20081224_r01c_0801041
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20081224_r01c_0801041

Course Number: ZMH 1040, Fall 2009

College/University: Stanford

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UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF INDIANA INDIANAPOLIS DIVISION PLUMBERS AND PIPEFITTERS LOCAL : UNION 719 PENSION FUND, Individually : and On Behalf of All Others Similarly Situated,: : Plaintiff, : : vs. : : ZIMMER HOLDINGS, INC., et al., : : Defendants. : : No. 1:08-cv-01041-DFH-JMS CLASS ACTION CONSOLIDATED COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS DEMAND FOR JURY TRIAL TABLE OF...

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STATES UNITED DISTRICT COURT SOUTHERN DISTRICT OF INDIANA INDIANAPOLIS DIVISION PLUMBERS AND PIPEFITTERS LOCAL : UNION 719 PENSION FUND, Individually : and On Behalf of All Others Similarly Situated,: : Plaintiff, : : vs. : : ZIMMER HOLDINGS, INC., et al., : : Defendants. : : No. 1:08-cv-01041-DFH-JMS CLASS ACTION CONSOLIDATED COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS DEMAND FOR JURY TRIAL TABLE OF AUTHORITIES Page I. II. III. IV. V. VI. VII. INTRODUCTION ...............................................................................................................1 JURISDICTION AND VENUE ..........................................................................................5 THE PARTIES.....................................................................................................................5 FACTUAL BACKGROUND AND FRAUDULENT CONDUCT ....................................7 CONFIDENTIAL WITNESSES CONFIRM DEFENDANTS FRAUDULENT CONDUCT ........................................................................................................................23 FDA ADVERSE EVENT REPORTS CONFIRM KNOWN PROBLEMS WITH THE DUROM CUP ...........................................................................................................39 MATERIALLY FALSE AND MISLEADING STATEMENTS DURING THE CLASS PERIOD................................................................................................................40 A. B. C. D. E. F. G. VIII. IX. X. XI. XII. Materially False and Misleading January 2008 Statements...................................40 Reasons Why January 2008 Statements Were Materially False and Misleading..............................................................................................................44 Materially False and Misleading March and April 2008 Statements ....................45 Reasons Why March and April 2008 Statements Were Materially False and Misleading.......................................................................................................48 Materially False and Misleading May and June 2008 Statements.........................50 Reasons Why May and June 2008 Statements Were Materially False and Misleading..............................................................................................................53 The End of the Class Period...................................................................................54 ADDITIONAL ALLEGATIONS OF SCIENTER............................................................62 LOSS CAUSATION/ECONOMIC LOSS ........................................................................67 APPLICABILITY OF THE PRESUMPTION OF RELIANCE: FRAUD ON THE MARKET DOCTRINE .....................................................................................................72 NO STATUTORY SAFE HARBOR EXISTS FOR DEFENDANTS STATEMENTS..................................................................................................................73 CLASS ACTION ALLEGATIONS ..................................................................................74 XIII. CLAIMS ............................................................................................................................74 XIV. PRAYER FOR RELIEF ....................................................................................................76 XV. JURY DEMAND ...............................................................................................................76 I. INTRODUCTION 1. Court-appointed lead plaintiff Plumbers and Pipefitters Local Union 719 Pension Fund brings this federal securities class action pursuant to 10(b) and 20(a) of the Securities Exchange Act of 1934 (the 1934 Act) and Securities and Exchange Commission (SEC) Rule 10b-5 on behalf of itself and all persons who purchased or otherwise acquired the common stock of Zimmer Holdings, Inc. (Zimmer or the Company) between January 29, 2008 and July 22, 2008 (the Class Period), against Zimmer and its Chief Executive Officer (CEO) David C. Dvorak (Dvorak) and Chief Financial Officer (CFO) James T. Crines (Crines). Plaintiffs allege defendants participated in a scheme to defraud class members by, inter alia, making materially false and misleading statements concerning the Companys finances and operations. Specifically, defendants issued false guidance and failed to disclose material flaws in the quality systems at Zimmers Dover, Ohio facility, which manufactured Zimmer orthopaedic surgical products (OSPs). In addition, defendants failed to disclose material problems with the Companys Durom Acetabular Component (Durom Cup). As a result of defendants materially false and misleading statements, Zimmers common stock traded at artificially inflated prices during the Class Period. 2. Defendants Dvorak and Crines were appointed CEO and CFO in the midst of a Department of Justice (DOJ) investigation regarding illegal kickbacks dethroning former CEO Ray Elliott and CFO Sam Leno. After disappointing the street while at the helm of Zimmer for their first two quarters, the pressure to produce results and put the DOJ investigation and resulting deferred prosecution agreement behind them was mounting. When defendants announced in a January 29, 2008 press release and conference call better than anticipated 2008 guidance of doubledigit net sales growth and adjusted earnings per share (EPS) of $4.20-$4.25 (which included expected costs related to enhancements in quality systems), Zimmers stock price increased by 13%. -1- 3. At the time defendants issued this guidance, on January 29, 2008, defendants knew it to be false. Defendants, in particular Dvorak, had deliberately chosen not to invest money in the quality systems at Dover because the financial and investment targets of the Company in the OSP and other divisions were not being met. Further, defendants knew that Zimmers Dover facility, which manufactured OSPs, would have to be shut down in the wake of quality problems and that the U.S. Food and Drug Administration (FDA), would be issuing 483 observations (483s) regarding the defects in Zimmers quality systems. Not only had defendants sent a special team to Dover to assist with the FDA inspection a team that coached Dover employees as to what they should say in response to FDA questions Dvorak himself had hired a specialist who previously worked for Abbott Laboratories to help Zimmer get out of trouble with the FDA. Dvorak was embarrassed by the fact that the systems at Dover were 10 to 15 years behind the times, and yet he told investors in the January 29, 2008 press release that We believe that investing today in the infrastructure needed to serve the health care market of the future will generate attractive returns in the years to come. Later that same day, when asked whether Zimmer had any FDA warning letters or 483 observations, Dvorak commented there were no warning letters, but was deliberately and misleadingly silent about 483s. Dvorak would later admit to investors during an April 24, 2008 conference call that there had been an FDA inspection and some observations but defendants would continue to mislead investors about the impact of the deficiencies in Zimmers quality systems. In short, defendants deliberately misled investors about Zimmers quality systems, and having made the decision to shut down the Dover facility in the middle of January 2008, defendants knew when they issued the 2008 guidance as well as in subsequent statements to investors regarding Zimmers financial condition and operations that (1) no revenue would be generated from the sales of OSPs at Dover while it was shut down; and (2) their expenses would increase as a result of having to update the antiquated quality systems at Dover. -2- 4. Defendants were also told in 2007 that they had a serious issue with one of their hip replacement products the Durom Cup. A prominent surgeon who collaborated in the development of the Durom Cup, Dr. Lawrence Dorr, expressed concerns to Zimmer that an abnormal number of patients upon whom he had performed surgeries required additional hip replacement surgeries after being in agony. Indeed, on July 29, 2008, The New York Times published an article entitled The Evidence Gap: A Call for a Warning System on Artificial Joints, which stated: Dr. Lawrence Dorr, a nationally known orthopedic surgeon in Los Angeles, realized last year that something was very wrong with some of his patients. Months after routine hip replacements, patients who had expected to live without pain were in agony. The pain was grabbing me around the back, said Stephen Csengeri, who is 54, and a lawyer from Torrance, Calif. Dr. Dorr found he had implanted the same metal hip socket in each patient. Several needed surgery again a replacement for their replacement. The doctor first told the devices manufacturer, Zimmer Holdings, last year about his concerns but nothing happened. Then in April, Dr. Dorr, who was a highly paid consultant for Zimmer, sounded an alarm to colleagues in a professional association and soon heard back from doctors with similar experiences. I saw one of Zimmers engineers at a meeting, and I told her that you should pull this cup because you are crippling patients, Dr. Dorr said. 5. Dr. Dorr was not the only Zimmer consultant to express concerns with the Durom Cup. As analysts at Cowen & Company would report on June 25, 2008: Our HVC [High-volume consultant-surgeon who has implanted a couple hundred Durom Cups over the past two years], who is also a Zimmer consultant, relayed certain concerns he had about the Durom cup to the company early in Duroms launch, as he foresaw certain characteristics as being potentially problematic. These challenges included an unfamiliar and uneven 165 circumference (most cups are 180) and that the rim is labeled as being 58mm, when it is really 61mm around the rim (need to ream to 58-59). Without prompting, Zimmer management acknowledged that some of these unique product attributes could play a role in challenges with Durom. 