For year ended December 31, 2010

 

Commission file number 001-16407

 

 

ZIMMER HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code: (574) 267-6131

 

Securities registered pursuant to Section 12(b) of the Act:

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o     No þ

 

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 þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o

 

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.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

 

 

Indicate by check mark whether the registrant is a shell company (as defined Exchange Act Rule 12b-2). Yes o     No þ

 

The aggregate market value of shares held by non-affiliates was $10,878,248,016 (based on the closing price of these shares on the New York Stock Exchange on June 30, 2010 and assuming solely for the purpose of this calculation that all directors and executive officers of the registrant are “affiliates”). As of February 10, 2011, 192,125,427 shares of the registrant’s $.01 par value common stock were outstanding.

 

Documents Incorporated by Reference

Cautionary Note About Forward-Looking Statements

This Annual Report on Form 10-K includes “forward-looking” statements within the meaning of federal securities laws. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as “may,” “will,” “should,” “would,” “could,” “anticipate,” “expect,” “plan,” “seek,” “believe,” “predict,” “estimate,” “potential,” “project,” “target,” “forecast,” “intend,” “strategy,” “future,” “opportunity,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. A detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in the section titled “Risk Factors” (refer to Part I, Item 1A of this report). Readers of this report are cautioned not to place undue reliance on these forward-looking statements. While we believe the assumptions on which the forward-looking statements are based are reasonable, there can be no assurance that these forward-looking statements will prove to be accurate. We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K.

 

 

 

2

PART I

 

OVERVIEW

 

We are a global leader in the design, development, manufacture and marketing of orthopaedic reconstructive, spinal and trauma devices, dental implants and related surgical products. We also provide other healthcare related services. In this report, “Zimmer,” “we,” “us,” “our” and similar words refer collectively to Zimmer Holdings, Inc. and its subsidiaries. Zimmer Holdings refers to the parent company only.

 

Zimmer Holdings was incorporated in Delaware in 2001. Our history dates to 1927, when Zimmer Manufacturing Company, a predecessor, was founded in Warsaw, Indiana. On August 6, 2001, Zimmer Holdings was spun off from its former parent and became an independent public company.

 

CUSTOMERS, SALES AND MARKETING

 

Our primary customers include orthopaedic surgeons, neurosurgeons, oral surgeons, dentists, hospitals, stocking distributors, healthcare dealers and, in their capacity as agents, healthcare purchasing organizations or buying groups. These customers range from large multinational enterprises to independent surgeons.

 

We have operations in more than 25 countries and market 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. We manage our operations through three major geographic segments — the Americas, which is comprised principally of the U.S. and includes other North, Central and South American markets; Europe, which is comprised principally of Europe and includes the Middle East and Africa markets; and Asia Pacific, which is comprised primarily of Japan and Australia and includes other Asian and Pacific markets.

 

We market and sell products through three principal channels: 1) direct to healthcare institutions, such as hospitals or direct channel accounts; 2) through stocking distributors and healthcare dealers; and 3) directly to dental practices and dental laboratories. With direct channel accounts, inventory is generally consigned to sales agents or customers. With sales to stocking distributors, healthcare dealers, dental practices and dental laboratories, title to product passes upon shipment or upon implantation of the product. Direct channel accounts represented approximately 80 percent of our net sales in 2010. No individual direct channel account, stocking distributor, healthcare dealer, dental practice or dental laboratory accounted for more than 1 percent of our net sales for 2010.

 

We stock inventory in our warehouse facilities and retain title to consigned inventory in sufficient quantities so that products are available when needed for surgical procedures. Safety stock levels are determined based on a number of factors, including demand, manufacturing lead times and quantities required to maintain service levels. We also carry trade accounts receivable balances based on credit terms that are generally consistent with local market practices.

 

We utilize a network of sales associates, sales managers and support personnel, most of whom are employed or contracted by independent distributors and sales agencies. We invest a significant amount of time and expense in training sales associates in how to use specific products and how to best inform surgeons of product features and uses. Sales force representatives must have strong technical selling skills and medical education to provide technical support for surgeons.

 

In response to the different healthcare systems throughout the world, our sales and marketing strategies and organizational structures differ by region. We utilize a global approach to sales force training, marketing and medical education to provide consistent, high quality service. Additionally, we keep current with key surgical developments and other issues related to orthopaedic surgeons, neurosurgeons, dentists and oral surgeons and the medical procedures they perform.

 

Americas.  The Americas is our largest geographic segment, accounting for $2,431.6 million, or 58 percent, of 2010 net sales, with the U.S. accounting for 94 percent of net sales in this region. The U.S. sales force primarily consists of independent sales agents, most of whom sell products exclusively for Zimmer. Sales agents in the U.S. 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, we contract with group purchasing organizations and managed care accounts and have promoted unit growth by offering volume discounts to customer healthcare institutions within a specified group. Generally, we are designated as one of several preferred purchasing sources for specified products, although members are not obligated to purchase our products. Contracts with group purchasing organizations generally have a term of three years, with extensions as warranted.

 

In the Americas, we monitor and rank independent sales agents across a range of performance metrics, including the achievement of certain sales targets and maintenance of efficient levels of working capital.

 

Europe.  The European geographic segment accounted for $1,099.5 million, or 26 percent, of 2010 net sales, with France, Germany, Italy, Spain, Switzerland and the United Kingdom collectively accounting for 74 percent of net sales in the region. This segment also includes other key markets, including Benelux, Nordic, Central and Eastern Europe, the Middle East and Africa. Our sales force in this segment is comprised of direct sales associates, commissioned agents, independent distributors and sales support personnel. In Europe, we emphasize the advantages of our clinically

 

 

 

3

proven, established designs and innovative solutions, such as minimally invasive surgical procedures and technologies and new and enhanced materials and surfaces. In most European countries, healthcare is sponsored by the government and therefore government budgets have a role in healthcare spending, which can affect our sales in this segment.

 

Asia Pacific.  The Asia Pacific geographic segment accounted for $689.1 million, or 16 percent, of 2010 net sales, with Japan being the largest market within this segment, accounting for approximately 55 percent of the region’s sales. This segment also includes key markets such as Australia, New Zealand, Korea, China, Taiwan, India, Thailand, Singapore, Hong Kong and Malaysia. In Japan and most countries in the Asia Pacific region, we maintain a network of dealers, who act as order agents on behalf of hospitals in the region, and sales associates, who build and maintain relationships with orthopaedic surgeons, neurosurgeons and dental surgeons in their markets. These sales associates cover over 7,000 hospitals in the region. The knowledge and skills of these sales associates play a critical role in providing service, product information and support to surgeons.

 

SEASONALITY

 

Our business is somewhat seasonal in nature, as many of our products are used in elective procedures, which typically decline during the summer months and can increase at the end of the year once annual deductibles have been attained on health insurance plans.

 

DISTRIBUTION

 

We operate distribution facilities domestically in Warsaw, Indiana; Dover, Ohio; Statesville, North Carolina; Memphis, Tennessee; Carlsbad, California; and Austin, Texas and internationally in Australia, Austria, Belgium, Canada, the Czech Republic, China, Finland, France, Germany, Hong Kong, India, Italy, Japan, Korea, Malaysia, the Netherlands, New Zealand, Portugal, Russia, Singapore, South Africa, Spain, Sweden, Switzerland, Taiwan, Thailand and the United Kingdom.

 

We generally ship our orders via expedited courier. We do not consider our backlog of firm orders to be material to an understanding of our business.

 

PRODUCTS

 

Our products include orthopaedic reconstructive, spinal and trauma devices, dental implants and related surgical products.

 

We utilize our exclusive Trabecular Metal^tm Technology across various product categories. Trabecular Metal Material is a structural biomaterial with a cellular architecture that resembles bone and approximates its physical and mechanical properties more closely than other prosthetic materials. The highly porous trabecular configuration is conducive to more normal bone formation and bone in-growth. Trabecular Metal Implants are fabricated using elemental tantalum metal and a patented vapor deposition technique that creates a metallic strut configuration resembling cancellous bone with nano-textured surface features.

 

Orthopaedic Reconstructive Implants

 

 

 

Total knee replacement surgeries typically include a femoral component, a patella (knee cap), a tibial tray and an articular surface (placed on the tibial tray). Knee replacement surgeries include first-time, or primary, joint replacement procedures and revision procedures for the replacement, repair or enhancement of an implant or component from a previous procedure. 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) and ultracongruent (UC) 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.

 

Our portfolio of Minimally Invasive Solutions^tm Procedures (MIS) includes the MIS Mini-Incision Total Knee Procedure. The MIS Mini-Incision Procedure utilizes specialized MIS Instruments which feature smaller, ergonomic and highly precise instruments which accommodate and facilitate a smaller incision and less disruption of the surrounding soft tissues.

 

We offer a wide range of products for specialized knee procedures, including the following:

 

NexGen^® Complete Knee Solution.  The number one selling knee brand in the world, the NexGen Knee product line is a comprehensive system for knee replacement surgery which has significant application across the continuum of care in all things related to primary and revision knee arthroplasty, including CR, PS and revision procedures. The NexGen Knee System offers joint stability, sizing and performance options in a unified system of interchangeable components that can be tailored to an individual patient. The NexGen Knee System provides surgeons with complete and versatile knee instrument options spanning multiple surgeon and treatment philosophies, including soft tissue balancing and measured resection MIS Mini-Incision Instruments, and multiple traditional instrument systems. The breadth and versatility of the NexGen Knee System allows surgeons to transition from one type of implant to another during surgery, according to the respective needs of the patient, and to support current surgical philosophies.

 

The NexGen CR product line is designed to be used in conjunction with a functioning posterior cruciate ligament. Similar to the posterior stabilized design, the NexGen CR-Flex Fixed Bearing Knee is designed to provide a greater range of motion for patients who require deep bending in their activities of daily living. The NexGen CR-Flex Femoral Components offer a tissue balancing (flexion balancing)

 

 

 

4

solution which allows the surgeon to adjust component sizing and balance and stabilize the implant without removing additional bone or wasting critical procedure time.

 

The NexGen Complete Knee Solution Legacy^® Knee-Posterior Stabilized product line provides stability in the absence of the posterior cruciate ligament. The PS capabilities can be augmented via the use of a NexGen Legacy Posterior Stabilized Flex Knee (LPS-Flex Knee), a high-flexion implant that has the potential to accommodate knee flexion up to 155-degrees range of motion for patients whose lifestyle and body type demand and can accommodate this performance standard. With our NexGen LPS-Flex Mobile Knee, we are one of only two companies that can offer a mobile-bearing total knee treatment option in the U.S. market.

