| ZIMMER HOLDINGS INC ITEM 1A Risk Factors Risk factors which could cause actual results to differ from our expectations and which could negatively impact our financial condition and results of operations are discussed below and elsewhere in this report |
| 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 uncertainties described below or any additional risks and uncertainties actually occur, our business, results of operations and financial condition could be materially and adversely affected |
| RISKS RELATED TO OUR INDUSTRY 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 orthobiological therapies |
| To remain competitive, we must continue to develop and acquire new products and technologies |
| In the global markets for reconstructive orthopaedic implants, trauma products and other orthopaedic products, a limited number of competitors, including DePuy Orthopaedics, Inc |
| and Smith & Nephew plc, compete with us for the majority of product sales |
| (a subsidiary of Medtronic, Inc |
| ), DePuy Spine (a subsidiary of Johnson & Johnson), Synthes, Inc, Stryker Corporation and EBI, LP (a subsidiary of Biomet, Inc |
| In the dental reconstructive implant category, we compete primarily with Nobel Biocare Holding AG, Straumann Holding AG, and Implant Innovations, Inc |
| Competition is primarily on the basis of: • technology; • innovation; • quality; • reputation; • relationships with customers; and • service |
| In local markets outside of the United States, other factors influence competition as well, including: • local distribution systems; • complex regulatory environments; and • differing medical philosophies and product preferences |
| Our competitors may: • have greater financial, marketing and other resources than us; • respond more quickly to new or emerging technologies; • undertake more extensive marketing campaigns; • adopt more aggressive pricing policies; or • be more successful in attracting potential customers, employees and strategic partners |
| Any of these factors, alone or in combination, could cause us to have difficulty maintaining or increasing sales of our products |
| If 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 health care providers, all of which receive reimbursement for the health care 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 health care costs by limiting both coverage and the level of reimbursement for medical products and services |
| For example, managed care programs often prescribe only those orthopaedic recovery products that match a patient as to age, need for mobility and other parameters in an effort to provide more cost-effective care |
| If third-party payors reduce reimbursement levels to hospitals and other health care 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 sales, financial condition and results of operation |
| In international markets, where the movement toward health care reform and the development of managed care are generally not as advanced as in the United States, we have experienced downward pressure on product pricing and other effects of health care reform |
| In Japan, for example, a government-operated insurance system reimburses customers 15 _________________________________________________________________ [69]Table of Contents ZIMMER HOLDINGS, INC AND SUBSIDIARIES 2005 FORM 10-K for our products |
| Under this system, the Japanese government periodically reviews and reduces the reimbursement levels for products |
| If the Japanese government continues to reduce the reimbursement level for orthopaedic products, our sales, financial condition and results of operation may be adversely affected |
| We are subject to cost-containment efforts of healthcare purchasing organizations, which may have a material adverse effect on our financial condition and results of operations |
| Many existing and potential customers for our products have combined to form 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, financial condition and results of operations |
| We are involved in an ongoing investigation by the United States Department of Justice of companies in the orthopaedics industry, the results of which may have a material adverse effect on our sales, financial condition and results of operations |
| On March 31, 2005, we received a subpoena from the United States Department of Justice through the United States Attorney’s Office in Newark, New Jersey, requesting documents related to consulting contracts or professional service agreements we have with orthopaedic surgeons |
| We understand that similar inquiries were directed to at least four other companies in the orthopaedics industry |
| We are cooperating fully with federal authorities with regard to this matter |
| If, as a result of this investigation, we are found to have violated one or more applicable laws, our business, financial condition and results of operations could be materially adversely affected |
| If some of our existing business practices are challenged as unlawful, we may have to change those practices, which could have a material adverse effect on our business, financial condition and results of operations |
| We and our customers are subject to various governmental regulations 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, particularly from the FDA and certain foreign governmental authorities, can be costly and time consuming and approvals might not be granted for future products on a timely basis, if at all |
| Delays in receipt of, or failure to obtain, approvals for future products could result in delayed realization of product revenues or in substantial additional costs which could have a material adverse effect on our business or results of operations |
| In addition, if we fail to comply with applicable FDA medical device or other material regulatory requirements, including, for example, the Quality System Regulation, recordkeeping regulations, labeling requirements and adverse event reporting regulations, that failure could result in, among other things: • warning letters; • fines or civil penalties; • injunctions; • repairs, replacements or refunds; • recalls or seizures of products; • total or partial suspension of production; • the US Food and Drug Administration’s refusal to grant future premarket clearances or approvals; • withdrawals or suspensions of current product applications; and • criminal prosecution |