6. By February 2008, at least one sales representative specifically recalls doctors questioning him about the continued use of the Durom Cup, and that by March/April 2008 there was -3- a noticeable decrease in the orders for Durom Cups (from approximately 20 cups a month to 5 cups). Defendants, however, even in the face of quality system issues at Dover continued to mislead investors by telling them that Zimmer would hit double digit net sales growth of 10%-11% and 2008 EPS of $4.20 to $4.25. The defects with the Durom Cup were a particular problem for defendants because they were losing market share to other competitors as a result of the lack of FDA approval for a hip resurfacing system in the U.S. the Durom Cup was a component of the Companys pending FDA application for such a hip resurfacing system. After ignoring Dr. Dorrs and others concerns since, at the latest, the spring of 2007, defendants put together a crisis team in April/May of 2008 to handle the Durom Cup situation. Importantly, rather than attempting to ascertain the truth regarding the Durom Cup, the crisis team was charged with searching for evidence to support the Companys position. In late May 2008, after Dr. Dorr had informed his colleagues at the American Association of Hip and Knee Surgeons (AAHKS) of his concerns (and to defendants dismay, the news leaked to industry analysts), defendants tried to stop the hemorrhaging by writing to surgeons, telling them that the Company was investigating Dr. Dorrs complaints, but defendants did not suspend sales. After hundreds of more patients had Durom Cup hip replacement surgery, defendants on July 22, 2008 announced the suspension of the product from sale and the suspension of premarketing trials of Zimmers resurfacing systems. UBS analyst, Bruce Nudell, was quoted in The New York Times on July 24, 2008 as follows: They had given hints that there would not be a recall but this came as a surprise. 7. Defendants, citing their Durom Cup problems and a reduction in sales from prior guidance informed the market on July 22, 2008 that Zimmer would not meet their FY08 guidance. Upon this news Zimmers stock dropped nearly 7% in a single day. -4- II. JURISDICTION AND VENUE 8. The claims asserted herein arise under 10(b) and 20(a) of the 1934 Act, 15 U.S.C. 78j(b) and 78t(a), and Rule 10b-5, 17 C.F.R. 240.10b-5, promulgated thereunder. Jurisdiction is conferred by 27 of the 1934 Act, 15 U.S.C. 78aa. 9. Venue is proper here pursuant to 27 of the 1934 Act. Acts and transactions giving rise to the violation of laws complained of occurred here. III. THE PARTIES 10. Lead plaintiff Plumbers and Pipefitters Local Union 719 Pension Fund purchased Zimmer common stock as described in the certification filed with the Court on August 5, 2008 and was damaged thereby. 11. Defendant Zimmer is headquartered in Warsaw, Indiana. Zimmer Manufacturing Company, a predecessor of Zimmer was founded in 1927. On August 6, 2001, Zimmer was spun off from its former parent company and became an independent public company. Zimmer designs, develops, manufactures and markets reconstructive orthopedic implants, including joint, dental and spinal implants, trauma products and related OSPs. The Companys related OSPs include surgical supplies and instruments designed to aid in orthopedic surgical procedures. The Companys primary customers include musculoskeletal surgeons, neurosurgeons, oral surgeons, dentists, hospitals, distributors, healthcare dealers and, in their capacity as agents, healthcare purchasing organizations or buying groups. Zimmer markets and sells its products through three principal channels: (1) directly to healthcare institutions, such as hospitals, or direct channel accounts; (2) stock distributors and healthcare dealers; and (3) directly to dental practices and dental laboratories. Zimmer claims in its 2007 Form 10-K that the Zimmer Institute has trained over 7,900 surgeons on Orthopaedic Reconstructive Implants by teaching them Minimally Invasive Solutions (MIS) Procedures and Technologies. During the Class Period, Zimmer had over 200 million shares of -5- common stock outstanding, which traded in an efficient market on the New York Stock Exchange under the symbol ZMH. 12. Defendant Dvorak was President and CEO of the Company during the Class Period. He joined Zimmer in December 2001 as Senior Vice President (SVP), Corporate Affairs and General Counsel. Dvorak was appointed Corporate Secretary in February 2003. From October 2003 to December 2005, Dvorak served as Executive Vice President, Corporate Services, Chief Counsel and Secretary, as well as Chief Compliance Officer. From December 2005 to April 2007, Dvorak served as Group President, Global Businesses and Chief Legal Officer. Dvorak was appointed as CEO and to the Board of Directors of Zimmer on May 1, 2007. Dvorak has a Bachelor of Science in Business Administration (Finance) and a J.D. Prior to joining Zimmer, Dvorak was SVP, General Counsel and Secretary for STERIS Corporation, an Ohio-based leader in medical sterilization and contamination prevention products and services. He also practiced law at two law firms with a focus on corporate law, securities and mergers and acquisitions. Defendant Dvorak signed Zimmers 2007 Form 10-K and the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley) certifications attached to Zimmers 2007 Form 10-K and 1Q08 Form 10-Q filed with the SEC during the Class Period. 13. Defendant Crines was Executive Vice President, Finance and CFO of the Company From October 2003 to December 2005, Crines served as SVP, during the Class Period. Finance/Controller and Information Technology and from July 2001 to October 2003, he served as Vice President (VP), Finance/Controller. Crines was appointed Executive Vice President, Finance and CFO of Zimmer on May 1, 2007. From December 2005 to April 2007, Crines served as SVP, Finance, Operations and Corporate Controller and Chief Accounting Officer. Defendant Crines is a CPA and has over 20 years of experience in corporate and operations finance and accounting, including five years as an auditor with Zimmers independent auditor, PricewaterhouseCoopers LLP. -6- Defendant Crines signed Zimmers 2007 Form 10-K and 1Q08 Form 10-Q as well as attached Sarbanes-Oxley certifications for each of those forms filed with the SEC during the Class Period. 14. Defendants Dvorak and Crines, by reason of their stock ownership and positions with and relations to Zimmer as officers as well as their conduct alleged herein, were control persons of Zimmer. Zimmer in turn controlled defendant Dvorak and Crines. IV. FACTUAL BACKGROUND AND FRAUDULENT CONDUCT 15. Zimmer designs, develops, manufactures and markets reconstructive orthopedic implants, including hip implants, and orthopedic surgical products (OSPs) related to its implants. In its 2006 Annual Report, Zimmer told investors that it was No. 1 in market position for hip products with a 27% market share. Analysts at William Blair & Co., LLC on July 26, 2007 characterized [h]ips and knees to be the core franchises for Zimmer, accounting for about 70% of total revenue. Included in its hip products was the Durom Cup which Zimmer touted as the only metal-on-metal offering that is forged, not cast, with a high carbon content producing a smoother, harder surface that could lead to less wear and greater implant longevity; its pure titanium coating is intended for secure cementless fixation to a hip sockets skeleton. 16. Zimmer, however, did not have a hip resurfacing system approved by the FDA for use in the United States. The Durom Cup was approved by the FDA for hip replacement surgeries in the United States only in 2006. Zimmer had taken over a company called Centerpulse (which had been formerly called Sulzer) for more than $3 billion in 2003, and its metal-on-metal product became the Durom Cup. Hip resurfacing products have been used in Europe since approximately the mid-1990s, and in the middle of 2006, Zimmers competitor, Smith & Nephew PLC, received FDA approval for a hip resurfacing product in the United States. Analysts at Canaccord Adams reported on July 26, 2007 that Zimmers competitors Stryker Corp. (Stryker) and Wright Medical Group, Inc. (Wright Medical) were expected to be the next to enter the U.S. market with a hip -7- resurfacing product, noting that Zimmer was far behind the pack. The lack of a hip resurfacing product in the United States was noted by analysts at Bear Stearns on July 26, 2007 as the reason why Zimmers growth in the hip market was below average. After the 3Q07 conference call, analysts at Wachovia Capital Markets, LLC (Wachovia) noted on October 25, 2007 that Management comments on the call indicate that the company is in fact losing procedures to resurfacing. 17. In May of 2007, while in the midst of a DOJ investigation (which began in March 2005), Zimmer named defendant Dvorak, its former Group President and Chief Legal Officer, as President, CEO and a board member. The same day, defendant Crines was appointed as the Companys CFO. It was the first time since 2001, when the Company became an independent public company, that there had been a change in the individuals who held these positions. Four months later, in September 2007, to avoid criminal charges, Zimmer entered into a Deferred Prosecution Agreement (DPA) wherein Zimmer agreed to pay $169.5 million for allegations regarding illegal kickbacks paid to doctors to use its products. Defendants later indicated in the Companys 2007 Form 10-K that in addition to the DOJ investigation, Zimmer was under investigation by the SEC for violations of the Foreign Corrupt Practices Act in connection with the sales of its medical devices. 18. The market was closely watching Zimmer and in particular its new CEO and CFO defendants Dvorak and Crines. As analysts at Cowen and Company reported on July 26, 2007, the new management faced tough competition: The team of Elliot/Leno [the former CEO/CFO] set a very high bar. They routinely beat their own guidance on the top- and bottom-line. After Zimmer lowered its 4Q07 outlook, on November 8, 2007 analysts at Canaccord Adams questioned whether Zimmers challenges were management related noting that [a]fter a tough Q307 and disappointing guidance, Zimmer has realized a significant correction in the stock price . . . . [A]ny -8- slowdown in hip and knee sales will have a direct impact to the top line going forward. Further, the defendants were facing increased expenses as a result of the DPA, which included estimated monitoring and compliance costs exceeding $52 million. 