 

Gender Solutions^® NexGen Femorals represent the first knee implants specifically shaped to offer fit and function optimized for the unique anatomical considerations more commonly seen in female patients. Gender^tm Implants are an important strategic focus, as more than half of total knee arthroplasty patients are female. Gender Solutions Femorals are available in both NexGen CR-Flex and LPS-Flex configurations. The concept of advancing implant design through customization based on anatomy or other patient characteristics has manifested in rapidly expanding gender technologies across the continuum of our products and into other important brands in our growing portfolio.

 

The NexGen Revision Knee product line consists of several different products that are designed to provide clinical solutions to surgeons for various revision situations, including multiple constraint levels for ligament and soft tissue inefficiencies and a bone augmentation implant system made from our Trabecular Metal Technology material. These augments are designed to address significant bone loss in revision surgery while allowing natural bone to reconstruct within the implant construct.

 

We offer improved polyethylene performance in the NexGen Knee System with our conventional polyethylene and Prolong^® Highly Crosslinked Polyethylene, which offers reduced wear and resistance to oxidation, pitting and cracking. Prolong Highly Crosslinked Polyethylene is available in designs compatible with both NexGen CR-Flex and LPS-Flex femoral components.

 

Natural-Knee^® II System.  The Natural-Knee II System consists of a range of interchangeable, anatomically designed implants which include a proprietary CSTi^tm Cancellous-Structured Titanium Porous Coating option for stable fixation in active patients.

 

Gender Solutions Natural-Knee Flex System.  The Gender Solutions Natural-Knee Flex System adds our High Flex and Gender Solutions design concepts to the Natural-Knee System. The Gender Solutions Natural-Knee Flex System recognizes that two distinct populations exist in total knee arthroplasty (female and male) and offers two distinct implant shapes for enhanced fit. The system is compatible with muscle sparing MIS procedures and accommodates high flexion capacity up to 155 degrees. The system features the proven clinical success of our asymmetric tibial plate, CSTi Porous Coating, Prolong Highly Crosslinked Polyethylene and ultracongruent articular surface.

 

Innex^® 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 and the availability of differing levels of articular constraint, the Innex Revision Knee and Innex Gender Solutions Knee components make this offering a comprehensive mobile and fixed bearing knee system. The Innex Knee System is distributed in Europe and Asia Pacific and is not currently available for commercial distribution in the U.S.

 

Zimmer^® Unicompartmental Knee Systems.  The Zimmer Unicompartmental Knee System offers a high flexion design for unicompartmental knee surgery. This high flex product was designed specifically for MIS Procedures and Technologies. The system offers the surgeon the ability to conserve bone by replacing only the compartment of the knee that has had degenerative changes. A Gender Solutions Patello-Femoral Joint System is also available, a system which incorporates key gender specific design features and a proprietary guided milling surgical technique for use in patello-femoral joint replacement.

 

Zimmer^® Patient Specific Instruments.  In late 2009, a 510(k) Application for the Zimmer Patient Specific Instruments was approved by the U.S. Food and Drug Administration (FDA). The Zimmer Patient Specific Instruments simplify a total knee procedure and help enhance appropriate placement of the final implant based on a surgeon’s preoperative surgical plan. Based on a patient’s MRI scan, a computer generated, custom guide is produced to conform to a patient’s unique knee anatomy. This guide is then utilized intraoperatively to aid in the surgical correction of the patient’s knee.

 

Zimmer^® Segmental System.  Adding to our broad portfolio of revision options, the Zimmer Segmental System is a comprehensive system designed to address patients with severe bone loss associated with disease, trauma or revision. This important addition realizes our strategic goal of expanding our product solutions across the continuum of care and, with the incorporation of Trabecular Metal Technology, expands the possibilities for treatment, short and long-term fixation and stability.

 

 

 

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. Approximately 30 percent of hip implant procedures involve the use of bone cement to attach or affix the prosthetic components to the surrounding bone. The remaining are

 

 

 

5

press-fit into bone, which means that they have a surface that bone affixes to through either ongrowth or ingrowth technologies.

 

Our portfolio of MIS Techniques includes the Zimmer MIS Anterior Supine Technique, the MIS Posterior Procedure, the Zimmer MIS Anterolateral Technique and MIS 2-Incision^tm Hip Replacement Procedure. The MIS Techniques are designed to be less invasive to soft tissues and to shorten recovery time.

 

Our key hip replacement products include:

 

Zimmer^® M/L Taper Hip Prosthesis.  The Zimmer M/L Taper Hip Prosthesis offers a proximally porous-coated wedge-shaped design based on long-term clinically proven concepts. The M/L Taper has become widely used in MIS Procedures due to several key design features.

 

Zimmer M/L Taper Hip Prosthesis with Kinectiv^® Technology.  The Zimmer M/L Taper with Kinectiv Technology is a system of modular stem and neck components designed to help the surgeon restore the natural hip joint center intraoperatively by addressing the key variables of leg length, offset and version independently.

 

Alloclassic^® (Zweymüller^®) Hip System.  The Alloclassic (Zweymüller) Hip System has become one of the most used, primary, cementless hip systems in the world. This is one of the few stems available today that is practically unchanged since its introduction in 1979. A new offset design was added in 2004 and offers the surgeon increased capability to restore the patient’s anatomical joint movement.

 

CLS^® Spotorno^® Hip System.  The CLS Spotorno Stem is one of our largest selling hip prostheses, especially in the European markets. Additions to the product line provide the capability for restoration of the physiological center of rotation.

 

Fitmore^® Hip Stem.  The Fitmore Hip Stem offers the surgeon a short, bone preserving stem. Maintaining bone stock is particularly important for patients who may undergo a later revision procedure. Its shape facilitates MIS procedures, especially the MIS Anterior Supine approach which is gaining in popularity.

 

VerSys^® Hip System.  The VerSys Hip System is supported by a common instrumentation set and is an integrated family of hip products with design-specific options to meet varying surgical philosophies and patient needs. An offering within the VerSys Hip System, the VerSys Epoch^® Fullcoat Hip System, is the first reduced-stiffness stem specifically designed to address varying patient femoral anatomies and minimize implant-related complications such as thigh pain, bone resorption and leg lengthening.

 

Continuum^® Acetabular System, Trilogy^® IT Acetabular System and Allofit^® IT Alloclassic Acetabular System.  These systems were released in 2009 and each acetabular system offers the surgeon a choice of advanced bearing options to meet the clinical and lifestyle needs of each patient. Bearing options include Longevity^® Highly Crosslinked Polyethylene, Metasul^® Metal-on-Metal Technology and a BIOLOX^®1 delta Ceramic-on-Ceramic Technology (where Zimmer has regulatory clearances). The acetabular systems also provide surgeons a choice of fixation method that accommodates their surgical philosophy.

 

Trilogy Acetabular System.  The Trilogy Acetabular System, with its titanium alloy shell, fiber metal mesh ingrowth surface and Longevity Highly Crosslinked Polyethylene Liners, is our most widely sold acetabular cup system.

 

Trabecular Metal Modular Acetabular System.  We offer the Trabecular Metal Modular Acetabular System, which incorporates design features from the Trilogy family of acetabular shells augmented with the advanced fixation surface of Trabecular Metal Material. In addition, we offer a Trabecular Metal Acetabular Revision System that provides the surgeon with a variety of off-the-shelf options to address a wide range of bone deficiencies encountered during acetabular revisions and to achieve a stable construct.

 

 

 

Our extremity portfolio, primarily shoulder and elbow products, is designed to treat arthritic conditions, soft tissue injuries and fractures.

 

Our key products include:

 

Bigliani/Flatow^® Complete Shoulder Solution Family.  The Bigliani/Flatow Shoulder product line combined with the Trabecular Metal Humeral Stem give us a significant presence in the global shoulder implant market.

 

Trabecular Metal Glenoid.  The Trabecular Metal Glenoid offers surgeons a glenoid component designed to improve fixation. Trabecular Metal Material’s properties allow for more normal bone formation and maintenance.

 

Trabecular Metal Reverse Shoulder System.  The Trabecular Metal Reverse Shoulder System incorporates advanced materials and design to offer improved biological ingrowth potential through the utilization of Trabecular Metal Technology, while addressing significant loss of rotator cuff function. The reverse shoulder system is designed to restore function to patients who, because of debilitating rotator cuff tears, are not candidates for traditional shoulder surgery and have exhausted other means of repair.

 

Zimmer^® Anatomical Shoulder^tm System.  The Anatomical Shoulder System can be adjusted to each patient’s individual anatomy. This portfolio of products includes the Anatomical Shoulder Inverse/Reverse System, designed to address significant loss of rotator cuff function, and the Anatomical Shoulder Fracture System. Both the primary and fracture shoulder implants can be converted to a reverse shoulder without removal of the initial implant.

 

¹ Registered trademark of CeramTec AG

 

 

 

6

 

Coonrad/Morrey Total Elbow. The Coonrad/Morrey Total Elbow product line is a family of elbow replacement implant products to address patients with conditions of severe arthritis or trauma.

 

Dental Implants

 

 

Our dental products division manufactures and/or distributes: (1) dental reconstructive implants — for individuals who are totally without teeth or are missing one or more teeth; (2) dental restorative products — aimed at providing a more natural restoration to mimic the original teeth; and (3) dental regenerative products — for soft tissue and bone rehabilitation.

 

 

 

Our dental reconstructive implant products and surgical and restorative techniques include:

 

Tapered Screw-Vent^® Implant System.  Our highest selling dental product line provides the clinician a tapered geometry which mimics the natural shape of a tooth root. The Tapered Screw-Vent Implant System, with its two-stage design, was developed to minimize valuable chair time for restorations. The Tapered Screw-Vent Implant System is a technologically advanced dental implant featuring a proprietary internal hex connection, multiple lead threads for reduced insertion time and selective surface coatings. The Zimmer One-Piece Implant System, designed to complement the success of the Tapered Screw-Vent Implant System, enhances this product line by offering clinicians a fast, convenient restorative option. In 2010, the Tapered Screw-Vent Implant System celebrated its 10-year anniversary with more than two million implants sold worldwide since its introduction.

 

AdVent^® Implant System.  Utilizing many features of the Tapered Screw-Vent Implant System, the AdVent Implant System is a transgingival, one stage design that utilizes the same surgical system as the Tapered Screw-Vent Implant 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, the Tapered SwissPlus Implant System incorporates multiple lead threads for faster insertion time and a tapered body to allow it to be placed in tight interdental spaces. The Tapered SwissPlus Implant System also incorporates an internal connection.

 

 

 

We commercialize products for the aesthetic market aimed at providing a more natural restoration. We offer a full line of prosthetic devices for each of the above dental implant systems as well as a custom solution, as follows:

 

Zimmer Hex-Lock^® Contour Abutment and Restorative Products.  Designed to be used with our Tapered Screw-Vent and Zimmer One-Piece Implant Systems, our contour lines are a solution for addressing the diversity of patients’ needs. Featuring prepared margins, titanium and ceramic options and snap-on impression caps, our abutments are designed to simplify the restoration process, save time for clinicians and technicians and offer versatility.