| Any of these actions, in combination or alone, could have a material adverse effect on our business, financial condition and results of operations |
| In many of the foreign countries in which we market our products, we are subject to regulations affecting, among other things: • clinical efficacy; • product standards; • packaging requirements; • labeling requirements; • import/export restrictions; • tariff regulations; • duties; and • tax requirements |
| Many of the regulations applicable to our devices and products in these countries, such as the European Medical Devices Directive, are similar to those of the FDA In addition, in many countries the national health or social security organizations require our products to be qualified before they can be marketed with the benefit of reimbursement eligibility |
| Failure to receive or delays in the receipt of, relevant foreign qualifications also could have a material adverse effect on our business, financial condition and results of operations |
| As both the FDA and foreign government regulators have become increasingly stringent, we may be subject to more rigorous regulation by governmental authorities in the future |
| 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 will be harmed |
| We are subject to health care fraud and abuse regulations that could require us to change our 16 _________________________________________________________________ [70]Table of Contents ZIMMER HOLDINGS, INC AND SUBSIDIARIES 2005 FORM 10-K business practices and restrict our operations in the future |
| Violations of these laws are punishable by criminal and/or civil sanctions, including, in some instances, fines, imprisonment and, within the United States, exclusion from participation in government healthcare programs, including Medicare, Medicaid, Veterans Administration (VA) health programs and Civilian Health and Medical Program Uniformed Service (CHAMPUS) |
| The scope and enforcement of these laws and regulations are uncertain and subject to rapid change |
| Because of the far-reaching and uncertain nature of these laws, we are required to monitor our practices to remain in compliance with these laws |
| If we were to violate one or more of these laws, our business, financial condition and results of operations could be materially adversely affected |
| If there is a change in law, regulation or administrative or judicial interpretations, some of our existing business practices could be challenged as unlawful and, as a result, we may have to change those practices, which could have a material adverse effect on our business, financial condition and results of operations |
| We may incur product liability losses, and insurance coverage may be inadequate or unavailable to cover these losses |
| Our business is subject to potential product liability risks that are inherent in the design, development, manufacture and marketing of medical devices |
| Our products are often used in surgical and intensive care settings |
| In addition, some of the medical devices we manufacture and sell are designed to be implanted in the human body for long periods of time |
| 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 |
| 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 |
| As part of our risk management policy, we maintain third-party product liability insurance coverage |
| However, product liability 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 may have substantial retentions or deductibles that provide that we will not receive insurance proceeds until the losses incurred exceed the amount of those retentions or deductibles |
| We will be responsible for paying any losses that are below those retentions or deductibles |
| A product liability claim in excess of applicable insurance could have a material adverse effect on our business, financial position and results of operations |
| RISKS RELATED TO OUR BUSINESS If we fail to effectively utilize the skills and knowledge of orthopaedic surgeons, customers may not buy our products and our revenue and profitability may decline |
| We maintain professional relationships with a number of orthopaedic surgeons who assist in product research and development and advise us on how to satisfy the full range of surgeon and patient needs |
| These professionals speak about our products at medical seminars, assist in the training of other professionals in the use of our products and provide us with feedback on the industry’s acceptance of our new products |
| The failure of our products to retain the support of orthopaedic surgeons, who frequently recommend products or are involved in product selection decisions, or the failure of our new products to secure and retain similar support from surgeons, could have a material adverse effect on our business, financial condition and results of operations |
| 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 United States and abroad depends largely 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 their detailed knowledge of products and instruments |
| Many commonly provide operating room personnel with implant and instrument product training as well as product support in the operating room |
| A loss of a significant number of these agents could have a material adverse effect on our business, financial condition and results of operations |
| If some of the business practices of our independent sales agents and distributors are challenged as unlawful, they may have to change those practices, which could have a material adverse effect on our business, financial condition 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: • evolving customer needs; • changing demographics; • slowing industry growth rates; • declines in the reconstructive implant market; • the introduction of new products and technologies; • evolving surgical philosophies; and • evolving industry standards |
| Without the timely introduction of new products and enhancements, our products may become obsolete over time |