19. At the beginning of the Class Period, on January 29, 2008, defendants, for the first time, disclosed Zimmers net sales and earnings outlook for full-year 2008, noting that Zimmer would no longer be providing guidance on a quarterly basis. They also informed the market that the Company expected 2008 reported net sales growth of 10% to 11%, or sales of $4,287 million to $4,326 million. Deutsche Bank Securities Inc. (Deutsche Bank) reported on January 29, 2008 that defendants guidance exceed[ed] both the prior consensus estimate of $4,176 million and [its] prior $4,157 million forecast. On the bottom line, guidance calls for earnings of $4.20 to $4.25 per share versus prior consensus and DB estimates of $4.22 and $4.17, respectively . . . . [M]anagement [also] did indicate it expects to return to at least low double-digit growth [in 2009]. On this news, Zimmers stock went from $68.08 to $77.03, an increase of 13% for the day. As set forth in greater detail herein, defendants guidance was false because defendants knew (1) they had severe quality issues with Zimmers OSPs produced at its Dover facility which would impact their sales and EPS; and (2) Zimmers hip sales would be negatively impacted as a result of defects with its Durom Cup, including the fact that surgeons were seeing increased revision rates and encountering patients in agony who had undergone hip replacement surgery with the Durom Cup. 20. Zimmers OSPs accounted for approximately 6% of the Companys total sales in 2007. OSPs include a variety of patient care items used to support orthopedic surgery, including disposables used in blood management, surgical wound site debridement and cement accessories. Zimmers 2006 Annual Report emphasized its commitment to providing high quality products to [its] customers and . . . [the] implement[ation] [of] modern quality systems and concepts throughout the organization. . . . Senior management is actively involved in setting quality policies and -9- managing internal and external quality performance. In an October 22, 2007 Company Profile issued by Datamonitor, defendants conveyed to investors that their detailed focus on execution and operations is enabling [Zimmer] to deliver industry leading margins and strong cash flow generation. On January 29, 2008, during Zimmers investor conference call, defendants were specifically asked about issues with the FDA and whether they expected any 483s or warning letters. In response, defendants falsely led investors to believe that there were no issues when they knew of severe quality problems at Zimmers Dover facility as well as FDA observations. 21. Dvorak deliberately chose not to invest money into the quality systems at Dover because of the failure of divisions overseen by Dvorak, including Dover, to meet their financial targets. The systems at Dover were antiquated and defendants knew it Dvorak himself suppressed information about the facility from others in the Company because he was embarrassed. A former Director of Quality Assurance and Regulatory Affairs at the Dover facility explained that in November 2007 Zimmer was notified of a problem with one of its products manufactured at Dover and the product was recalled in either November or December 2007; the decision to recall was made by Zimmers corporate office. The FDA then provided Zimmer with one weeks notice of an FDA inspection in January 2008. Immediately thereafter, Zimmers corporate office sent a team of auditors to handle the audit, who coached employees at Dover on what to say to FDA inspectors. In the middle of the inspection, Dovers General Manager (GM) was dismissed. During the FDA inspection, it was recommended by the quality department that the Dover facility be shut-down until the significant issues with the quality systems at the Dover facility could be satisfactorily addressed; Dvorak agreed. 22. On the April 24, 2008 conference call, Dvorak belatedly admitted that there had been an FDA inspection and observations as follows: Let me walk through a little bit more with a little bit more detail, Mike, the events that occurred. As you said we had a recall in December. There were other recalls - 10 - subsequent to that event and as we were rescoping those issues we got deeper and deeper and became more and more concerned with some of the fundamental quality systems there, ultimately leading to the decision [that] we announced earlier this month. Included in that time period was, as you know any time you make a recall theres likely to be an FDA inspection. There was an inspection. There were some observations. We had a third party come in and essentially do a wall to wall review and as a consequence of that very in depth review we identified some specific actions that we want to take so thats a lot of work over the course of many weeks. 23. These admissions were echoed at a May 6, 2008 Deutsche Bank Health Care conference by defendant Crines, who conceded that the FDA made observations that caused [Zimmer] some concern when it audited the Dover facility and that the FDA inspection at Dover in 1Q08 was focused on quality systems. 24. Not only did defendants know in January 2008 that Dover would receive FDA observations, defendant Dvorak had hired a specialist to try to avoid 483s or warning letters, and after the FDA auditor left, production of disposable OSPs was completely shut down. Further, as described in V., four confidential witnesses (CWs) (CW4, CW5, CW6 and CW9) all confirm that Zimmers OSP products were on backorder. Indeed, CW4 explained that beginning in October 2007, many OSPs were on backorder and that while it initially affected a small number of products, by December 2007, a large number of products were continually being placed on backorder. CW5 described that when he first started his position in February 2008, he was told by his supervisor that the products at the Dover facility had been contaminated so they were not available to customers.1 Another CW, CW9, a former sales representative for a Zimmer distributor, was further advised as early as January 2008 that there was an FDA inspection of Zimmers Dover facility in response to sterilization issues. By the end of February/March 2008, he was advised that the OSP products were being recalled and the Dover facility was temporarily closing down. CW2, a former Zimmer The use of the words he, his and him in connection with CWs is not meant to be gender specific and shall also be meant to pertain to the female gender. - 11 - 1 employee who supported the sterilization of devices, confirms the FDA inspection of Dover in January 2008. 25. Not until April 3, 2008 did defendants even hint to investors that an internal quality review uncovered issues in the Dover facility resulting in a voluntary recall and temporary suspension of certain products. Analysts at Credit Suisse openly questioned the failure to disclose the quality problems earlier: On its quarterly conf call in Jan, when asked whether it had any FDA warning letters or 483 observations, ZMH commented there were no warning letters, but did not comment on 483s. The recall suggests the possibility of a 483 . . . . While management told investors on April 3, 2008 that they expected at $70-$80 million negative revenue impact for 2008, they continued to purposely mislead the market about the financial impact and scope of the quality problems. The misleading nature of defendants statements was reflected in the markets reaction. Indeed, analysts, such as Credit Suisse, reported on April 4, 2008 that we estimate the EPS impact to be around $0.03-$0.05. 26. Less than three weeks later, on an April 24, 2008 conference call, defendants belatedly told investors that Zimmer shareholders should expect a $0.18-$0.20 decrease in EPS for 2008 based on OSP quality problems but importantly defendants also falsely claimed that Zimmers 2008 guidance of 10%-11% net sales growth and $4.20-$4.25 adjusted EPS would be confirmed for the year as a result of off-setting factors. At this point, an analyst at Credit Suisse questioned defendants purported explanation for not disclosing the OSP recall during the Companys January conference call: [L]ack of disclosure is a concern for us as we worry there are other issues that have yet to be disclosed. Analysts at Wachovia also noted that Zimmer now had little room for EPS upside and less margin for error. 27. Zimmer told investors in its 2006 Annual Report that the Company had the entire package of what surgeons, patients, and hospitals need, both today and in the future, explaining that - 12 - [s]urgeons know Zimmer as the company putting Confidence in your hands by [its] educational initiatives focusing on skills and knowledge . . . . Zimmer went on to brand itself in its 2007 Annual Report as Zimmer Enhancing lives. Indeed, Zimmer told investors that the focus on enhancing patients lives is the foundation for [its] business. Yet, when Zimmer filed its 2007 Annual Report on February 29, 2008, defendants had been told months earlier by the surgeon who collaborated on the development of its Durom Cup hip product and was considered to be Zimmers own specialist on metal-on-metal hips, Dr. Dorr, that it had severe problems X-rays showed that the socket was separating from bone, rather than fusing with it and that patients who thought their new hips might last 15-plus years were in agony. Indeed, The New York Times would subsequently report on July 29, 2008 that: Dr. Lawrence Dorr, a nationally known orthopedic surgeon in Los Angeles, realized last year that something was very wrong with some of his patients. Months after routine hip replacements, patients who had expected to live without pain were in agony. The pain was grabbing me around the back, said Stephen Csengeri, who is 54, and a lawyer from Torrance, Calif. Dr. Dorr found he had implanted the same metal hip socket in each patient. Several needed surgery again a replacement for their replacement. The doctor first told the devices manufacturer, Zimmer Holdings, last year about his concerns but nothing happened. Then in April, Dr. Dorr, who was a highly paid consultant for Zimmer, sounded an alarm to colleagues in a professional association and soon heard back from doctors with similar experiences. I saw one of Zimmers engineers at a meeting, and I told her that you should pull this cup because you are crippling patients, Dr. Dorr said. 28. Further, as detailed by CW11 below in V., Dr. Dorr informed Zimmer in 2007 of the severe problems with the Durom Cup. 29. Dr. Dorr is a prominent and well-respected hip surgeon who has conducted more than 5,000 hip replacement surgeries which cost $30,000 to $40,000 a procedure; he is considered by some to be the surgeon most knowledgeable about hips. Dr. Dorr, along with a colleague, is - 13 - reported to have more articles published on the clinical use of modern metal-on-metal than any other surgeon/researcher. Indeed, Zimmer itself owed Dr. Dorr approximately $6.7 million in consulting fees when he was discussing the defects of the Durom Cup with defendants. 