 

Our Hex-Lock Short Abutment and Restorative System is an all-inclusive solution that promotes posterior restorations. We also offer the Zimmer^® Contour Zirconia Abutment. Both are engineered for use with the Tapered Screw-Vent Implant System.

 

In 2010 we released the Zimmer^® Plastic Temporary Abutments for the Tapered Screw-Vent and Screw-Vent^® Implant Systems. These new provisional abutments, offered in angled and straight designs, allow for expedient and simplified modification.

 

 

 

We market the following product lines for use in regenerative techniques in oral surgery:

 

Puros^® Allograft Products.  The Puros biologic offering is an allograft material, which in the case of mineralized bone and dermal tissues, utilizes the Tutoplast^®2 Tissue Processing Technique to provide exceptional bone and soft tissue grafting material for use in oral surgery. Zimmer Dental offers a number of distinct Puros Allograft products to use together or separately for various bone and soft tissue grafting needs: Puros Cancellous Particulate, Puros Cortical Particulate, Puros Block Allografts, Puros Pericardium Membranes, Puros Dermis Membranes, Puros Demineralized Bone Matrix (DBM) and Puros DBM Putty with Chips.

 

We distribute the Puros Allograft Products through an exclusive, worldwide agreement with RTI Biologics, Inc., which was amended and renewed in 2010.

 

Through this same agreement with RTI Biologics, Inc., we provide CopiOs^® Pericardium Membrane in the U.S. Sourced from bovine pericardial tissue, the CopiOs Pericardium Membrane provides the characteristics of natural tissue and can be used as a direct substitute for Puros Pericardium Membranes.

 

In addition, we have expanded our regenerative portfolio by adding new, key product offerings to provide wound management and sinus lift solutions. The HemCon^®3 Dental Dressing is an advanced wound dressing material that utilizes a proprietary chitosan-based technology to effectively seal the wound and minimize pain in various surgical procedures. The HemCon Dental Dressing is exclusively

² Registered trademark of RTI Biologics, Inc.

 

³ Registered trademark of HemCon Medical Technologies, Inc.

 

 

 

7

distributed by Zimmer Dental. We have also introduced our Zimmer^® Sinus Lift Balloon, created to simplify the delicate sinus lift procedure, as well as the Zimmer^® Collagen Capsules, which represent the industry’s first-ever bone-shaping membranes — all under an agreement with Osseous Technologies of America (OTA). Finally, in line with our goal to offer cutting-edge sinus lift solutions and instrumentation, we began distributing the minimally-invasive Neobiotech Sinus Lateral Approach and Sinus Crestal Approach Kits in the U.S. These surgical kits streamline and simplify the process for accessing the delicate sinus area.

 

Spine Implants

 

 

Our Spine products division designs, manufactures and distributes medical devices and surgical instruments to deliver comprehensive solutions for those with back or neck pain caused by degenerative conditions, deformities or traumatic injury of the spine. We provide surgeons a broad range of technologies for posterior and anterior procedures in the cervical, thoracic and lumbar regions of the spine.

 

Zimmer Spine’s portfolio of spinal solutions includes:

 

PathFinder NXT^tm Minimally Invasive Pedicle Screw System.  Released in 2010, the PathFinder NXT System builds on the legacy of the PathFinder^® Device, a pioneering technology in MIS spinal fusion procedures. The PathFinder NXT System is designed to allow for a mini-open or true percutaneous approach, depending on the preferred surgeon technique and patient need. In addition, the PathFinder NXT System incorporates enhanced features that provide improved efficiency in performing MIS fusion procedures.

 

Universal Clamp^tm Spinal Fixation System.  The design of the Universal Clamp Implant allows it to be used alongside traditional hooks, screws and wires to treat scoliotic deformities and correct complex spinal pathologies.

 

Sequoia^® Pedicle Screw System.  The Sequoia System was developed to simplify surgical flow, reduce implantation time and improve ergonomic tool design. This pedicle screw system combines ergonomic instrumentation with an effective design that reduces implant metal volume.

 

Ardis^® Interbody System.  The Ardis Implant features a self-distracting nose, convex geometry and wide range of sizes. This versatile PEEK-OPTIMA^®4 Device incorporates a large space for graft placement, plus an advanced tooth design to effectively resist migration and expulsion during procedures. Ardis instrumentation was also designed to streamline the surgical procedure and improve surgeon comfort.

 

Trinica^® Select Anterior Cervical Plating System.  The Trinica Select System is designed to simplify the surgical procedure with the Secure-Twist^® Anti-Migration System, which provides visual confirmation of screw capture, as well as a wide variety of screw options to customize the construct depending on patient need.

 

Biological Products.  Zimmer Spine offers a full line of bone void filler products to accommodate most surgical procedures. Puros^® Demineralized Bone Matrix is available in Putty and Putty with Chips formulations, and the CopiOs^® Bone Void Filler family of products includes synthetic bone graft material in the form of sponges or pastes that are used to fill bone voids during spine surgery.

 

Dynesys^® Dynamic Stabilization System.  The Dynesys Implant family was designed to facilitate a more physiologic approach to low back spinal stabilization. The system threads flexible components, instead of traditional rigid titanium rods, through pedicle screws in order to stabilize affected spinal segments in a more natural anatomic position and to alleviate pain. The Dynesys Dynamic Stabilization System is currently only indicated for use as an adjunct to fusion in the U.S.

 

Wallis^® Posterior Dynamic Stabilization System (available outside the U.S. only).  The Wallis System is a spinal implant that was designed to stabilize the lumbar spine while preserving the anatomy and minimizing the need for bony resection. The Wallis System combines a PEEK-OPTIMA Spacer linked to the vertebrae via a polyester band that permits an even distribution of stresses on bone.

 

Trauma

 

 

Trauma products include devices used to stabilize damaged or broken bones and their surrounding tissues to support the body’s natural healing processes. Fractures are most often stabilized using internal fixation devices such as plates, screws, nails, wires and pins, but may also be stabilized using external fixation devices. Orthobiologics are used in conjunction with traditional trauma devices to encourage healing and replace bone lost during an injury. We are focused on providing exceptional options to treat a broad range of traumatic injuries, addressing unmet clinical needs and implementing next-generation technologies into our portfolio of trauma solutions.

 

Zimmer Trauma offers a comprehensive line of products, including:

 

Zimmer Natural Nail^® System.  The Zimmer Natural Nail System includes a series of intramedullary nails designed to address a broad range of long bone fractures. The nails are anatomically shaped and incorporate a feature that allows the screws to be linked to the nails, creating a construct even in poor quality bone. Instrumentation for nail placement is designed to make it easy for surgeons to utilize the implants as well as to address growing concerns with obesity and osteoporosis.

 

NCB^® Polyaxial Locking Plate System.  NCB Polyaxial Locking Plates provide surgeons with the ability to place screws with polyaxial freedom and utilize both conventional and locking technology in the treatment of complex fractures of the distal femur, proximal humerus and

⁴ Registered trademark of Ivibio, Ltd.

 

 

 

8

proximal tibia. We continue to invest in additional applications of this technology.

 

Zimmer^® Periarticular Locking Plate System.  The Zimmer Periarticular Locking Plate System combines anatomic designs with locking screw technology to create constructs for use in comminuted fractures or where deficient bone stock or poor bone quality is encountered. By combining locking screw holes with compression slots, the plates can be used as both locking devices and fracture compression devices.

 

Zimmer^® Universal Locking System.  The Zimmer Universal Locking System is a comprehensive system of mini and small fragment plates, screws and instruments for fracture fixation. The Universal Locking System plates resemble standard plates, but have figure-8 shaped holes which allow the plates to be used as compression plates, locked internal fixators or as an internal fixation system combining both techniques.

 

Zimmer^® Cable-Ready^® System.  The Zimmer Cable-Ready System includes a series of instruments, cables and other implants that help a surgeon treat several different fracture types, including those that occur around a previously implanted device (periprosthetic). The cables are wrapped around the bone and then secured, either to themselves or to plates, to provide fixation for fractured limbs.

 

Surgical

 

 

We develop, manufacture and market products that support reconstructive, trauma, spine and dental implant procedures, with a focus on Bone Cements, Surgical Wound Site Management and Blood Management. The Surgical product portfolio includes:

 

PALACOS^®5 Bone Cement.  We have exclusive U.S. and Canada distribution rights for the PALACOS line of bone cement products manufactured by Heraeus Kulzer GmbH. Included in these brands are PALACOS R and PALACOS R+G Bone Cements, as well as PALACOS LV and PALACOS LV+G Bone Cements. The PALACOS R+G and PALACOS LV+G products are bone cements with the antibiotic gentamicin pre-mixed in the formulation. Both are used by orthopaedic surgeons to reduce the risk of postoperative infection in second stage revisions. The PALACOS family’s history of clinical success, fatigue strength, high visualization and handling characteristics make it well-suited for orthopaedics.

 

Hi-Fatigue^tm6 Bone Cement.  We have exclusive European and Asian distribution rights for the Hi-Fatigue line of bone cement products manufactured by aap Biomaterials GmbH & Co. KG. Included in these brands are Hi-Fatigue and Hi-Fatigue G Bone Cements. The Hi-Fatigue G Bone Cement utilizes the antibiotic gentamicin pre-mixed in the formulation and is used by orthopaedic surgeons to reduce the risk of postoperative infection.

 

A.T.S.^® Automatic Tourniquet Systems.  The A.T.S.  Tourniquet Systems Product Line is our family of tourniquet machines and cuffs that are designed to safely create a bloodless surgical field. The portfolio includes the A.T.S. 3000 Tourniquet System, which utilizes proprietary technology to determine the patient’s appropriate “Limb Occlusion Pressure” (LOP) based on the patient’s specific physiology. Through reduction of a patient’s LOP, the clinician may reduce the risk of tissue and/or nerve damage. Complementing A.T.S. Tourniquet Systems machines is a wide range of cuffs that provide the flexibility to occlude blood flow safely with convenience and accuracy for limbs of virtually every size and shape.

 

Pulsavac^® Plus, Pulsavac Plus AC and Pulsavac Plus LP Wound Debridement System.  The Pulsavac Systems are used for cleaning and debridement of contaminants and foreign matter from wounds using simultaneous irrigation and suction. All three Pulsavac Systems are disposable to reduce the risk of cross contamination. While Pulsavac Plus and Pulsavac Plus LP Wound Debridement Systems are both battery-powered, the Pulsavac Plus AC Wound Debridement System is a disposable system that is powered by a reusable AC power source to help alleviate environmental concerns associated with battery disposal.