| If that happens, our revenue and operating results would suffer |
| The success of our new product offerings will depend on several factors, including our ability to: • properly identify and anticipate customer needs; • commercialize new products in a timely manner; 17 _________________________________________________________________ [71]Table of Contents ZIMMER HOLDINGS, INC AND SUBSIDIARIES 2005 FORM 10-K • manufacture and deliver instruments and products in sufficient volumes on time; • differentiate our offerings from competitors’ offerings; • achieve positive clinical outcomes for new products; • satisfy the increased demands by healthcare payors, providers and patients for shorter hospital stays, faster post-operative recovery and lower-cost procedures; • innovate and develop new materials, product designs and surgical techniques; and • provide adequate medical education relating to new products and attract key surgeons to advocate these new products |
| In addition, new materials, product designs and surgical techniques that we develop may not be accepted quickly, in some or all markets, because of, among other factors: • entrenched patterns of clinical practice; • the need for regulatory clearance; and • uncertainty with respect to third-party reimbursement |
| Moreover, innovations generally require a substantial investment in research and development before we can determine their commercial viability and we may not have the financial resources necessary to fund the production |
| In addition, even if we are able to successfully develop enhancements or new generations of our products, these enhancements or new generations of products may not produce revenue in excess of the costs of development and they may be quickly rendered obsolete by changing customer preferences or the introduction by our competitors of products embodying new technologies or features |
| We conduct a significant amount of our sales activity outside of the United States, which subjects us to additional business risks and may cause our profitability to decline due to increased costs |
| Because we sell our products in more than 100 countries, our business is subject to risks associated with doing business internationally |
| In 2005, we derived approximately dlra1cmam344 million, or 41prca of our total revenue, from sales of our products outside of the United States |
| We intend to continue to pursue growth opportunities in sales internationally, which could expose us to additional risks associated with international sales and operations |
| Our international operations are, and will continue to be, subject to a number of risks and potential costs, including: • changes in foreign medical reimbursement policies and programs; • unexpected changes in foreign regulatory requirements; • differing local product preferences and product requirements; • fluctuations in foreign currency exchange rates; • diminished protection of intellectual property in some countries outside of the United States; • trade protection measures and import or export licensing requirements; • difficulty in staffing and managing foreign operations; • labor force instability; • differing labor regulations; • potentially negative consequences from changes in tax laws; and • political and economic instability |
| Any of these factors may, individually or as a group, have a material adverse effect on our business, financial condition and results of operations |
| We are subject to risks arising from currency exchange rate fluctuations, which can increase our costs and may cause our profitability to decline |
| A substantial portion of our foreign generated revenues are generated in Europe and Japan |
| The United States dollar value of our foreign-generated revenues varies with currency exchange rate fluctuations |
| Significant increases in the value of the United States 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 |
| We address currency risk management through regular operating and financing activities, and on a limited basis, through the use of derivative financial instruments |
| The derivative financial instruments we enter into are in the form of foreign exchange forward contracts with major financial institutions |
| The forward contracts are designed to hedge anticipated foreign currency transactions, primarily intercompany sale and purchase transactions, for periods consistent with commitments |
| Realized and unrealized gains and losses on these contracts that qualify as cash flow hedges are temporarily recorded in other comprehensive income, then recognized in earnings when the hedged item affects net earnings |
| 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 |
| In the United States, patent applications are confidential for 18 months following their filing, and because third parties may have filed patent applications for technology covered by our pending patent applications without our being aware of those applications, our patent applications may not have priority over patent applications of others |
| In addition, our issued patents may not contain claims sufficiently broad to protect us against third parties with similar technologies or products, or provide us with any competitive advantage |
| If a third party initiates litigation regarding our patents, our collaborators’ patents, or those patents for which we have license rights, and is successful, a court could declare our patents invalid or unenforceable or limit the scope of coverage of those patents |
| The United States Patent and Trademark Office (USPTO) and the courts have not consistently treated the breadth of claims allowed or interpreted in orthopaedic reconstructive implant and biotechnology patents |
| If the USPTO or the courts begin to allow or interpret claims more 18 _________________________________________________________________ [72]Table of Contents ZIMMER HOLDINGS, INC AND SUBSIDIARIES 2005 FORM 10-K broadly, the incidence and cost of patent interference proceedings and the risk of infringement litigation will likely increase |
| On the other hand, if the USPTO or the courts begin to allow or interpret claims more narrowly, the value of our proprietary rights may be reduced |