30. For more than a year, and not until Dr. Dorr took action to make the information known to other surgeons, defendants would ignore Dr. Dorrs expertise and warnings. Defendants kept the Durom Cup on the U.S. market for several reasons, including: (1) they already knew they would have to reduce Zimmers 2008 EPS and double-digit net sales growth guidance as a result of the OSP issue at Dover; (2) it was extremely important for defendants to receive FDA approval for the Durom Cup hip resurfacing system in order to gain market share; and (3) disclosure of any problems with the Durom Cup would likely lead to the payment of expenses associated with revisions and/or product liability claims. 31. Indeed, as CW11 explains in V., Zimmers competitor Smith & Nephew had seen sales grow 50% each quarter since releasing its hip resurfacing product, and the recall of the Durom Cup would have put Zimmers hip resurfacing plan at risk. Accordingly, defendants continued to market and sell the Durom Cup even after Dr. Dorr urged Zimmer executives to stop selling the cup. 32. After Dr. Dorrs repeated warnings about the Durom Cup (as well as others) were effectively ignored by Zimmer defendants, on or about April 22, 2008, Dr. Dorr wrote to AAHKS members describing the problems and stating that he had conducted ten revisions in 165 hips and identified four additional hips that needed to be revised using Zimmers Durom Cup. He explained that he did not believe that the fixation surface on the cups was good and that there was a circular cutting surface on the periphery of the cup that prevents the cup from fully seating. He further elaborated that based on his experience with Sulzer cup failures (which Sulzer did not recall for six months after Dr. Dorrs complaints), he had learned his lesson in not informing everyone of the magnitude of failures with a device and that it was his obligation to inform everyone of the failures - 14 - with the Durom Cup. He further informed his fellow surgeons that Zimmer had been notified as well as the FDA. 33. Once news of the Durom Cups defects began to leak to surgeons, they were not willing to risk implanting the product. A nearly 10% failure rate (which is what Dr. Dorr described) two post-operative years later is considered to be a catastrophic failure rate for any total surface hip replacement. Defendants, however, continued to try to bolster Zimmers financial condition by minimizing the problems with the Durom Cup and Dr. Dorrs and other surgeons concerns. Defendants misled investors by telling them that its U.S. sales of hip products were up 4% year-toyear to $148 million and made no disclosure of Dr. Dorrs complaints or the extent of difficulties with the Durom Cup. Indeed, analysts at Canaccord Adams on April 24, 2008 noted a 10% improvement in hip sales for 1Q08 as well as [s]trong sales of the TM primary and modular cups, Durom, M/L Taper and EPOCH stems. 34. Sales representatives had already noticed by March/April 2008 a noticeable decrease in sales as described by CW9 in V. Defendants, however, continued to conceal from investors the problems with the Durom Cup, including the known problems with the cup and the fact that their own highly paid consultant was urging them to take the Durom Cup off the market. Dr. Dorrs warning to his fellow surgeons, however, could not be contained by defendants. On May 4, 2008, Deutsche Bank reported: On Friday, [May 2, 2008] we were notified that a prominent surgeon (Dr. Larry Dorr) had issued a negative letter on Zimmers Durom (metal) hip cup. (We talked to ZMH management and they are aware of this.) ZMH shares were down on $1.50 (2%) on the news, which we believe reflects the potential ensuing financial impact. 35. Further, Deutsche Bank noted the importance of Dr. Dorrs complaints: [I]n our opinion, Dr. Dorrs comments will sway some surgeons away from Durom. While its possible the problems are technique related, this may be irrelevant in terms of usage of Durom, again due to Dr. Dorrs influence. - 15 - 36. Rather than acknowledging the problems with the Durom Cup and the resulting significant decreased sales, defendants attempted to deflect the negative news regarding the Durom Cup by misleadingly pointing to success rates of the Durom Cup in other countries. Analysts at Cowen and Company noted on May 5, 2008 that Zimmer management acknowledged that a prominent orthopedic surgeon has circulated a letter to many of his peers suggesting that the companys Durom metal acetabular cup should be removed from the market based on the high rate of revisions he has seen in his patients a 3 years. The analysts further noted that [o]ur sense is that ZMH was caught off guard by the distribution of the letter based on our discussion. The company pointed us towards Swedish and Australian registry data which demonstrate a generally low revision rate for Durom at 3 years. 37. By Friday of the same week, May 9, 2008, Zimmer announced on Form 8-K the termination of Sheryl Conley as Group President, Americas and Global Marketing and Chief Marketing Officer. Analysts at Cowen and Company noted the unanswered questions by her departure, including: (1) why now, (2) was this move at all tied to specific regulatory challenge(s), and if so, is it a new development (i.e., Durom) . . . . 38. On the evening of the following Monday, May 12, 2008, Zimmer filed its 1Q08 Form 10-Q. Defendants belatedly disclosed in the Form 10-Q that they were investigating the high revision rates for the Durom Cup and indicated that this matter could result in product liability lawsuits and claims, safety alerts or product recalls which, regardless of their outcome, could have a material adverse effect on our business and reputation. By the following day, analysts at Credit Suisse issued a report entitled: Durom Cup Issues: Surprise, Now Its Material Enough to Disclose. Credit Suisse went on to express that it is concerned with the way in which this company is communicating and what else may be immaterial today that turns into something material tomorrow as was the case with the OSP recall and now the Durom hip cup. Zimmers Form 10-Q - 16 - for 1Q08 was false and misleading as it failed to sufficiently disclose the seriousness of the problems with the Durom Cup and its significant financial impact. Indeed, on May 13, 2008, analysts at Cowen and Company reported that based on what is now known . . . we do not believe there is any reason to conclude that Durom sales are going to completely disappear in the U.S. 39. Only in late May 2008 did Zimmer write to surgeons telling them they were investigating Dr. Dorrs complaints, but defendants did not suspend sales. While Zimmer was investigating, roughly 1300 patients received the Durom Cup. 40. Indeed, patients such as Marianne Hunter and Larry Ramsey experienced pain as a result of the Durom Cup. Mrs. Hunters X-rays on December 31, 2007 showed that the Durom Cup had slipped. Similarly, Mr. Ramseys X-rays showed he had a radiolucent gap. Both had to have revision surgery and have filed suit against Zimmer for the Durom Cup. 41. Surgeons were also discussing concerns with the Durom Cup. On May 18, 2008, analyst Tao Levy of Deutsche Bank issued a report on Zimmer which attached a conference call Levy had arranged with Dr. John Maltry, an orthopedic surgeon, regarding the Durom Cup. Dr. Maltry explained the defects with the Durom Cup and the importance of Dr. Dorrs complaints: My name is Dr. John Maltry and Im in Tucson with the Tucson Orthopedic Institute. I am starting my 16th year and all I do is hip and knee replacements. Our group is a 30-member pure orthopedic specialty group which lends itself to people like me. For approximately the last 8 to 10 years I have been a consultant for Zimmer. * * * As of about three weeks ago I discontinued use of the Durom cup, since we have seen the same type of problems that Larry Dorr has. Even when the product seems to be fully implanted at time of surgery, a certain percentage of the people, lets say between 5% and 10%, have persistent pain associated with it and wont put up with it for more than about six to eight months. * * * Tao Levy: With Dr. Dorrs Letter out there for a couple weeks, would you expect Durom utilization to significantly decline from your colleagues? - 17 - John Maltry: Certainly Larry Dorr is a thought leader and has a certain degree of notoriety within the orthopedic community. With the currently concepts meeting coming up next week, this is an issue that will be fully disseminated, if its not already fully disseminated between hip and knee surgeons and the general orthopedic community, it will be by the end of next week. I would anticipate usage of this product to drop nearly completely until the product is redesigned. * * * Tommy Thomas: Sorry just to follow up. So the cases where youve had revisions on this Durom cup, do you attribute that to the product itself or to technique and then if it is technique, could there be a spill-over effect? Could this be going on or happening in other resurfacing problems? Its striking that this is I dont know if its as challenging to implant as other hip resurfacing products or metal on metal systems. John Maltry: Good, a very valid question. No I believe that Ive put in 6,000 or 7,000 hip replacements and had none ever fail at the rate this is. So from my standpoint I believe that simply speaking for me this is a design issue with this cup which then makes it getting to perform very difficult from a technical standpoint, very unpredictable. Therefore, if you had to ask me to question technique versus design, my simple opinion would be design, and therefore not spilling over into any of the other products from any other company that might have this same type of thought process. * * * Tommy Tomas: Yeah, I just wanted to go through the numbers with you again. So you said 5% to 10% of your hip procedures use this. Whats the cumulative number that youve put inside and how many of those are you replacing? John Maltry: I have installed approximately 67 of the Durom acetabular components that you speak of. To date I have revised three of those which proved to be loose. And I think I have one more to do, so perhaps four out of 67. 