 

Zimmer^® Blood Reinfusion System (ZBRS) and Hemovac^® Blood Management Systems.  These two blood management products are part of a larger family that supports the clinician in managing patient blood loss after a surgical procedure. The ZBRS product is a closed-loop postoperative system that effectively salvages and filters the patient’s own blood to help reduce dependency on banked blood and/or preoperative autologous donation.

 

HEALTHCARE CONSULTING

 

Our healthcare consulting services subsidiary, Accelero Health Partners, LLC (Accelero), is based in Canonsburg, Pennsylvania. Accelero consultants work to design a customized program for each client that promotes the active participation and collaboration of the physicians and the hospital-based departments with the goal of consistently producing a superior outcome in the form of a growing, efficient and effective care delivery network. Currently, revenue related to Accelero services represents less than 1 percent of our total net sales.

 

ORTHOBIOLOGICS

 

Our research and development efforts include an Orthobiologics group based in Austin, Texas, with its own full-time staff and dedicated projects focusing on the development of a variety of biologic technologies for musculoskeletal

⁵ Registered trademark of Heraeus Kulzer GmbH

 

⁶ Registered trademark of aap Biomaterials GmbH & Co. KG

 

 

 

9

applications. This group works on biological solutions to repair and regenerate damaged or degenerated musculoskeletal tissues using biomaterials/cell therapies which offer the possibility of treating damaged joints by biological repair rather than replacing them. A sampling of some of our key projects in the Orthobiologics area is set forth below.

 

We are collaborating with ISTO Technologies, Inc. (ISTO) to develop chondral grafts for cartilage repair. ISTO creates cell-based therapies for cartilage regeneration using cells from juvenile donor cartilage. DeNovo^® NT Natural Tissue Graft was commercialized in 2009 and represents our first product entry into the cartilage repair market. This tissue product provides particulated juvenile cartilage tissue for repair of articular cartilage defects of the knee, ankle, shoulder, hip, elbow and toe joints. More than 1,700 patients have undergone this innovative cartilage repair procedure. DeNovo ET Engineered Tissue Graft is a living tissue-engineered cartilage graft under clinical investigation for the restoration of cartilage defects, reestablishment of joint function and relief of pain in the knee. The Phase I/II clinical trial for DeNovo ET has been completed and the data has been supplied to the FDA with a request to allow Zimmer/ISTO to proceed with enrollment of the pivotal Phase III clinical trial.

 

Many musculoskeletal surgical procedures use bone grafts to help regenerate lost or damaged bone. Our Spine, Dental and Trauma divisions have introduced a technologically advanced all-human demineralized bone matrix, Puros DBM Putty and Putty with bone chips. This bone-derived allograft material is used to fill bone voids or defects. It is placed into the bone void where it is then completely replaced by natural bone during the healing process.

 

RESEARCH AND DEVELOPMENT

 

We have extensive research and development activities to develop new surgical techniques, materials, orthobiologics and product designs. The research and development functions work closely with our strategic brand marketing function. The rapid commercialization of innovative new materials, orthobiologics products, implant and instrument designs and surgical techniques remains one of our core strategies and continues to be an important driver of sales growth.

 

We are broadening our product offerings in each of our product categories and exploring new technologies with possible applications in multiple areas. For the years ended December 31, 2010, 2009 and 2008, we spent $220.0 million, $205.7 million and $192.3 million, respectively, on research and development. Our primary research and development facility is located in Warsaw, Indiana. We have other research and development personnel based in, among other places, Winterthur, Switzerland; Austin, Texas; Minneapolis, Minnesota; Carlsbad, California; Dover, Ohio; and Parsippany, New Jersey. As of December 31, 2010, we employed more than 1,000 research and development employees worldwide.

 

We expect to continue to identify innovative technologies and consider acquiring complementary products or businesses, or establishing technology licensing arrangements or strategic alliances.

 

GOVERNMENT REGULATION AND COMPLIANCE

 

We are subject to government regulation in the countries in which we conduct business. In the U.S., numerous laws and regulations govern all the processes by which medical devices are brought to market. These include, among others, the Federal Food, Drug and Cosmetic Act and regulations issued or promulgated thereunder. The FDA has enacted regulations that control all aspects of the development, manufacture, advertising, promotion and postmarket surveillance of medical products, including medical devices. In addition, the FDA controls the access of products to market through processes designed to ensure that only products that are safe and effective are made available to the public.

 

Most of our new products fall into an FDA classification that requires the submission of a Premarket Notification (510(k)) to the FDA. This process requires us to demonstrate that the device to be marketed is at least as safe and effective as, that is, substantially equivalent to, a legally marketed device. We must submit information that supports our substantial equivalency claims. Before we can market the new device, we must receive an order from the FDA finding substantial equivalence and clearing the new device for commercial distribution in the U.S. Other devices we develop and market are in a category (class) for which the FDA has implemented stringent clinical investigation and Premarket Approval (PMA) requirements. The PMA process requires us to provide clinical and laboratory data that establishes that the new medical device is safe and effective. The FDA will approve the new device for commercial distribution if it determines that the data and information in the PMA constitute valid scientific evidence and that there is reasonable assurance that the device is safe and effective for its intended use(s). All of our devices marketed in the U.S. have been cleared or approved by the FDA, with the exception of certain pre-amendment devices which were in commercial distribution prior to May 28, 1976. The FDA has grandfathered these devices, so new FDA submissions are not required. 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 and to seek criminal prosecution of executives for violation of FDA regulations. There are also certain requirements of state, local and foreign governments that we must comply with in the manufacture and marketing of our products.

 

In many of the foreign countries in which we market our products, we are subject to local regulations affecting, among other things, design and product standards, packaging requirements and labeling requirements. Many of the regulations applicable to our devices and products in these countries are similar to those of the FDA. The member countries of the European Union have adopted the European Medical Device Directive, which creates a single set of medical device regulations for products marketed in all member countries. Compliance with the Medical Device Directive and certification to a quality system enable the manufacturer to place a CE mark on its products. To obtain

 

 

 

10

authorization to affix the CE mark to a product, a recognized European Notified Body must assess a manufacturer’s quality systems and the product’s conformity to the requirements of the Medical Device Directive. We are subject to inspection by the Notified Bodies for compliance with these requirements.

 

Further, we are subject to various federal and state laws concerning healthcare fraud and abuse, including false claims laws and anti-kickback laws. These laws are administered by, among others, the U.S. Department of Justice, the Office of Inspector General of the Department of Health and Human Services and state attorneys general. Many of these agencies have increased their enforcement activities with respect to medical device manufacturers in recent years. Violations of these laws are punishable by criminal and/or civil sanctions, including, in some instances, fines, imprisonment and, within the U.S., exclusion from participation in government healthcare programs, including Medicare, Medicaid and Veterans Administration (VA) health programs.

 

Our operations in foreign countries are subject to the extraterritorial application of the U.S. Foreign Corrupt Practices Act (FCPA). As part of our global compliance program, we seek to address FCPA risks proactively.

 

Our facilities and operations are also subject to complex federal, state, local and foreign environmental and occupational safety laws and regulations, including those relating to discharges of substances in the air, water and land, the handling, storage and disposal of wastes and the clean-up of properties by pollutants. We do not expect that the ongoing costs of compliance with these environmental requirements will have a material impact on our consolidated earnings, capital expenditures or competitive position.

 

We continue to assess the impact that the healthcare reform legislation passed in 2010 by the U.S. federal government will have on our business. The new law includes a 2.3 percent excise tax on a majority of our U.S. sales that is scheduled to be implemented in 2013.

 

COMPETITION

 

The orthopaedics industry is highly competitive. In the global markets for reconstructive implants, trauma and related surgical products, our major competitors include: DePuy Orthopaedics, Inc. (a subsidiary of Johnson & Johnson), Stryker Corporation, Biomet, Inc., Smith & Nephew plc, Wright Medical Group, Inc., Synthes, Inc. and Tornier, Inc.

 

In the Americas geographic segment, we and DePuy Orthopaedics, Inc., Stryker Corporation, Biomet, Inc., Smith & Nephew, Inc. (a subsidiary of Smith & Nephew plc), Wright Medical Group, Inc. and Synthes, Inc. account for a large majority of the total reconstructive and trauma implant sales.

 

In the Asia Pacific market for reconstructive implant and trauma products, we compete primarily with DePuy Orthopaedics, Inc., Stryker Corporation, Synthes, Inc., Smith & Nephew plc and Biomet, Inc., as well as regional companies, including Japan Medical Materials Corporation and Japan Medical Dynamic Marketing, Inc. Factors, such as the dealer system and complex regulatory environments, make it difficult for smaller companies, particularly those that are non-regional, to compete effectively with the market leaders in the Asia Pacific region.

 

The European 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 regional European companies, including Aesculap AG (a subsidiary of B. Braun), Waldemar LINK GmbH & Co., KG and Mathys AG which, in addition to the global competitors, compete with us. Today most hip implants sold in Europe are products developed specifically for the European market, although global products are gaining acceptance. We will continue to develop and produce specially tailored products to meet specific European needs.

 

In the spinal implant category, we compete globally primarily with the spinal and biologic business of Medtronic, Inc., DePuy Spine (a subsidiary of Johnson & Johnson), Synthes, Inc., Stryker Corporation, Biomet Spine (a subsidiary of Biomet, Inc.) and NuVasive, Inc.

 

In the dental implant category, we compete primarily with Nobel Biocare Holding AG, Straumann Holding AG, Astra Tech Dental, Dentsply International and Biomet 3i (a subsidiary of Biomet, Inc.).

 

Competition within the industry is primarily based on technology, innovation, quality, reputation and customer service. A key factor in our continuing success in the future will be our ability to develop new products and improve existing products and technologies.

 

MANUFACTURING AND RAW MATERIALS

 

We manufacture substantially all of our products at nine sites, including Warsaw, Indiana; Winterthur, Switzerland; Ponce, Puerto Rico; Dover, Ohio; Statesville, North Carolina; Carlsbad, California; Parsippany, New Jersey; Shannon, Ireland; and Etupes, France. Additionally, in December 2010 we acquired two businesses, Beijing Montagne Medical Device Co., Ltd. (Montagne) and Sodem Diffusion S.A. (Sodem). Montagne has manufacturing facilities in Beijing and Xianning, China and Sodem has manufacturing facilities in Geneva, Switzerland. We expect these facilities will become an important part of our manufacturing network.

 

We believe that our manufacturing facilities are among the best in our industry in terms of automation and productivity 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 and optimization. Our continuous improvement efforts are driven by Lean and Six Sigma methodologies. In addition, at certain of our manufacturing facilities, many of the employees are cross-trained to perform a broad array of operations.

 

We generally target operating our manufacturing facilities at levels up to 90 percent of total capacity. We continually

 

 

 

11

evaluate the potential to in-source products currently purchased from outside vendors to on-site production.

