.24* 10.25* 10.26* 10.27* 10.28* 10.29* 10.30* First Amendment dated July 15, 2002 to the Uncommitted Credit Agreement dated October 29, 2001 between Zimmer, Inc. and Sumitomo Mitsui Banking Corporation (incorporated herein by reference to Exhibit 10.1 to Quarterly Report on Form 10-Q dated November 12, 2002) $20,000,000 Uncommitted Line of Credit between Zimmer Holdings, Inc. and Fleet National Bank dated October 16, 2002 (incorporated herein by reference to Exhibit 10.2 to Quarterly Report on Form 10-Q dated November 12, 2002) Tender Agreement, dated as of August 31, 2003, between Ren ´e Braginsky, Hans Kaiser, Z ¨urich Versicherungs- Gesellschaft, III Institutional Investors International Corp. and Zimmer Holdings, Inc. (incorporated by reference to Exhibit 99.1 to the Registrant’s Form 8-K dated September 2, 2003) $1,350,000,000 Amended and Restated Revolving Credit and Term Loan Agreement among Zimmer Holdings, Inc., Zimmer, Inc., Zimmer K.K., Zimmer Ltd., the borrowing subsidiaries and the lenders named therein, dated as of May 24, 2004 (incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q dated August 5, 2004) $400,000,000 364-Day Credit Agreement among Zimmer Holdings, Inc., Zimmer, Inc., the borrowing subsidiaries and the lenders named therein, dated as of May 24, 2004 (incorporated by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q dated August 5, 2004) Zimmer Holdings, Inc. Supplemental Performance Incentive Plan (incorporated by reference to Exhibit 10.3 to the Registrant’s Quarterly Report on Form 10-Q dated August 5, 2004) Change in Control Severance Agreement with Jon E. Kramer (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q dated November 8, 2004) Change in Control Severance Agreement with Richard Fritschi (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q dated November 8, 2004) Employment Contract with Richard Fritschi (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q dated November 8, 2004) Conﬁdentiality, Non-Competition and Non-Solicitation Employment Agreement with Richard Fritschi (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q dated November 8, 2004) Form of Nonqualiﬁed Stock Option Grant Award Letter under the Zimmer Holdings, Inc. 2001 Stock Incentive Plan (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K dated January 12, 2005) Form of Restricted Stock Award Letter under the Zimmer Holdings, Inc. 2001 Stock Incentive Plan (incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K dated January 12, 2005) Form of Nonqualiﬁed Performance-Conditioned Stock Option Grant Award Letter under the Zimmer Holdings, Inc. Stock Incentive Plan (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K dated January 21, 2005) 10.31* Summary Compensation Sheet 21 23 31.1 31.2 32 99 List of Subsidiaries of Zimmer Holdings, Inc. Consent of PricewaterhouseCoopers LLP Certiﬁcation pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934 of the Chief Executive Ofﬁcer, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Certiﬁcation pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934 of the Chief Financial Ofﬁcer, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Certiﬁcation pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Annual CEO Certiﬁcation ﬁled with the New York Stock Exchange on June 8, 2004 * indicates management contracts or compensatory plans or arrangements 66 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S Valuation and Qualifying Accounts Description Doubtful Accounts: Year Ended December 31, 2002 Year Ended December 31, 2003 Year Ended December 31, 2004 Excess and Obsolete Inventory: Year Ended December 31, 2002 Year Ended December 31, 2003 Year Ended December 31, 2004 2 0 0 4 F O R M 1 0 - K Schedule II (in millions) Balance at Beginning of Period Additions Charged to Expense Deductions to Reserve Effects of Foreign Currency Acquired Centerpulse Allowances Balance Sheet Reclass* Balance at End of Period $ 6.5 7.2 29.5 $ 1.1 2.6 4.9 $ (0.8) (1.5) (7.4) $ 43.3 45.5 129.1 $ 6.0 11.6 30.8 $ (7.1) (11.7) (14.1) $ 0.4 1.7 1.4 $ 3.3 2.0 2.9 $ $ – 19.5 – – 81.7 – $ – – – $ 7.2 29.5 28.4 $ – – (24.6) $ 45.5 129.1 124.1 * In 2004, a balance sheet reclassiﬁcation between gross inventory and the reserve for excess and obsolete inventory was recorded which had no effect on the net inventory balance. 