42. In addition to doctors experiences with the Durom Cup, by June 3, 2008, analysts at Credit Suisse noted some discrepancies in some of defendants explanations with respect to the concerns about the Durom Cup as follows: Durom is a real issue and should not be dismissed or minimized. Zimmer and others have pointed to an internal registry, and two international registries as support for the products performance. We see flaws and are not comforted as we will discuss in this report. The internal registry is too selective (just 13 physicians) and is voluntary. The international registries are like mixing apple and oranges. First, internationally, Durom is used in hip resurfacing plus, the US product has a different coating (its thicker). It may be subtle but its a difference, thus international data is - 18 - not 100% applicable. A problem with Durom Cup also means a problem with bringing a hip resurfacing system to the US, which means a long term competitive disadvantage. * * * Zimmers internal registry. Our take: Its too selective and its voluntary. On an industry conference on May 14, Zimmer referred to its internal registry tracking 13 surgeons in the U.S. and cited 3 failures out of 480 patients (0.6% failure rate). However, in our view this is way too selective (i.e., only 13 surgeons) and its voluntary, thus not all events may be captured. Obviously, Dr. Dorr was not one of the select 13 in the registry. Dr. Dorr reported 10 revisions in 165 hips, with 4 more scheduled to be revised. The Australian registry data: Its being used in hip resurfacing patients, so its not comparable unless in the U.S. the Durom cup is being used off-label in hip resurfacing since components are available which raises even more concerns. The 2007 annual report states, Using the Registry algorithm, the ASR and the Durom were identified as having a higher than anticipated rate of revision. It also says The Durom has twice the risk of revision compared to other resurfacing procedures with 2.7 revisions per 100 observed component years. The revision rate overall was 4.4%. Moreover, the patient characteristics in the Australian registry may be different (since its hip resurfacing) from the typical patient receiving the Durom cup is being used. 43. Defendants had also previously told investors in Zimmers 2007 Form 10-K that most European implants are designed specifically for Europe: 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 Mathys AG and Waldemar LINK GmbH & Co. KG, which compete with us in addition to the global competitors. Today most hip implants sold in Europe are products developed specifically for Europe, although global products are gaining acceptance. Therefore, we will continue to develop and produce specially tailored products to meet specific European needs. 44. Later, on June 25, 2008, Cowen & Company analysts, based on their research, reported a 75% decline in Durom Cup sales for 2008 and a revision of Zimmers EPS forecast by $0.04 and specifically noted that: While our changes are on the lower end of the sensitivity analysis we included in notes issued last month subsequent to Dr. Dorrs disclosure, absent a recall, we - 19 - believe these changes adequately capture the likely impact of reduced Durom sales. We believe the changes we made to our 2009 forecast could prove conservative. * * * Durom Challenges Not Completely Surprising Our HVC [High-volume consultant-surgeon who has implanted a couple hundred Durom Cups over the past two years], who is also a Zimmer consultant, relayed certain concerns he had about the Durom cup to the company early in Duroms launch, as he foresaw certain characteristics as being potentially problematic. These challenges included an unfamiliar and uneven 165 circumference (most cups are 180) and that the rim is labeled as being 58mm, when it is really 61mm around the rim (need to ream to 58-59). Without prompting, Zimmer management acknowledged that some of these unique product attributes could play a role in challenges with Durom. Consistent with other metal cups on the market (e.g., Biomet M2A Magnum, DePuy ASR, SNN BHR), there are no holes in which a surgeon can use screws to achieve fixation (or bail out a more challenging procedure); pres-fit is the only fixation means for Durom and most other large head metal-on-metal hip cups. The Durom procedure is more complicated than the norm as it requires: 1. 2. 3. 4. 5. Reaming of the acetabular to the appropriate size Using a trial cup to check sizing and positioning Removal of trial Insertion of cup Repositioning, if necessary, as cup does not always fit perfectly into trial mold Zimmer strongly recommends that surgeons reposition cups only if absolutely necessary this is in part because it is believed that the rotation of Duroms large fins can cause fixation problems. While the larger size should render Durom relatively more forgiving than smaller cups, repositioning is fairly typical in hip replacement procedures the recommendation against repositioning is atypical and potentially more technically unfamiliar to less Durom-experienced surgeons. 45. Also disturbing was that Zimmer management told Cowen & Company analysts that they expect to provide more detail on the financial impact on the Q2 call, and that if there were any material developments that occur prior to the call they would strongly consider holding a conference call with both the medical and investment community. - 20 - 46. Defendant Crines would later, at a May 6, 2008 Deutsche Bank Health Care Conference, state that in the early part of 2007, Zimmer was aware of problems in France with the Durom Cup and that [t]his is a cup that once its seated up into the acetabulum cannot be repositioned. 47. On June 26, 2008, analyst Raj Denhoy of Thomas Weisel Partners issued a report on Zimmer, noting both the Durom Cup and OSP issues: In addition, concerns over Zimmers Durom metal on metal hip were raised by one particular U.S. surgeon and has gained more recent traction. Although it is a bit early to assess the impact, the surgeons letter does appear to be impacting sales of the device. * * * In 1Q08, ZMH announced the recall of several products within their OSP (orthopedic surgical products) segment, reducing 2008 sales by $70-$80mn and removing $0.20 from EPS. The recall of roughly 1/2 of ZMHs $230mn OSP product portfolio was precipitated by of a spot of silicone lubrication appearing on the pouch of its PulsaVac product, creating sterility concerns. Following the issue with the spotting, the company and the FDA conducted inspections of its Dover facility. The FDA issued several 483 letters and ZMH proactively brought down several manufacturing lines and recalled products on several ancillary product lines. The recalls were voluntary and Zimmer will bring the lines back up as it validates them further FDA sign off isnt needed. 48. The Tomas Weisel Partners report went on to identify Zimmers ability to leverage its planned investments as a central driver behind better EPS, identifying the OSP segment and concerns with respect to Durom as a challenge. Further, the report read OSP Recall Still Unresolved and indicated that there could be downside to future top-line growth if planned reinvestment in other areas has been pushed off and costs that were expected to be reduced or removed from the model in 2009 continue to impact reported numbers. 49. Analysts (not the defendants) also continued to research and report problems with the Durom Cup. On July 21, 2008, Credit Suisse issued a report in which it detailed the reports of a survey it took of U.S. surgeons that had experience with the Durom Cup. Of 61 surgeons who - 21 - responded, only six had not heard of Dr. Dorrs letter and more than half (33) had stopped using the Durom Cup. Seventeen of the surgeons indicated they stopped because they had heard of Dr. Dorrs letter; 18 had stopped because of their own experience with the Durom Cup and four had stopped after hearing of other surgeons experience. 50. The next day, two days earlier than anticipated, on July 22, 2008, Zimmer reported an in line quarter but announced it was suspending the sales of its Durom Cup. Further, Zimmer cut guidance lowering its 2008 EPS guidance by $0.15 to $4.05-$4.10 and sales growth from 10%11% to 8.5%-9.0%. Defendants told the market on July 23, 2008, among other things, that [t]he adjustment to our sales guidance includes a projected loss of $20 million to $30 million in hip products sales, pertaining principally to Durom Cup in the US; and [r]evised adjusted earnings guidance gives effect to the reduction in sales from prior guidance. 51. On July 22, 2008, Zimmer also had sent a letter to surgeons marked Urgent Device Correction which advised surgeons that The results of our in-depth investigation have led us to conclude that additional surgical technique instructions and training are necessary in the United States, and we strongly recommend that U.S. surgeons stop implanting the Durom Cup until receiving such training. . . . Revised product labeling to include more detailed surgical technique instructions will be the subject of a further communication to surgeons over the next several weeks. Further, Zimmer conceded to doctors that these revised technique instructions would include the following steps: line-to-line reaming, use of trials in every case, proper cup position for this device, appropriate impaction techniques, and no repositioning. 52. On July 23, 2008 analysts at Cowen and Company reported that we are admittedly surprised by the voluntary suspension of marketing and distribution [of the Durom Cup]. The impact of defendants defective Durom Cup would be felt by the Company for years. Indeed, as Dvorak conceded on July 23, 2008, the suspension of the Durom Cup would have financial - 22 - consequences. Further, defendant Crines was also forced to concede that there would be a delay beyond 2011 in any hip resurfacing product as a result of their suspension of the sales of the Durom Cup. An analyst for Thomas Weisel projected that hip resurfacing sales could represent more than 10% of total hip sales in the United States by 2012. 