 

We have improved our manufacturing processes to protect our profitability and offset the impact of inflationary costs. We have, for example, employed computer-assisted robots and multi-axis grinders to precision polish medical devices; automated certain manufacturing and inspection processes, including on-machine inspection and process controls; purchased state-of-the-art equipment; in-sourced core products, such as castings and forgings; and negotiated reductions in third party supplier costs.

 

We use a diverse and broad range of raw materials in the manufacturing of our products. We purchase all of our raw materials and select components used in manufacturing our products from external suppliers. In addition, we purchase some supplies from single sources for reasons of quality assurance, sole source availability, cost effectiveness or constraints resulting from regulatory requirements. We work closely with our suppliers to assure continuity of supply while maintaining high quality and reliability. To date, we have not experienced any significant difficulty in locating and obtaining the materials necessary to fulfill our production schedules.

 

INTELLECTUAL PROPERTY

 

Patents and other proprietary rights are important to the continued success of our business. We also rely upon trade secrets, know-how, continuing technological innovation and licensing opportunities to develop and maintain our competitive position. We protect our proprietary rights through a variety of methods, including confidentiality agreements and proprietary information agreements with vendors, employees, consultants and others who may have access to proprietary information. We own or control through licensing arrangements more than 5,000 issued patents and patent applications throughout the world that relate to aspects of the technology incorporated in many of our products.

 

EMPLOYEES

 

As of December 31, 2010, we employed more than 8,800 employees worldwide, including more than 1,000 employees dedicated to research and development. Approximately 4,900 employees are located within the U.S. and approximately 3,900 employees are located outside of the U.S., primarily throughout Europe and in Japan. We have over 3,700 employees dedicated to manufacturing our products worldwide. The Warsaw, Indiana production facility employs more than 1,500 employees. Approximately 150 U.S. employees are members of a trade union covered by a collective bargaining agreement.

 

We have a collective bargaining agreement with the United Steel, Paper and Forestry, Rubber Manufacturing, Energy, Allied Industrial and Service Workers International Union for and on behalf of Local 2737-15 covering employees at the Dover, Ohio facility, which continues in effect until May 15, 2012.

 

 

EXECUTIVE OFFICERS

 

 

The following table sets forth certain information with respect to our executive officers as of February 15, 2011.

 

 

Mr. Dvorak was appointed President, Chief Executive Officer and a member of the Board of Directors in May 2007. From December 2005 to April 2007, he served as Group President, Global Businesses and Chief Legal Officer. Prior to that, he had served as Executive Vice President, Corporate Services, Chief Counsel and Secretary, as well as Chief Compliance Officer, since October 2003. Mr. Dvorak joined Zimmer in 2001.

 

Dr. Blanchard was appointed Senior Vice President and Chief Scientific Officer in December 2005. She is responsible for Corporate Research, Global Quality and Regulatory Affairs, Global Medical Affairs, Biologics Research and Development and Biologics Marketing. Previously, she had served as Vice President, Corporate Research and Clinical Affairs since October 2003. Dr. Blanchard joined Zimmer in 2000.

 

Mr. Crines was appointed Executive Vice President, Finance and Chief Financial Officer in May 2007. From December 2005 to April 2007, he served as Senior Vice President, Finance, Operations and Corporate Controller and Chief Accounting Officer. Prior to that, he had served as Senior Vice President, Finance/Controller and Information Technology since October 2003. Mr. Crines joined Zimmer in 1995.

 

 

 

12

 

Mr. Davis was appointed Vice President, Finance and Corporate Controller and Chief Accounting Officer in May 2007. He has responsibility for internal and external reporting, planning and analysis, and corporate and business unit accounting. From March 2006 to May 2007, he served as Director, Financial Planning and Accounting. Prior to that, he had served as Director, Finance, Operations and Logistics since December 2003. Mr. Davis joined Zimmer in 2003.

 

Mr. McCaulley was appointed President, Zimmer Reconstructive in November 2008. He has overall responsibility for the Global Reconstructive Division, including direct responsibility for Global Brand Management, Product Research and Development, Quality and Regulatory Affairs, and Medical Training and Education, as well as Americas Marketing and Sales. Prior to joining Zimmer, he served as President and Chief Executive Officer of the Health Division of Wolters Kluwer from 2005, Vice President and General Manager of the Diabetes Division of Medtronic, Inc. from 2002, and spent 14 years with GE Healthcare in numerous positions of increasing responsibility, including President and Chief Executive Officer of GE Clinical Services from 2000.

 

Mr. Melzi was appointed Chairman, Europe, Middle East and Africa in October 2003. He is responsible for the sales, marketing and distribution of products in the European, Middle Eastern and African regions. Mr. Melzi joined Zimmer in 1990.

 

Mr. Ooi was appointed President, Asia Pacific in December 2005. He is responsible for the sales, marketing and distribution of products in the Asia Pacific region. Prior to that, he had served as President, Australasia since September 2003. Mr. Ooi joined Zimmer in 1986.

 

Mr. Paulsen was appointed Group President, Global Businesses in December 2009. He has responsibility for Zimmer Spine, Zimmer Dental, Zimmer Trauma and Zimmer Surgical. Prior to joining Zimmer, Mr. Paulsen served as Chief Operating Officer of MPS Group, Inc., a privately held environmental services and facility management firm, from September 2008 to December 2009. Prior to that, he served as Group President of TriMas Corporation, a specialty manufacturing company, from January 2007 to June 2008. Previously, Mr. Paulsen had held a number of increasingly responsible executive roles at Stryker Corporation from 1996 to December 2006, including President, Orthopaedic Reconstructive Division.

 

Mr. Phipps was appointed Senior Vice President, General Counsel and Secretary in May 2007. He has global responsibility for our legal affairs and he serves as Secretary to the Board of Directors. Mr. Phipps also oversees our Government Affairs, Corporate Marketing and Communications and Public Relations activities. From December 2005 to May 2007, he served as Associate General Counsel and Corporate Secretary. Prior to that, he had served as Associate Counsel and Assistant Secretary since September 2003. Mr. Phipps joined Zimmer in 2003.

 

AVAILABLE INFORMATION

 

Our Internet address is www.zimmer.com. We routinely post important information for investors on our website in the “Investor Relations” section, which may be accessed from our homepage at www.zimmer.com or directly at http://investor.zimmer.com. We intend to use this website as a means of disclosing material, non-public information and for complying with our disclosure obligations under Regulation FD. Accordingly, investors should monitor the Investor Relations section of our website, in addition to following our press releases, SEC filings, public conference calls, presentations and webcasts. Our goal is to maintain the Investor Relations website as a portal through which investors can easily find or navigate to pertinent information about us, free of charge, including:

 

The information available on our website is not incorporated by reference in, or a part of this or any other report we file with or furnish to the SEC.

 

 

Risk factors which could cause actual results to differ from our expectations and which could negatively impact our financial condition and results of operations are discussed below and elsewhere in this report. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that are currently not believed to be significant to our business may also affect our actual results and could harm our business, financial condition and results of operations. If any of the risks or

 

 

 

13

uncertainties described below or any additional risks and uncertainties actually occur, our business, results of operations and financial condition could be materially and adversely affected.

 

If we fail to comply with the terms of the Corporate Integrity Agreement we entered into in September 2007, we may be subject to exclusion from federal healthcare programs.

 

As previously reported, in September 2007 we settled an investigation conducted by the U.S. Attorney’s Office for the District of New Jersey (U.S. Attorney) into financial relationships between major orthopaedic manufacturers and consulting orthopaedic surgeons. As part of that settlement, we entered into a Corporate Integrity Agreement (CIA) with the Office of Inspector General of the Department of Health and Human Services (OIG-HHS). A copy of the CIA is filed as an exhibit to this report. If we do not comply with the terms of the CIA, we could be subject to exclusion by OIG-HHS from participation in federal healthcare programs, including Medicaid and Medicare.

 

The ongoing investigation by the U.S. Securities and Exchange Commission and the U.S. Department of Justice regarding potential violations of the Foreign Corrupt Practices Act in the sale of medical devices in a number of foreign countries by companies in the medical device industry could have a material adverse effect on our business, financial condition and cash flows.

 

We are cooperating fully with the U.S. Securities and Exchange Commission and the U.S. Department of Justice with regard to an ongoing investigation of potential violations of the Foreign Corrupt Practices Act in the sale of medical devices in a number of foreign countries by companies in the medical device industry. Although we have adopted policies and procedures designed to prevent improper payments and we train our employees, distributors and others concerning these issues, we cannot assure that violations of these requirements will not occur. If we are found to have violated the Foreign Corrupt Practices Act, we may face sanctions including fines, criminal penalties, disgorgement of profits and suspension or debarment of our ability to contract with governmental agencies or receive export licenses.

 

If we fail to retain the independent agents and distributors upon whom we rely heavily to market our products, customers may not buy our products and our revenue and profitability may decline.

 

Our marketing success in the U.S. and abroad depends significantly upon our agents’ and distributors’ sales and service expertise in the marketplace. Many of these agents have developed professional relationships with existing and potential customers because of the agents’ detailed knowledge of products and instruments. A loss of a significant number of these agents could have a material adverse effect on our business and results of operations.

 

If we do not introduce new products in a timely manner, our products may become obsolete over time, customers may not buy our products and our revenue and profitability may decline.

 

Demand for our products may change, in certain cases, in ways we may not anticipate because of:

 

Without the timely introduction of new products and enhancements, our products may become obsolete over time. If that happens, our revenue and operating results would suffer. The success of our new product offerings will depend on several factors, including our ability to:

 

In addition, new materials, product designs and surgical techniques that we develop may not be accepted quickly, in some or all markets, because of, among other factors:

 

Moreover, innovations generally require a substantial investment in research and development before we can determine their commercial viability and we may not have the financial resources necessary to fund the production. In addition, even if we are able to successfully develop enhancements or new generations of our products, these enhancements or new generations of products may not produce revenue in excess of the costs of development and they may be quickly rendered obsolete by changing customer preferences or the introduction by our competitors of products embodying new technologies or features.

 

We conduct a significant amount of our sales activity outside of the U.S., which subjects us to additional business risks and may cause our profitability to decline due to increased costs.

 

We sell our products in more than 100 countries and derive more than 40 percent of our net sales from outside the U.S. We intend to continue to pursue growth opportunities in sales internationally, including in emerging markets, which could expose us to additional risks associated with international sales and operations. Our international operations

 

 

 

14

are, and will continue to be, subject to a number of risks and potential costs, including:

 

Violations of foreign laws or regulations could result in fines, criminal sanctions against us, our officers or our employees, prohibitions on the conduct of our business and damage to our reputation.

 

We are subject to risks arising from currency exchange rate fluctuations, which can increase our costs, cause our profitability to decline and expose us to counterparty risks.