67 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S Certiﬁcation 2 0 0 4 F O R M 1 0 - K Exhibit 31.1 Certiﬁcation pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 I, J. Raymond Elliott, certify that: 1. I have reviewed this Annual Report on Form 10-K of Zimmer Holdings, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the ﬁnancial statements, and other ﬁnancial information included in this report, fairly present in all material respects the ﬁnancial condition, results of operations and cash ﬂows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying ofﬁcer and I are responsible for establishing and maintaining disclosure controls and procedures (as deﬁned in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over ﬁnancial reporting (as deﬁned in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal controls over ﬁnancial reporting, or caused such internal control over ﬁnancial reporting to be designed under our supervision, 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; c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant’s internal control over ﬁnancial reporting that occurred during the registrant’s most recent ﬁscal quarter (the registrant’s fourth ﬁscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over ﬁnancial reporting; and 5. The registrant’s other certifying ofﬁcer and I have disclosed, based on our most recent evaluation of internal control over ﬁnancial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors: a. All signiﬁcant deﬁciencies and material weaknesses in the design or operation of internal control over ﬁnancial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report ﬁnancial information; and b. Any fraud, whether or not material, that involves management or other employees who have a signiﬁcant role in the registrant’s internal control over ﬁnancial reporting. Date: March 11, 2005 J. Raymond Elliott Chairman, President and Chief Executive Ofﬁcer 68 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S Certiﬁcation 2 0 0 4 F O R M 1 0 - K Exhibit 31.2 Certiﬁcation pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 I, Sam R. Leno, certify that: 1. I have reviewed this Annual Report on Form 10-K of Zimmer Holdings, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the ﬁnancial statements, and other ﬁnancial information included in this report, fairly present in all material respects the ﬁnancial condition, results of operations and cash ﬂows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying ofﬁcer and I are responsible for establishing and maintaining disclosure controls and procedures (as deﬁned in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over ﬁnancial reporting (as deﬁned in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal controls over ﬁnancial reporting, or caused such internal control over ﬁnancial reporting to be designed under our supervision, 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; c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant’s internal control over ﬁnancial reporting that occurred during the registrant’s most recent ﬁscal quarter (the registrant’s fourth ﬁscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over ﬁnancial reporting; and 5. The registrant’s other certifying ofﬁcer and I have disclosed, based on our most recent evaluation of internal control over ﬁnancial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors: a. All signiﬁcant deﬁciencies and material weaknesses in the design or operation of internal control over ﬁnancial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report ﬁnancial information; and b. Any fraud, whether or not material, that involves management or other employees who have a signiﬁcant role in the registrant’s internal control over ﬁnancial reporting. Date: March 11, 2005 Sam R. Leno Executive Vice President, Corporate Finance and Operations and Chief Financial Ofﬁcer 69 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S Certiﬁcation Certiﬁcation pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 2 0 0 4 F O R M 1 0 - K Exhibit 32 In connection with the Annual Report of Zimmer Holdings, Inc. (the ‘‘Company’’) on Form 10-K for the period ending December 31, 2004 as ﬁled with the Securities and Exchange Commission on the date hereof (the ‘‘Report’’), each of the undersigned certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the ﬁnancial condition and results of operations of the Company. J. Raymond Elliott Chairman, President and Chief Executive Ofﬁcer March 11, 2005 Sam R. Leno Executive Vice President, Corporate Finance and Operations and Chief Financial Ofﬁcer March 11, 2005 70 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S Certiﬁcation Annual CEO Certiﬁcation (Section 303A.12(a)) 2 0 0 4 F O R M 1 0 - K Exhibit 99 As the Chief Executive Ofﬁcer of Zimmer Holdings, Inc. (‘‘Company’’), and as required by Section 303A.12(a) of the New York Stock Exchange Listed Company Manual, I hereby certify that as of the date hereof I am not aware of any violation by the Company of NYSE’s Corporate Governance listing standards, other than has been notiﬁed to the Exchange pursuant to Section 303A.12(b) and disclosed as an attachment hereto. By: /s/ J. RAYMOND ELLIOTT Print Name: J. Raymond Elliott Title: Chairman, President and Chief Executive Ofﬁcer Date: June 8, 2004 71 Z I M M E R H O L D I N G S , I N C . A N D S U B S I D I A R I E S Reconciliations of Non-GAAP Financial Measures ZIMMER HOLDINGS, INC. RECONCILIATION OF OPERATING PROFIT TO ADJUSTED OPERATING PROFIT FOR THE YEARS ENDED DECEMBER 31, 2004 and 2003 (in millions, unaudited) Operating Proﬁt Acquisition and integration Inventory step-up