53. Later, on a October 23, 2008 conference call, defendants reported Zimmers 3Q08 financial results revealing that it had set aside $47.5 million related to known and anticipated claims and other expenses and credits related solely to revisions associated with the Durom Cup. Zimmer is self-insured for product liability claims such as those made by Stephen Csengari, a patient of Dr. Dorr, related to the Durom Cup a claim that was resolved on the same day Zimmer announced suspension of sales of the Durom Cup. 54. On the same conference call, defendants explained that Zimmers OSP business was down 19% for 3Q08 and that Zimmer had lost customers as a result of not only the enhanced compliance program implementation but obviously the disruption that was created by the Durom Cup matter and some of the other things that the Company faced, including OSP. On this news, Zimmers stock price dropped 13.49% from $51.66 to $44.69. V. CONFIDENTIAL WITNESSES CONFIRM DEFENDANTS FRAUDULENT CONDUCT 55. CW1 was a Director of Quality Assurance (QA) and Regulatory Affairs at the Zimmer facility in Dover, Ohio from January 2004 through April 1, 2008. CW1 was the top QA person at the Dover facility. From October 1, 2007, CW1 reported to the VP of Quality, Carter, who then reported to SVP of Research and Development Cheryl Blanchard (Blanchard). Blanchard reported to Zimmers CEO Ray Elliot, and after Elliot, Blanchard report to Zimmers CEO defendant Dvorak. 56. CW1 stated that in November 2007 Zimmer was notified of silicone spotting on its Pulsavac Plus Wound Debridement System Fan Spray Gun (Pulsavac gun), a product - 23 - manufactured at its Dover facility. CW1 was notified of the complaint by the Marketing Department, upon which, he contacted the customer himself to inquire about the problem. CW1 explained the Pulsavac gun to be like a water pistol used in cleaning out wounds during surgery. CW1 further explained that silicone, which was used to lubricate the pump gun, was leaking from the product onto the packaging. The product was recalled either in November or December of 2007. CW1 said that the decision to recall the Pulsavac gun was made by Zimmers corporate headquarters, including VP of Quality Carter. CW1 explained that he was involved in compiling the paperwork which was filed with the FDA indicating the problem with the Pulsavac gun. He stated that while paperwork was being assembled in order to file for a recall, customers were not notified of an impending recall. CW1 further stated that marketing was responsible for how a recall would have appeared to distributors placing orders and that a recall could have appeared as a backorder on the computer system. 57. CW1 noted that the FDA inspection of the Dover facility occurred in January 2008 and was not planned. For this inspection, Zimmer was provided one weeks notice by the FDA before the inspection. CW1 stated that the January 2008 inspection was most likely triggered by the prior product recall regarding silicone spotting. Immediately after learning about the inspection, CW1 said that Zimmers corporate office sent a team specifically to handle this audit. Never in his career at Zimmer had there been such a team assembled by the corporate office for inspection. The head of the team, Andrew Parker (based out of Zimmers headquarters), was assertive to the point of being aggressive, and the FDA auditor made it known to the other members of the team that she did not like Parker. CW1 stated that the team from corporate headquarters coached employees at the Dover facility on what to say to the FDA auditor. The GM of the Dover facility, Ken Coonce, who had been a long time employee of Zimmer, was dismissed in the middle of the FDAs week-long audit. - 24 - 58. CW1 indicated that at the end of the week-long audit, it was very clear that the Dover facility would receive 483 observations and possibly another warning letter. CW1 further stated that after the FDA auditor left in January 2008, production of disposable OSPs was completely shut down at Dover. There was nothing being shipped out of the facility. 59. CW2 worked at Zimmer for approximately a year and a half until his departure on January 30, 2008. CW2 was the Manager of Microbiology, a department organized under production and operations in Warsaw, IN. In that position, he supported sterilization of devices from other divisions, and his group conducted testing. He reported to the Director of Sterilization, Russell Rusty Mills, who reported to Mike Hawkins, who in turn reported to CEO Dvorak. 60. Prior to his departure on January 30, 2008, CW2 was aware of the quality problems at the Dover facility. He was aware of defects or failure trends with products at the facility and stated that the corporate quality department was also aware of these issues at Dover because the defect trends were discussed in monthly management meetings. These meetings were attended by the Quality Department, including Mills, Hawkins and, VP of Quality Carter, as well as directors of various departments and regulatory assurance. At these meetings, internal metrics which illustrated defect trends were discussed. According to CW2, CEO Dvorak was made aware of the contents of those meetings since Carter and Hawkins both reported to him. 61. CW2 stated that it was Zimmers general approach not to spend money correcting quality defect issues. He believed that OSP issues could have been addressed by Zimmer years ahead of time. CW2 was aware prior to leaving the Company that there were problems with silicone spotting in the Pulsavac line of products manufactured at Dover before he left at the end of January 2008. He explained that silicone was categorized as sterility issue in that the silicone would leak out and plug holes in the product. During his tenure, CW2 attended two management meetings, and at the second management meeting internal metrics for the Dover facility were discussed. He saw - 25 - charts and graphs at the meeting which showed defect trends increasing at the Dover facility over a two-year period. He did not see a plateau or downward slope indicating that the issues had either leveled off or decreased. 62. CW2 recalled that the FDA inspection at the Dover facility took place around the same time he was leaving the Company in January 2008. He believed that the FDA possibly was alerted because the Company planned to issue recalls, and the FDA had to be alerted whenever there was a field action. He defined a field action as recalling a product that was already distributed and needed to be collected from the field. Finally, CW2 stated that he personally would not have any type of device implanted in his body made by Zimmer, explaining that it was the worst company he had worked for. 63. CW3 was the GM of the Dover facility for 4 1/2 years until his departure in mid- January 2008. He reported to defendant Dvorak. He was responsible for OSPs for the Dover, Ohio and Statesville, North Carolina facilities. 64. CW3 stated that Zimmers OSP sales had declined approximately 5% each year and were becoming less competitive because other companies were producing OSPs, offshore, such as in China. 65. According to CW3, Zimmer was notified by a customer of silicone spotting on its Pulsavac gun before January 2008. After doing tests on this product, Zimmers corporate headquarters in Warsaw, Indiana decided to recall it. CW3 explained that a recall meant Zimmer had to retrieve a large volume of product from the field because approximately 800,000 units of this product were sold each year all over the world. It was this recall that prompted the FDA inspection at the Dover facility. CW3 also stated that individuals who handled this matter from Zimmers corporate headquarters would have been responsible for reporting directly to Dvorak. - 26 - 66. CW4 was employed by Zimmer Wilson Phillips (Wilson Phillips), a distributor for Zimmer in San Antonio, Texas, as a Customer Service/Surgical Billing Representative from 2005 through mid-January 2008. CW4 was responsible for billing hospitals for products used during surgeries, as well as re-ordering and replacing those products, which were usually stored at the hospitals. He explained that Wilson Phillips covered a large portion of the Southwest region, including parts of Texas and Louisiana. 67. CW4 confirmed that each of Zimmers distributors was independently owned, but had an exclusive contract with the Company to sell its products. During his employment, Zimmers distributors were all named and referred to using Zimmer and then the last names of the owner(s), as with Zimmer Wilson Phillips. He said that owners were often referred to as distributors, but that was not their official titles. Additionally, the owners/distributors were employees of Zimmer. 68. CW4 also confirmed that sales representatives were present at surgical procedures. CW4 was responsible for ordering Zimmers OSPs used during surgeries in Louisiana hospitals and also occasionally assisted in processing orders for hospitals in the San Antonio area. Beginning in October 2007, many OSP products were on backorder as reflected in the DCS Inventory Application Software. CW4 indicated that a backorder message appeared on the screen when he attempted to place an OSP order. He explained that in October 2007, the backorder initially affected only a small number of OSP products, but that between October 2007 and December 2007, a larger number of OSP products were continually being placed on backorder. According to CW4, by December 2007, customers were going ballistic because many of their most frequently used items were on backorder. CW4 further explained that at this time, in December 2007, the computer listed the OSPs on backorder with an indefinite in-stock date. The ordering software would not even allow CW4 to enter an order which would have placed the hospital on the backorder list. - 27 - 69. Around December 2007, CW4 called Zimmers Customer Service Department to obtain information about the status of the OSP backorders. CW4 was advised that there were ordering issues, that the OSPs were out of stock indefinitely, and that he should tell the hospitals to place orders with Zimmers competitors. CW4 stated that he heard as early as October 2007 that Zimmer was not going to sell OSPs anymore because it was having order issues with the supplier. 