 

A substantial portion of our foreign revenues is generated in Europe and Japan. The U.S. dollar value of our foreign-generated revenues varies with currency exchange rate fluctuations. Significant increases in the value of the U.S. dollar relative to the Euro or the Japanese Yen, as well as other currencies, could have a material adverse effect on our results of operations. Although we address currency risk management through regular operating and financing activities, and, on a limited basis, through the use of derivative financial instruments, those actions may not prove to be fully effective.

 

We may fail to adequately protect our proprietary technology and other intellectual property, which would allow competitors or others to take advantage of our research and development efforts.

 

Our long-term success largely depends on our ability to market technologically competitive products. If we fail to obtain or maintain adequate intellectual property protection, we may not be able to prevent third parties from using our proprietary technologies. Also, our currently pending or future patent applications may not result in issued patents, and issued patents are subject to claims concerning priority, scope and other issues.

 

The U.S. Patent and Trademark Office and the courts have not consistently treated the breadth of claims allowed or interpreted in orthopaedic reconstructive implant and biotechnology patents. Future changes in, or unexpected interpretations of, the patent laws may adversely affect our ability to enforce our patent position.

 

In addition, intellectual property rights may be unavailable or of limited effect in some foreign countries. If we do not obtain sufficient international protection for our intellectual property, our competitiveness in international markets could be impaired, which could limit our growth and revenue.

 

We also attempt to protect our trade secrets, proprietary know-how and continuing technological innovation with security measures, including the use of confidentiality agreements with our employees, consultants and collaborators. These measures may prove to be ineffective and any remedies available to us may be insufficient to compensate our damages.

 

We may be subject to intellectual property litigation and infringement claims, which could cause us to incur significant expenses or prevent us from selling our products.

 

A successful claim of patent or other intellectual property infringement against us could adversely affect our growth and profitability, in some cases materially. From time to time, we receive notices from third parties of potential infringement and receive claims of potential infringement. We may be unaware of intellectual property rights of others that may cover some of our technology. If someone claims that our products infringed their intellectual property rights, any resulting litigation could be costly and time consuming and would divert the attention of management and key personnel from other business issues. If we were to lose such litigation involving material intellectual property rights, we may be unable to manufacture, sell or use some of our products.

 

We may incur product liability losses, and insurance coverage may be inadequate or unavailable to cover these losses.

 

In the ordinary course of business, we are the subject of product liability lawsuits alleging that component failures, manufacturing flaws, design defects or inadequate disclosure of product-related risks or product-related information resulted in an unsafe condition or injury to patients. As previously reported, we temporarily suspended the marketing and distribution of our Durom^® Acetabular Component (Durom Cup) in the U.S. in July 2008. Following our action, product liability lawsuits and other claims were asserted against us and additional similar claims may be asserted. Product liability lawsuits and claims, safety alerts or product recalls, regardless of their ultimate outcome, could have a material adverse effect on our business and reputation and on our ability to attract and retain customers.

 

Although we maintain third-party product liability insurance coverage, it is possible that claims against us may exceed the coverage limits of our insurance policies or cause us to record a self-insured loss. Even if any product liability loss is covered by an insurance policy, these policies typically have substantial retentions or deductibles for which we are responsible. Product liability claims in excess of applicable insurance could have a material adverse effect on our business, financial condition and results of operations.

 

 

 

15

 

We are involved in legal proceedings that may result in adverse outcomes.

 

In addition to intellectual property and product liability claims and lawsuits, we are involved in various commercial and securities litigation and claims, government investigations and other legal proceedings that arise from time to time in the ordinary course of our business. Although we believe we have substantial defenses in these matters, litigation and other claims are subject to inherent uncertainties and management’s view of these matters may change in the future. We could in the future incur judgments or enter into settlements of claims that could have a material adverse effect on our results of operations in any particular period.

 

We may make additional acquisitions or enter into strategic alliances that could increase our costs or liabilities or be disruptive.

 

We intend to continue to look for additional strategic acquisitions of other businesses that are complementary to our businesses and other companies with whom we could form strategic alliances or enter into other arrangements to develop or exploit intellectual property rights. These activities involve risks, including the following:

 

We depend on a limited number of suppliers for some key raw materials and outsourced activities.

 

We use a number of suppliers for raw materials that we need to manufacture our products and to outsource some key manufacturing activities. These suppliers must provide the materials and perform the activities to our standards for us to meet our quality and regulatory requirements. Some key raw materials and outsourced activities can only be obtained from a single source or a limited number of sources. A prolonged disruption or other inability to obtain these materials or outsource key manufacturing activities could materially and adversely affect our ability to satisfy demand for our products.

 

Future material impairments in the carrying value of our intangible assets, including goodwill, would negatively affect our operating results.

 

Our assets include intangible assets, primarily goodwill. The goodwill results from our acquisition activity and represents the excess of the consideration transferred over the fair value of the net assets acquired. We assess at least annually whether events or changes in circumstances indicate that the carrying value of our intangible assets may not be recoverable. If the operating performance at one or more of our business units falls significantly below current levels, if competing or alternative technologies emerge, or if market conditions or future cash flow estimates for one or more of our businesses decline, we could be required, under current U.S. accounting rules, to record a non-cash charge to operating earnings for the amount of the impairment. Any write-off of a material portion of our unamortized intangible assets would negatively affect our results of operations.

 

We may have additional tax liabilities.

 

We are subject to income taxes in the U.S. and many foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. We regularly are under audit by tax authorities. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different from our historical income tax provisions and accruals. The results of an audit or litigation could have a material effect on our financial statements in the period or periods for which that determination is made.

 

We earn a significant amount of our operating income from outside the U.S., and any repatriation of funds currently held in foreign jurisdictions may result in higher effective tax rates. In addition, there have been proposals to change U.S. tax laws that would significantly impact how U.S. multinational corporations are taxed on foreign earnings. Although we cannot predict whether or in what form this proposed legislation will pass, if enacted it could have a material adverse impact on our tax expense and cash flow.

 

In January 2011, the IRS issued a Notice of Proposed Adjustment (NOPA) for tax years 2006 and 2007. The NOPA relates to intercompany pricing between certain of our U.S. and foreign subsidiaries. We believe that we have followed applicable U.S. tax laws and will vigorously defend our income tax positions. However, the ultimate settlement with the IRS related to these proposed adjustments could have a material impact on our income tax expense and net earnings.

 

The impact of U.S. healthcare reform legislation on us remains uncertain.

 

In March 2010, federal legislation to reform the U.S. healthcare system was enacted into law. The legislation is far-reaching and is intended to expand access to health insurance coverage, improve quality and reduce costs over time. We expect the new law will have a significant impact upon various aspects of our business operations. For example, to the extent that the number of uninsured or underinsured patients is reduced, demand for our products in the U.S. could marginally increase. However, it is unclear how the new law will impact patient access to new technologies or reimbursement rates under the Medicare program. In addition, the new law imposes a 2.3 percent excise tax on medical devices scheduled to be implemented in 2013 that will apply to U.S. sales of a majority of our medical device products.

 

Many of the details of the new law will be included in new and revised regulations, which have not yet been promulgated, and require additional guidance and specificity to be provided

 

 

 

16

by the Department of Health and Human Services, Department of Labor and Department of the Treasury. Accordingly, while it is too early to understand and predict the ultimate impact of the new law on our business, the legislation could have a material adverse effect on our business, cash flows, financial condition and results of operations.

 

We are subject to healthcare fraud and abuse regulations on an ongoing basis that could require us to change our business practices and restrict our operations in the future.

 

Our industry is subject to various federal and state laws pertaining to healthcare fraud and abuse, including false claims laws, the federal Anti-Kickback Statute, similar state 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 U.S., exclusion from participation in government healthcare programs, including Medicare, Medicaid and Veterans Administration (VA) health programs. The interpretation and enforcement of these laws and regulations are uncertain and subject to rapid change.

 

If third-party payors decline to reimburse our customers for our products or reduce reimbursement levels, the demand for our products may decline and our ability to sell our products profitably may be harmed.

 

We sell our products and services to hospitals, doctors, dentists and other healthcare providers, all of which receive reimbursement for the healthcare services provided to their patients from third-party payors, such as domestic and international government programs, private insurance plans and managed care programs. These third-party payors may deny reimbursement if they determine that a device used in a procedure was not in accordance with cost-effective treatment methods, as determined by the third-party payor, or was used for an unapproved indication. Third-party payors may also decline to reimburse for experimental procedures and devices. If our products are not considered cost-effective by third-party payors, our customers may not be reimbursed for our products.

 

In addition, third-party payors are increasingly attempting to contain healthcare costs by limiting both coverage and the level of reimbursement for medical products and services. If third-party payors reduce reimbursement levels to hospitals and other healthcare providers for our products, demand for our products may decline, or we may experience pressure to reduce the prices of our products, which could have a material adverse effect on our sales and results of operations.

 

We have also experienced downward pressure on product pricing and other effects of healthcare reform in our international markets. If key participants in government healthcare systems reduce the reimbursement levels for our products, our sales and results of operations may be adversely affected.

 

The ongoing cost-containment efforts of healthcare purchasing organizations may have a material adverse effect on our results of operations.

 

Many customers for our products have formed group purchasing organizations in an effort to contain costs. Group purchasing organizations negotiate pricing arrangements with medical supply manufacturers and distributors, and these negotiated prices are made available to a group purchasing organization’s affiliated hospitals and other members. If we are not one of the providers selected by a group purchasing organization, affiliated hospitals and other members may be less likely to purchase our products, and, if the group purchasing organization has negotiated a strict compliance contract for another manufacturer’s products, we may be precluded from making sales to members of the group purchasing organization for the duration of the contractual arrangement. Our failure to respond to the cost-containment efforts of group purchasing organizations may cause us to lose market share to our competitors and could have a material adverse effect on our sales and results of operations.

 

Our success depends on our ability to effectively develop and market our products against those of our competitors.

 

We operate in a highly competitive environment. Our present or future products could be rendered obsolete or uneconomical by technological advances by one or more of our present or future competitors or by other therapies, including biological therapies. To remain competitive, we must continue to develop and acquire new products and technologies. Competition is primarily on the basis of:

 

In markets outside of the U.S., other factors influence competition as well, including:

 

Our competitors may:

 

Any of these factors, alone or in combination, could cause us to have difficulty maintaining or increasing sales of our products.

 

We and our customers are subject to various governmental regulations relating to the manufacturing, labeling and marketing of our products, and we may incur significant expenses to comply with these regulations and develop products compatible with these regulations.

 

The medical devices we design, develop, manufacture and market are subject to rigorous regulation by the FDA and numerous other federal, state and foreign governmental authorities. The process of obtaining regulatory approvals to market a medical device can be costly and time consuming and approvals might not be granted for future products on a timely

 

 

 

17

basis, if at all. Delays in receipt of, or failure to obtain, approvals for future products could result in delayed realization of product revenues or in substantial additional costs.