In-process research and development Adjusted Operating Proﬁt RECONCILIATION OF DILUTED EPS TO ADJUSTED DILUTED EPS FOR THE YEARS ENDED DECEMBER 31, 2004 and 2003 (unaudited) Diluted EPS Acquisition and integration Inventory step-up In-process research and development Tax beneﬁt of acquisition and integration, inventory step-up and in-process research and development Tax beneﬁt from decreased deferred taxes of acquired Centerpulse operations; due to Swiss tax rate reduction Cumulative effect of change in accounting principle, net of tax Adjusted Diluted EPS RECONCILIATION OF GROSS MARGIN TO ADJUSTED GROSS MARGIN FOR THE THREE MONTHS ENDED DECEMBER 31, 2004 (unaudited) Gross Margin Inventory step-up Adjusted Gross Margin RECONCILIATION OF EFFECTIVE TAX RATE TO ADJUSTED EFFECTIVE TAX RATE FOR THE YEARS ENDED DECEMBER 31, 2004 and 2003 (in millions, unaudited) Effective tax rate Impact of acquisition and integration Impact of inventory step-up Impact of in-process research and development Impact of decreased deferred taxes of acquired Centerpulse operations; due to Swiss tax rate reduction Adjusted effective tax rate 72 For the Years Ended December 31, 2004 $763.2 81.1 59.4 — $903.7 2003 $450.7 79.6 42.7 11.2 $584.2 For the Years Ended December 31, 2004 $ 2.19 0.32 0.24 — (0.20) (0.14) — $ 2.41 2003 $ 1.64 0.38 0.20 0.05 (0.21) — (0.26) $ 1.80 76.4% 0.4 76.8% For the Years Ended December 31, 2004 25.9% 0.6 0.3 4.7 31.5% 2003 33.6% 0.6 0.1 (0.9) — 33.4% BOARD OF DIRECTORS J. Raymond Elliott Chairman, President and Chief Executive Officer Zimmer Holdings, Inc. Larry C. Glasscock President and Chief Executive Officer WellPoint, Inc. Regina E. Herzlinger, D.B.A. The Nancy R. McPherson Professor of Business Administration Chair Harvard Business School John L. McGoldrick Executive Vice President and General Counsel Bristol-Myers Squibb Company Augustus A. White, III, M.D., Ph.D. Ellen and Melvin Gordon Professor of Medical Education, Professor of Orthopaedic Surgery, Master, Oliver Wendell Holmes Society, Harvard Medical School OFFICERS AND KEY MANAGEMENT J. Raymond Elliott Chairman, President and Chief Executive Officer Todd O. Davis Senior Vice President, Sales, Americas Jon E. Kramer President, Americas Cheryl R. Blanchard, Ph.D. Vice President, Corporate Research and Clinical Affairs David C. Dvorak Executive Vice President, Corporate Services, Chief Counsel and Secretary Sheryl L. Conley President, Global Products Group James T. Crines Senior Vice President, Finance/Controller and Information Technology Richard Fritschi President, Zimmer Europe and Australasia Christopher J. Jefferis Vice President, Global Integration Sam R. Leno Executive Vice President, Corporate Finance and Operations and Chief Financial Officer Bruno A. Melzi Chairman, Zimmer International Stephen H. L. Ooi President, Australasia Region Renee P. Rogers, Ph.D. Vice President, Human Resources Terry D. Schlotterback President, Zimmer Spine James P. Simpson Vice President, Quality, Regulatory and Government Affairs Richard C. Stair Vice President, Global Operations and Logistics STOCKHOLDER INFORMATION Headquarters Zimmer Holdings, Inc. 345 East Main Street Warsaw, IN 46580, USA +1-574-267-6131 www.zimmer.com Stock Listing Zimmer is listed on the New York Stock Exchange and the SWX Swiss Exchange under the symbol ZMH. Transfer Agent Communications concerning stock transfer requirements, loss of certificates and change of address should be directed to Zimmer’s Transfer Agent: The Bank of New York P.O. Box 11258 New York, NY 10286, USA +1-888-552-8493 (Domestic) +1-610-382-7833 (International) shareowner-svcs@bankofny.com www.stockbny.com Investor Relations Zimmer invites stockholders, security analysts, portfolio managers and other interested parties to contact: Marc S. Ostermann Manager, Investor Relations +1-574-371-8515 marc.ostermann@zimmer.com Sam R. Leno Executive Vice President, Corporate Finance and Operations and Chief Financial Officer +1-574-372-4790 sam.leno@zimmer.com To obtain a free copy of Zimmer’s annual report including form 10-K, quarterly reports on form 10-Q, news releases, earnings releases, proxy statements, or to obtain Zimmer’s financial calendar, access SEC filings, listen to earnings calls, or to look up Zimmer stock quotes, please visit investor.zimmer.com or call +1-866-688-7656. Independent Auditors PricewaterhouseCoopers LLP Chicago, IL, USA “Strong management, relentless innovation, sensible acquisitions, and the ability to understand the needs of all stakeholders in orthopedic surgery are among the reasons MD&DI has chosen Zimmer as one of its Medical Manufacturers of the Year.” — Medical Device and Diagnostics Industry Magazine, November 2004 issue. The magazine annually names a large and a small company for the award, and Zimmer was selected in the large company category. Zimmer Holdings, Inc., 345 East Main Street, P.O. Box 708, Warsaw, IN 46580, U.S.A. www.zimmer.com

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