70. CW5 worked from February 2008 through August 2008 as a receptionist for Zimmer Rocky Mountain, a Zimmer distributor in Utah. As a receptionist he was responsible for answering phones and processing OSP orders for surgical centers. The orders were for soft goods used during the implant surgeries and included the OSPs ultimately discontinued by Zimmers Dover facility. CW5 specifically recalled the Pulsavac product as one of the products from the Dover facility that was recalled. 71. CW5 explained that in February 2008, when he first started at Zimmer Rocky Mountain, OSPs from the Dover facility were already on backorder. This meant that customers could place an order for OSPs, but would not receive them until some unspecified later date. CW5s supervisor, Office Manager Carol Fox (Fox), told him that the products at the Dover facility had been contaminated and that Zimmer had to restart production of the products. CW5 was further informed that until production commenced and the facility was able to produce non-contaminated products, OSP products from Dover were not available to customers. He was instructed to advise medical facilities only that the products were on backorder and that the Company was trying to improve the product and get it back out as soon as possible. CW5 understood that Fox (and in May 2008 her replacement Kristen Day) received her information and instructions from Bonnie Wilson in Zimmers corporate office in Warsaw, Indiana. - 28 - 72. CW5 advised medical facilities that Zimmers OSP products were on backorder until he was told in March/April 2008 by Fox that due to the contamination problem at the Dover facility, Zimmer had to halt production at the Dover facility altogether. 73. CW6 was an Inventory Coordinator at Zimmer Rocky Mountain from November 2006 through July 2008. As an Inventory Coordinator, he was responsible for billing hospitals and other medical facilities for Zimmer implant products (which included the implants and any accompanying products in the implant kits discussed below) used during medical procedures. Zimmer Rocky Mountain sold various products used during partial and total joint replacement surgeries, which included OSPs and implants. CW6 confirmed that OSPs (also referred to as soft goods) were used during surgical procedures to assist with the wounds, and were considered to be everything but the implants. OSPs were manufactured at Zimmers Dover facility and included the Pulsavac products. 74. CW6 first overheard conversations between the receptionist and Office Manager Fox, about backorders of OSPs from the Dover facility around January or February 2008. These conversations involved how to handle the customers who were in need of Zimmer OSPs. CW6 understood from later conversations between the receptionist and the current Office Manager that the OSPs were pulled and ultimately recalled by Zimmer. 75. CW6 confirmed that sales representatives were present in the operating rooms during medical procedures where OSPs and joint implants (hip and knee joint replacement products) were utilized. He estimated sales representatives were present at 98% of the non-trauma related surgeries performed by doctors with whom they had accounts. According to CW6, sales representatives were present to answer questions, and ensure that the products opened during the procedures were the correct products and were sterile. - 29 - 76. CW6 further confirmed that Zimmer kept a record of all defective products opened during a surgical procedure to ascertain any trends. These were recorded on a Product Experience Report (PER). 77. CW7 was a Junior Sales Representative at Zimmer Deptula, Inc., a distributor for Zimmer in Melbourne, Florida, beginning in May 2007 through May 2008. As a Junior Sales Representative, CW7 worked with sales representatives assisting them with whatever they might need, from filing to interacting with doctors. CW7 explained that Zimmer provided training to distributor sales representatives through the Zimmer Institute (Institute). The Institute was located on one of the floors in Zimmers corporate building in Warsaw, Indiana. He recalled that the Institute offered classes in OSPs, Trauma, Knees, Hips, Selling Skills, Advanced Knees and Advanced Hips (which covered materials and products related to hip and knee revision surgeries). 78. CW7 was originally scheduled to attend the OSPs class in March 2008 but in February 2008, he was advised by the owner of Zimmer Deptula, Thomas Deptula, that the class was on hold. He believed that the postponement of the class was related to a problem at Zimmers Dover facility, which manufactured OSPs. 79. CW8 worked for two Zimmer distributors between September 2001 and August 2008. He began as a surgical instrument coordinator at Zimmer Southeast in September 2001 and was responsible for ensuring that surgical instruments necessary for joint replacement surgeries were available and delivered to hospitals for scheduled surgeries. He also assisted in ensuring that implant products were delivered if the hospital did not have the necessary products in inventory. Subsequently, he began working with just trauma-related surgical instruments. In September 2007, he moved and began working as a Billing Coordinator at Zimmers Rocky Mountain distributor position he left in August 2008. While a Billing Coordinator, he was responsible for billing hospitals that used Zimmers implants during surgeries. - 30 - 80. CW8 explained that Zimmer decided who could be a distributor for the Company, assisted with financing for the purchases of the distributor and could replace owners of distributors. CW8 further explained that sales representatives ordered the necessary joint implant products as well as the necessary instruments used during surgeries. He further confirmed that sales representatives were present during surgeries. The sales representatives received extensive training on the various Zimmer products and essentially had to be able to close their eyes and perform the surgery in their head. 81. CW8 indicated product failure information was tracked in a computer program separate from the DCS inventory program or the ZCIS program used by Zimmer and its distributors for inventory and billing. 82. CW9 was a sales representative at Zimmer Davis, a distributor for Zimmer in Minneapolis, MN from May 2005 until May 2008. CW9 was often present in the operating rooms when doctors performed surgeries using Zimmer products as a courtesy to the doctors in case they had any questions or needed assistance with any of the products. CW9 was also responsible for ensuring that whatever products a surgeon needed for a scheduled surgery were provided to the medical facility days before the scheduled procedure. 83. In approximately January/February 2008, CW9 was advised by Tom Davis (Davis) the President of Zimmer Davis who had frequent conversations with defendant Dvorak that there was an FDA inspection of Zimmers Dover facility where OSP products were manufactured. Davis further advised him that the FDA inspection was in response to sterilization issues at Dover. CW9 did not believe the FDA inspection was routine. Davis also informed CW9 at this time that the OSP products manufactured at the Dover facility were now on backorder. In late February/March 2008, CW9 was advised that the Dover OSP products were being recalled and that the Dover facility was temporarily closing down. As a result of the OSP recall, CW9 saw his total average monthly sales of - 31 - $200,000 decrease by 30%-50%. When CW9 left in May 2008, the Dover facility still was not manufacturing. 84. CW9 was advised around January/February 2008 by either Davis, or the VP of Zimmer Davis, Eric Schroeder (Schroeder), that Dr. Dorr had made some negative comments about the Durom Cup, but was instructed that distributors should continue to sell the product as usual. CW9 was also aware of Dr. Dorrs April 2008 letter to the AAHKS outlining his concern about the Durom Cup used in total hip replacement surgeries. CW9 received an e-mail from Schroeder about the letter shortly after the letter was made public. CW9 recalled that Dr. Dorrs complaints were that the implant was loose and was not made of good metal. 85. Around February 2008, approximately five doctors began questioning whether to continue using the Durom Cup. The questions were directly related to Dr. Dorrs concerns. CW9 stated that he was not required to advise the doctors about Dr. Dorrs concerns and was told by Schroeder to tell the doctors that Dr. Dorrs findings were not true. CW9 further stated that by March/April 2008 there was a noticeable decrease in the orders for Durom Cups. CW9 attributes the decrease to concerns expressed by the doctors about the continued use of the product. Prior to this March/April timeframe, CW9 sold about 20 Durom Cups a month. After this time, sales dwindled to five Durom Cups a month. 86. CW9 recalls that Zimmer had a technical guide for the Durom Cup that included the technique for implanting the device. CW9 indicated that the pamphlet was comprised of doublesided letter size pages stapled together and was approximately 20 to 40 pages in length. CW9 would sit down with doctors who purchased the device individually and review the Durom Cup pamphlet provided by Zimmer. 87. CW10 was a Director of Quality Assurance at Zimmers corporate headquarters from July 2002 through November 2007. He reported to VP of Quality Carter. CW10 had quality and - 32 - design control responsibilities over hip and knee product manufacturing and supply at Zimmers corporate headquarters as well as in Puerto Rico. 88. CW10 stated that Zimmer was attempting to bring the Durom Cup metal-on-metal product (hip resurfacing technology) to the U.S. market through pre-market approval with the FDA. Zimmer was expecting this approval by April or May of 2008. It was his understanding that Zimmers 2008 fiscal forecast was based on the sales revenue in the United States from the Durom Cups hip resurfacing technology and from the Durom Cups existing hip replacement technology. CW10 was also aware that Zimmer was preparing to increase production of the Durom Cup in Switzerland to meet the expected increased sales in the United States once the approval for metal-onmetal product was received. 