 

In addition, if we fail to comply with applicable material regulatory requirements, including, for example, the Quality System Regulation, recordkeeping regulations, labeling and promotional requirements and adverse event reporting regulations, we may be subject to a range of sanctions including:

 

Moreover, the FDA recently announced wide-ranging proposals to reform the 510(k) process. While it is not known which reforms may ultimately be implemented, they may result in more extensive data requirements and a longer process for obtaining clearance. We expect 510(k) reform could delay new products from reaching the market in the U.S. and increase the costs of introducing new products and features, which could adversely affect our business.

 

Our products and operations are also often subject to the rules of industrial standards bodies, such as the International Standards Organization. If we fail to adequately address any of these regulations, our business could be harmed.

 

 

Not Applicable.

 

 

 

18

 

We have the following properties:

 

We believe the current facilities, including manufacturing, warehousing, research and development and office space provide sufficient capacity to meet ongoing demands. Once a facility reaches 85 percent utilization, we examine alternatives for either expanding that facility or acquiring new facilities to meet our ongoing demands.

 

In addition to the above, we maintain more than 100 other offices and warehouse facilities in more than 25 countries around the world, including the U.S., Japan, Australia, France, Russia, India, Germany, Italy, Switzerland and China. We believe that all of the facilities and equipment are in good condition, well maintained and able to operate at present levels.

 

 

Information pertaining to legal proceedings in which we are involved can be found in Note 19 to our consolidated financial statements (see Part II, Item 8 of this report).

 

 

Not Applicable.

 

 

 

19

Part II

 

 

Our common stock is traded on the New York Stock Exchange and the SIX Swiss Exchange under the symbol “ZMH.” The high and low sales prices for our common stock on the New York Stock Exchange for the calendar quarters of fiscal years 2010 and 2009 are set forth as follows:

 

 

 

We have not declared or paid dividends on our common stock since becoming a public company in 2001. Currently, we do not anticipate paying any cash dividends on the common stock in the foreseeable future. Our credit facility also restricts the payment of dividends under certain circumstances.

 

The number of holders of our common stock on February 10, 2011 was approximately 315,700. On February 10, 2011, the closing price of the common stock, as reported on the New York Stock Exchange, was $60.05 per share.

 

The information required by this Item concerning equity compensation plans is incorporated by reference to Item 12 of this report.

 

The following table summarizes repurchases of common stock settled during the three months ended December 31, 2010:

 

 

 

 

 

 

20

 

The financial information for each of the past five years ended December 31 is set forth below (in millions, except per share amounts):

 

 

 

 

21

 

The following discussion and analysis should be read in conjunction with the consolidated financial statements and the corresponding notes included elsewhere in this Form 10-K. Certain percentages presented in this discussion and analysis are calculated from the underlying whole-dollar amounts and therefore may not recalculate from the rounded numbers used for disclosure purposes. Certain amounts in the 2009 and 2008 consolidated financial statements have been reclassified to conform to the 2010 presentation.

 

OVERVIEW

 

We believe the following developments or trends are important in understanding our financial condition, results of operations and cash flows for the year ended December 31, 2010.

 

Demand (Volume and Mix) Trends

 

 

Increased volume and changes in the mix of product sales contributed 3 percentage points of 2010 sales growth, which is 1 percentage point above the rate of growth from 2009 compared to 2008.

 

We believe long-term indicators point toward sustained growth driven by an aging global population, growth in emerging markets, obesity, proven clinical benefits, new material technologies, advances in surgical techniques and more active lifestyles, among other factors. In addition, the ongoing shift in demand to premium products, such as Longevity and Prolong Highly Crosslinked Polyethylenes, Trabecular Metal Technology products, hip stems with Kinectiv Technology, high-flex knees, knee revision products, porous hip stems and the introduction of patient specific devices, is expected to continue to positively affect sales growth.

 

Pricing Trends

 

 

Global selling prices decreased 1 percent during 2010. Selling prices in the Americas, Europe and Asia Pacific decreased 1 percent, were flat, and decreased 2 percent, respectively, during 2010. We continue to see pricing pressure from governmental healthcare cost containment efforts and from local hospitals and health systems. In the Americas, we have experienced compression of historic pricing differentials amongst our customers. Asia Pacific was especially influenced by a bi-annual pricing adjustment in Japan that went into effect on April 1, 2010. Due to these pressures, we expect selling prices will continue to have a negative 1 to 2 percent effect on sales on a global basis in 2011.

 

Foreign Currency Exchange Rates

 

 

For 2010, foreign currency exchange rates resulted in a 1 percent increase in sales. If foreign currency exchange rates remain consistent with 2010 year end rates, we estimate that a weaker dollar versus foreign currency exchange rates will have a positive effect in 2011 of approximately 1 percent on sales. We address currency risk through regular operating and financing activities and, under appropriate circumstances and subject to proper authorization, through the use of forward contracts and options solely to manage foreign currency volatility and risk. Changes to foreign currency exchange rates affect sales growth, but due to offsetting gains/losses on hedge contracts and options, which are recorded in cost of products sold, the effect on net earnings in the near term is expected to be minimal.

 

Global Economic Conditions

 

 

We believe adverse conditions in the broader economy have negatively affected elective hospital procedures. In the fourth quarter of 2010, we saw some stabilization in procedure volumes and we believe the number of procedures will increase as the global economy strengthens. Despite the current conditions of the global economy, it is well known that demographic trends will expand the patient base that needs our products. We believe these factors will ultimately foster long-term sustained growth even if in the short-term the timing of these elective procedures continues to be adversely affected.

 

2011 Outlook

 

 

We estimate our sales will grow between 3 and 5 percent in 2011. Such sales growth assumes knee and hip procedures will grow in low single digits with modest global economic growth and relatively stable employment. As discussed previously, we expect pricing to have a negative effect on sales growth by 1 to 2 percent, and foreign currency exchange rates to have a positive effect on sales growth by approximately 1 percent based upon December 31, 2010 rates.

 

Assuming currency rates remain at December 31, 2010 rates, we expect our gross margin to be approximately 75 percent of sales in 2011. This takes into account anticipated losses from foreign currency hedge losses resulting from relative weakness in the U.S. Dollar. We expect to continue making investments in research and development (R&D) in the range of 5 to 6 percent of sales. Selling, general and administrative expenses (SG&A) as a percent of sales is expected to be between 40 and 41 percent as we realize operational efficiencies from global restructuring and transformation initiatives and leverage revenue growth.

 

We expect to incur $75 to $80 million of expenses in 2011 related to certain global restructuring and transformation initiatives. We also expect to incur an additional $15 to $20 million for certain acquisition and integration costs connected with recent acquisitions. We anticipate recognizing some of the $90 to $100 million in cost of products sold and the majority in “Special items” on our statement of net earnings. The gross margin and SG&A percentages discussed above do not include these expenses.

 

We expect interest and other expense to be approximately $50 million in 2011, which is slightly lower than 2010 as we have entered into an interest rate swap to effectively convert a portion of our $1 billion senior notes from fixed-rate debt to variable-rate debt.

 

 

 

22

 

RESULTS OF OPERATIONS

 

 

 

The following tables present net sales by reportable segment and the components of the percentage changes (dollars in millions):

 

 

 

“Foreign Exchange” as used in the tables in this report represents the effect of changes in foreign currency exchange rates on sales growth.

 

 

 

The following tables present net sales by product category and the components of the percentage changes (dollars in millions):

 

 

 

 

 

23

 

 

The following table presents net sales by product category by region (dollars in millions):

 

 

 

 

Knee sales have experienced flat to moderate growth over the past two years. Our knee sales have been affected by broader economic conditions impacting volume/mix and competitive pressures from newer knee systems that have more modern surgical instruments for implantation. We intend to counter these competitive pressures in 2011 and thereafter as we continue to launch our new patient specific and posterior referencing instrumentation systems, as well as through new product development.

 

The NexGen Complete Knee Solution product line, including Gender Solutions Knee Femoral Implants, the NexGen LPS-Flex Knee and the NexGen CR-Flex Knee, together with the Gender Solutions Natural-Knee Flex System led knee sales. In addition, sales of partial knee devices, including the Zimmer Unicompartmental Knee and the recently released Gender Solutions Patello-Femoral Joint, exhibited growth. In Europe, changes in foreign currency exchange rates negatively affected knee sales in the years ended December 31, 2010 and 2009 by 2 percent and 6 percent, respectively. In Asia Pacific, changes in foreign currency exchange rates positively affected knee sales in the years ended December 31, 2010 and 2009 by 10 percent and zero percent, respectively.

 

 

 

Hip sales rebounded from negative growth in 2009 to positive growth in 2010 driven by new product introductions, such as our Continuum Acetabular System and our Zimmer M/L Taper Stem with Kinectiv Technology.

 

The Zimmer M/L Taper Stem, the Zimmer M/L Taper Stem with Kinectiv Technology, the CLS Spotorno Stem from the CLS Hip System and the Alloclassic Zweymüller Hip Stem led hip stem sales. In addition, sales of revision hip products, such as the ZMR Hip System and the Trabecular Metal Revision Shell and Augment Cups, were strong when compared to the prior year periods, as were sales of Fitmore Hip Stems. In Europe, changes in foreign currency exchange rates negatively affected hip sales in the years ended December 31, 2010 and 2009 by 2 percent and 6 percent, respectively. In Asia Pacific, changes in foreign currency exchange rates positively affected hip sales in the years ended December 31, 2010 and 2009 by 8 percent and 4 percent, respectively.

 

 

 

Extremities sales have grown by low double digits the past two years led by the Bigliani/Flatow Complete Shoulder Solution and the Zimmer Trabecular Metal Reverse Shoulder System. Trabecular Metal Technology is playing a critical role

 

 

 

24

in addressing previously unmet clinical needs in the expanding extremities market.

 

 

 

Dental sales have experienced a significant turnaround from a negative 10 percent decline in 2009 to positive 7 percent growth in 2010. In 2009, our dental sales were affected more by the global economic environment than our other product categories, as many dental procedures are not reimbursed by third-party payors. Sales were led by the Tapered Screw-Vent Implant System. Additionally, regenerative products have exhibited strong sales growth in 2010.

 

 

 

Trauma sales increased in the mid single digits the past two years. Zimmer Periarticular Locking Plates and the ITST^® Intertrochanteric/Subtrochanteric Fixation System led trauma sales, while sales of cable products also made a strong contribution. In 2009, we initiated the launch of the Zimmer Natural Nail System, which made a strong contribution to 2010 sales. We anticipate that a broader launch of that system will continue to positively affect sales growth.