| Any 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 limited in some foreign countries, which could make it easier for competitors to capture market position |
| Competitors may also capture market share from us by designing products that mirror the capabilities of our products or technology without infringing our intellectual property rights |
| If we do not obtain sufficient international protection for our intellectual property, our competitiveness in international markets could be impaired, which would limit our growth and future revenue |
| We also rely upon trade secrets, proprietary know-how, and continuing technological innovation to remain competitive |
| We attempt to protect this information with security measures, including the use of confidentiality agreements with our employees, consultants, and corporate collaborators |
| These individuals may breach these agreements and any remedies available to us may be insufficient to compensate our damages |
| Furthermore, our trade secrets, know-how and other technology may otherwise become known or be independently discovered by our competitors |
| 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 |
| The complexity of the technology involved and the uncertainty of intellectual property litigation increase these risks |
| Claims of intellectual property infringement also might require us to enter into costly royalty or license agreements |
| However, we may be unable to obtain royalty or license agreements on terms acceptable to us or at all |
| We also may be subject to significant damages or an injunction preventing us from manufacturing, selling or using some of our products in the event of a successful claim of patent or other intellectual property infringement |
| Any of these adverse consequences could have a material adverse effect on our business, financial condition and results of operations |
| We may complete additional acquisitions, which could increase our costs or liabilities or be disruptive |
| We intend to continue to look for additional strategic acquisitions |
| We may not be able to complete additional acquisitions or to integrate successfully any acquired businesses without substantial expense, delay or other operational or financial problems |
| Acquiring and integrating new businesses involves risk, including the following: • we may need to divert more management resources to integration than we planned, which may adversely affect our ability to pursue other more profitable activities; • the difficulties of integration may be increased if we need to integrate geographically separated organizations, personnel with disparate business backgrounds and companies with different corporate cultures; • we may not eliminate as many redundant costs as we anticipated in selecting our acquisition candidates; and • one or more of our acquisition candidates also may have liabilities or adverse operating issues that we failed to discover through our diligence prior to the acquisition |
| If we are unable to form strategic alliances, or if our strategic alliances fail to achieve their objectives, our operating results will be negatively impacted |
| Several of our strategic initiatives involve alliances with other orthopaedic and biotechnology companies |
| These include our agreement with Revivicor, Inc |
| relating to orthopaedic tissue technology, our collaboration with ISTO Technologies, Inc |
| relating to regenerative cartilage technology and our distribution agreement with Heraeus relating to orthopaedic bone cement products |
| The success of these and similar arrangements is largely dependent on technology and other intellectual property contributed by our strategic partners or the resources, efforts, and skills of these partners |
| Disputes and difficulties in such relationships are common, often due to conflicting priorities or conflicts of interest |
| Merger and acquisition activity may exacerbate these conflicts |
| The benefits of these alliances are reduced or eliminated when strategic partners: • terminate the agreements or limit our access to the underlying intellectual property; • fail to devote financial or other resources to the alliances and thereby hinder or delay development, manufacturing or commercialization activities; • fail to successfully develop, manufacture or commercialize any products; or • fail to maintain the financial resources necessary to continue financing their portion of the development, manufacturing, or commercialization costs or their own operations |
| Furthermore, under some of our strategic alliances, we may make milestone payments well in advance of commercialization of products with no assurance that we will ever recoup these payments |
| We also may make equity investments in our strategic partners |
| These investments may decline in value and result in our incurring financial statement charges in the future |
| 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 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 19 _________________________________________________________________ [73]Table of Contents ZIMMER HOLDINGS, INC AND SUBSIDIARIES 2005 FORM 10-K 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 activities could materially and adversely affect our ability to satisfy demand for our products, which could have a material adverse effect on our business, financial condition and results of operations |
| Our future profitability may be affected by changes to our product category and region sales mix |
| Reconstructive implants produce the highest operating profit margins among our product categories |
| These products accounted for approximately 83 percent of 2005 net sales |
| Sales in our Americas region accounted for approximately 59 percent of 2005 net sales |
| Sales in the Americas region produce the highest operating profit margins in the geographic markets in which we operate |
| While we expect net sales of reconstructive implants and net sales in the Americas region to remain strong, changes to our product category mix or our region sales mix could adversely affect our future profitability |