 

 

 

In the fourth quarter of 2008 we acquired Abbott Spine. As a result of the acquisition, spine sales increased in 2009, but underlying that performance were sales losses associated with integration of the business. In 2010, once we anniversaried out of the additional sales from the acquisition, we experienced sales declines, most notably in our Americas segment. In addition to the operational challenges associated with the integration of the Abbott Spine business in the Americas, a difficult reimbursement landscape and a significant decline in our Dynesys Dynamic Stabilization System have affected sales. In contrast to the Americas, our spine sales grew in Europe and Asia Pacific in 2010 driven by the stabilization of our distribution channels, which followed the Abbott Spine integration activity of 2009. Overall, solid sales of the PathFinder and Sequoia Pedicle Screw Systems, our Universal Clamp System and our Trinica Anterior Cervical Plate System partly offset a decline in sales of the Dynesys System.

 

 

 

Surgical and other sales went from 1 percent sales growth in 2009 to 13 percent sales growth in 2010. In 2008, we voluntarily recalled and suspended production of certain patient care products, and were able to reintroduce those products during the year in 2009. Accordingly, 2009 sales were suppressed, especially in the first half of the year, but we started to regain market share in the second half of 2009 and throughout 2010. Surgical sales were led by PALACOS Bone Cement, wound debridement products, tourniquet products and powered instruments.

 

The following table presents estimated* 2010 global market size and market share information (dollars in billions):

 

 

 

 

 

 

 

 

 

Gross margin in total has not changed significantly over the past three years for various offsetting reasons. In the last half of 2009 and early 2010, lower production levels caused our manufacturing costs per unit to be higher, resulting in increased costs in both 2010 and 2009. In 2010, the higher unit costs were offset by lower excess and obsolescence charges resulting from improved inventory management and certain product-specific matters that were experienced in 2009 which did not recur in 2010.

 

Foreign currency hedging also affects our gross margin. Under our hedging program, for derivatives which qualify as hedges of future cash flows, the effective portion of changes in fair value is temporarily recorded in other comprehensive income and then recognized in cost of products sold when the hedged item affects earnings. In 2010 and 2009, we recognized hedge gains in cost of products sold with 2010 gains being less than 2009 gains. In 2008, we recognized foreign currency hedge losses.

 

 

 

25

 

The following table reconciles the gross margin changes for 2010 and 2009:

 

 

 

 

R&D expense and R&D as a percent of sales has increased in each of the last two years. These increases are in line with our strategy to invest in new product development activities across nearly all of our product categories, as well as to increase spending on external research, clinical, regulatory and quality initiatives. Additionally, in 2008 we experienced some delay in R&D activities as we implemented enhancements to our compliance program. We continue to expect R&D spending to be between 5 to 6 percent of sales in 2011.

 

SG&A has increased in dollars terms over the last three years, but as a percent of sales was lower in 2010 and 2008 compared to 2009.

 

In 2010, SG&A increased in dollar terms from 2009 primarily for variable selling and distribution expenses as 2010 sales were higher than 2009 sales, and from increased spending to fund medical education programs. SG&A as a percent of sales in 2010 decreased by 60 basis points from 2009, reflecting disciplined spending combined with a higher base of sales, and no expense in 2010 related to corporate monitoring that ended after the first quarter of 2009.

 

In 2009, SG&A as a percent of sales increased approximately 90 basis points compared to 2008. SG&A expense in the 2008 period included approximately $60 million of incremental costs, such as monitor fees and consulting and legal fees associated with the global roll-out of enhancements to our compliance program. The savings from these costs in 2009 were offset by increased spending to fund enhanced medical education programs, Abbott Spine costs and increased product liability claims. The acquisition of Abbott Spine increased SG&A costs for items such as selling expenses, increased instrument depreciation and amortization of the acquired intangible assets. Additionally, SG&A as a percentage of net sales was negatively impacted by the decrease in revenues caused by changes in foreign currency rates. A majority of our SG&A spend is incurred in the U.S., primarily from our corporate headquarters and similar functions at our various businesses such as Dental, Trauma, Spine and Surgical. Therefore, SG&A expense does not respond to changes in foreign currency rates proportionally to our revenue, which caused SG&A as a percentage of net sales to increase in 2009 compared to 2008.

 

“Certain claims” expense is a provision for estimated liabilities to Durom Cup patients undergoing revision surgeries. Provisions of $35.0 million and $69.0 million were originally recorded during 2009 and 2008, respectively, with an additional $75.0 million recorded during 2010, bringing the total provision to $179.0 million for these claims. For more information regarding these claims, see Note 19 to the consolidated financial statements.

 

In connection with our annual goodwill impairment tests performed in the fourth quarters of 2010 and 2009, we noted that the carrying values of the assets of our U.S. Spine reporting unit were in excess of the reporting unit’s estimated fair value. As a result, we recorded goodwill impairment charges of $204.0 million and $73.0 million during the years ended December 31, 2010 and 2009, respectively. For more information regarding goodwill impairment and the factors that led to the impairment, see Note 9 to the consolidated financial statements. We have five other reporting units with goodwill assigned to them. We estimate the fair values of those reporting units using the income approach by discounting to present value the estimated future cash flows of the reporting unit. For each of those five other reporting units, the estimated fair values substantially exceed their carrying value.

 

We recognized a net curtailment and settlement gain of $32.1 million during 2009 related to amending our U.S. and Puerto Rico postretirement benefit plans. For more information regarding the net curtailment and settlement gain, see Note 14 to the consolidated financial statements.

 

“Special items” expense for the years ended December 31, 2010, 2009 and 2008 were $34.7 million, $75.3 million and $68.5 million, respectively. 2010 includes expenses related to restructuring of our information technology infrastructure as well as our management structure. This resulted in $7.7 million of asset impairment charges and $6.7 million of employee severance and termination-related expenses. We have also incurred consulting and professional fees, facility and employee relocation costs, contract termination expenses and other various expenses resulting from our acquisitions of Abbott Spine, Beijing Montagne Medical Device Co., Ltd, and third party distributors. “Special items” also includes the impairment of an available-for-sale security that was acquired as part of a business acquisition and certain litigation related matters.

 

“Special items” in 2009 included a workforce realignment, which resulted in the elimination of positions in some areas and increases in others to support long-term growth. As a result of this realignment and headcount reductions from acquisitions, we incurred approximately $19.0 million of severance and termination-related expenses. Other “Special items” in 2009 included approximately $9.4 million of expenses related to contract termination costs, $23.4 million of certain litigation matters that were recognized during the period and various costs incurred to integrate the Abbott Spine business acquired in the fourth quarter of 2008.

 

Included in “Special items” in 2008 was $38.5 million of in-process research and development related to the Abbott Spine acquisition and other costs related to the integration of Abbott Spine.

 

 

 

26

 

See Note 2 to the consolidated financial statements for more information regarding “Special items” charges.

 

 

 

Interest and other expense has increased over the past three years. Interest and other expense increased in 2010 over 2009 due to the $1.0 billion senior unsecured notes that we issued in November 2009. As a result, in 2010 we had a full year of interest on these notes. Interest and other expense in 2009 increased over 2008 as the result of long-term debt incurred to partially fund the Abbott Spine acquisition in the fourth quarter of 2008 and the issuance of the senior unsecured notes in November 2009. Interest and other income in 2008 included a realized gain of $38.8 million related to the sale of certain marketable securities.

 

The effective tax rate on earnings before income taxes for the years ended December 31, 2010, 2009 and 2008 has been 30.6 percent, 28.1 percent and 24.3 percent, respectively. The effective tax rates for 2010 and 2009 are negatively impacted by the goodwill impairment charges of $204.0 million and $73.0 million, respectively, for which no tax benefit was recorded. The goodwill impairment charges have increased the effective tax rate for the years ended December 31, 2010 and 2009 by approximately 6 percent and 2 percent, respectively. Additionally, in 2010 the effective tax rate was favorably impacted by the resolution of certain tax contingencies. The effective tax rate for 2008 includes the impact of a current tax benefit of $31.7 million related to a 2007 U.S. government civil settlement expense, resulting in a decrease of approximately 3 percent in the 2008 effective tax rate. This impact on the 2008 effective tax rate was partially offset by Abbott Spine acquisition-related in-process research and development charges recorded during 2008 for which no tax benefit was recorded. These discrete items account for the majority of the change in our effective tax rates in the past three years.

 

As a result of the revenues and expenses discussed previously, net earnings in 2010 decreased 17 percent compared to 2009. In 2009, net earnings decreased 15 percent compared to 2008. Basic and diluted earnings per share decreased 11 percent in 2010 compared to 2009, while 2009 basic and diluted earnings per share decreased 10 percent and 11 percent, respectively, from 2008. The disproportionate change in earnings per share as compared to net earnings is attributed to the effect of share repurchases made in the last three years.

 

 

 

We use non-GAAP financial measures to evaluate our operating performance that differ from financial measures determined in accordance with U.S. generally accepted accounting principles (GAAP). Our non-GAAP financial measures exclude the impact of inventory step-up charges, “Special items,” “Certain claims,” Net curtailment and settlement and Goodwill impairment, and the taxes on those items and the tax benefit related to a 2007 civil settlement. We use this information internally and believe it is helpful to investors because it allows more meaningful period-to-period comparisons of our on-going operating results, it helps to better identify operating trends and perform trend analysis that may otherwise be masked or distorted by these types of items, and provides a higher degree of transparency of certain items. Certain of these non-GAAP financial measures are used as metrics for our incentive compensation programs.

 

Our non-GAAP adjusted net earnings used for internal management purposes for the years ended December 31, 2010, 2009 and 2008 were $871.6 million, $849.9 million, and $924.3 million, respectively, and our non-GAAP adjusted diluted earnings per share were $4.33, $3.94, and $4.05, respectively.

 

Our non-GAAP adjusted net earnings increased in 2010 compared to 2009 due to increased sales, disciplined spending in SG&A, and the absence of monitor-related expenses in 2010. Such increases to non-GAAP adjusted net earnings were slightly offset by increased R&D and medical education expenses and increased interest expense from the senior unsecured notes issued in 2009.

 

Our non-GAAP adjusted net earnings decreased in 2009 compared to 2008 as lower sales and higher R&D and medical education expenses reduced non-GAAP adjusted net earnings. Additionally, 2008 non-GAAP adjusted net earnings featured a $38.8 million pre-tax gain related to sales of certain marketable securities. The 2009 period did contain some expense savings such as the $60 million of incremental savings related to monitor fees and consulting and legal fees associated with the global roll-out of enhancements to our compliance program, but such savings were not enough to offset the other items that reduced non-GAAP adjusted net earnings.

 

The following are reconciliations from our GAAP net earnings and diluted earnings per share to our non-GAAP adjusted net earnings and non-GAAP adjusted diluted earnings per share used for internal management purposes.

 

 

 

 

 

 

27