89. CW10 explained that surgical techniques should be included in an IFU (information for use), which accompanies the products as required by the FDA. In addition, he explained that Zimmer also issued training to surgeons on technique at the Institute for its products. 90. CW10 had heard that the OSP division had a problem which had triggered the FDA inspection. CW10 stated that Zimmer conducted regularly scheduled quality management review meetings to discuss the state of quality problems and trends. According to CW10, the FDA regularly scheduled meetings to discuss the state of quality problems and any potential issues. If a site manufactured products that were sold internationally, then it was also subject to ISO mandated management meetings as well. CW10 hosted these quality review meetings for the Warsaw facility. After these meetings, CW10 compiled a report, which would have been provided to Carter. Both ISO and FDA standards required that upper management must be notified of the outcome of these meetings. 91. According to CW10, who was aware of 483 letters received by Zimmer in 2003 and 2006, a 483 letter is a list of observations made by the FDA after conducting an inspection. He - 33 - explained that the observations contained in a 483 letter are very serious because it is essentially federal agents identifying lapses in quality systems. He explained that there should not be lapses in quality systems because it means that the Company is sending faulty or adulterated products. 92. CW11 worked for Zimmer for more than 20 years, including as a SVP of Sales; he left Zimmer in January 2008. In his last position, he reported to President of Americas and Chief Marketing Officer Sheryl Conley. He believed that Conley reported directly to CEO Dvorak. As a SVP of Sales, and then later in his marketing position, CW11 had numerous communications with Dr. Dorr. CW11 stated that Dr. Dorr assisted in designing the Durom Cup in conjunction with Centerpulse (previously known as Sulzer and later acquired by Zimmer) and described the Durom Cup as Dr. Dorrs baby. CW11 stated that Dr. Dorr informed Zimmer about design problems with the Durom Cup at least a year before the April 2008 letter sent by Dr. Dorr to the AAHKS. Thereafter, Zimmer tasked the VP of Clinical Affairs, Russell Schenck, with collecting data about the Durom Cup from various surgeons using the implant. However, according to CW11, Zimmer had stopped communicating with customers, i.e., surgeons, because of the DOJ investigation and the DPA. CW11 explained that he personally had asked CEO Dvorak about making efforts to communicate with surgeons about Zimmer products and Dvorak responded that Zimmer did not have anything to say to the surgeons and did not know how to explain the current situation with the DPA. 93. According to CW11, Zimmer was trying to obtain approval for the Durom Cup to be used for hip resurfacing in the United States. He explained that there were only two hip resurfacing products already on the market, one of which was marketed by Smith & Nephew. He said that Smith & Nephews hip sales grew 50% each quarter after releasing its product. As a result, it was important that Zimmer receive approval of the Durom Cup for hip resurfacing in order to obtain the - 34 - market share in this area. CW11 further elaborated that a recall of the Durom Cup would have put the hip resurfacing plan at risk. 94. CW11 also stated that Zimmer fired the GM of Zimmers Dover facility, Ken Coonce, months before the problems with the OSPs were announced publicly. 95. CW12 was employed at Zimmers headquarters for more than 20 years, leaving in June 2006. He held a variety of positions within the Product Development and Marketing Departments for the Company. He last held the position of Director of Computer Assisted Surgery from January 2004 to June 2006. He was responsible in this position for marketing computer navigation systems during surgery throughout the United States. Computer assisted surgery (CAS) was used for knee and hip implant surgeries while CW12 was at Zimmer. 96. CW12 observed at least 1,000 surgeries while at Zimmer, including a number of hip implant surgeries. He explained there are four components to a hip implant: the acetabular cup, the liner, the femoral head and the femoral stem. The acetabular cup is implanted into the acetabulum using a surgical instrument similar to a hammer or mallet. The surgeon drives the femoral component into the acetabulum and taps the rims of the cup to ensure that it is aligned. Alignment is also confirmed using the CAS program. CW12 explained that he observed a handful of hip replacement surgeries conducted by Dr. Dorr using the CAS software during the last three years of his employment. CW12 witnessed these surgeries during the live broadcasts of these surgeries. Zimmer used live broadcasts of various doctors using its products during joint replacement surgeries to train its sales force and other surgeons at the Institute. CW12 elaborated that Dr. Dorr was one of the best orthopedic surgeons he had ever seen operate and that Dr. Dorr knows and understands more about the hip joint than most surgeons. 97. CW12 explained that while each of Zimmers distributors were independently owned, they signed an exclusive contract with the Company to only sell Zimmers products. Zimmer - 35 - maintained ownership of the inventory but provided products to distributors and hospitals on a consignment basis, meaning Zimmer owned the inventory until a product was sold to the customer. Zimmers inventory was managed through a program called ZDI and each distributor was responsible for turning a certain amount of product a month or it had to pay or return any unused inventory. Each distributor maintained its own sales force and the sales representatives were employees of the distributors, not Zimmer. In approximately 2004/2005, there was a large reorganization of Zimmers distributors and as a result, 74 distributors merged into 25 distributors. 98. CW12 confirmed the presence of sales representatives during joint replacement surgeries. He indicated that sales representative are present at most joint replacement surgeries in order to assist the surgeons, answer any questions about the product and to make sure everything runs smoothly. Sales representatives were trained to handle problems that might occur during a procedure in the operating room and if there were ever a problem or a failure of a Zimmer orthopedic product in the operating room, the sales representative filled out a Product Experience Report (PER) and sent it to Zimmer. The sales representatives also notified the FDA (either directly or through someone at Zimmer) using a Medical Device Report (MDR) if the problem or failure caused any harm to the patient. 99. CW13 was a Senior Regulatory Affairs Manager from October 2006 through June 2008 and then subsequently an Associate Manager in Regulatory Affairs from June 2008 through approximately August 2008 for Zimmer TMT (a wholly owned subsidiary of Zimmer) in Parsippany, NJ. CW13 reported to the assistant director who, in turn, reported to Toni Kingsley, Zimmers VP of Regulatory Affairs in Warsaw, Indiana. While CW13s job titles changed during his employment, his job responsibilities remained the same. He was responsible for registering both foreign and domestic Zimmer TMT products with FDA, including completing and submitting 510(k) filings to the FDA. A 510(k) filing is essentially a pre-market notification or application to the FDA - 36 - of a companys intent to market a new medical device that is substantially the same or substantially equivalent to a product already on the market. Products are classified into risk categories as follows: Class I (lowest risk); Class II (middle of the road risk); and Class III (highest risk). CW13 was responsible for reviewing product materials when initially submitting the 510(k) as well as reviewing materials such as product labels and advertising materials when any changes were made to the materials or the products in order to determine if any of the changes impacted the safety of the products and thus necessitated amendments to the previously submitted 510(k). 100. CW13 explained that companies created the surgical techniques to be used during surgeries with their medical devices and that surgical techniques were required to be submitted to the FDA as part of a companys 510(k) filing. CW13 elaborated that the FDA only requires a draft of the documented surgical techniques, not necessarily the final surgical technique document. CW13 also indicated that the surgical technique documents were compiled in a Word/WordPerfect type document and that they included steps (similar to furniture directions) from preparing the surgical site, laying the patient on the table, the size of the implant being utilized, how to implant the device and perform the surgery, close the incision site and how to provide post-operative care to the patient. At Zimmer, surgical techniques were specific to the medical device being used and the surgery performed. 101. With respect to the surgical techniques, CW13 indicated that usually additional training was only required or needed when a unique device or surgery was involved. He stated most implants, such as hip and knee implants, were common and while some surgical techniques may have included a better way to size or position the implants, he never got the sense that the doctors needed the surgical techniques based on his experience in the industry. Indeed, surgical techniques were not included in the package insert for Zimmers medical devices. Instead, the package inserts provided general information and stated that the device is to be used for Rx or prescription purposes - 37 - only and that whomever is using the device has the training to do so. Most package inserts also included information about the device, its size, what it was made of, indications for its use, warnings and precautions, contraindications, possible adverse events, sterility, instrument care, how to clean the product, the package inserts revision date and company contact information for anyone that might have questions. 102. CW14 joined Zimmer in 1991 and retired in October 2008 as the Corporate VP of Regulatory Affairs. CW14 expresses that to the best of his knowledge Zimmers actions were correct and appropriate. He was part of the Regulatory Affairs Department for approximately 13 years. As the Corporate VP, CW14 was responsible for overseeing the entire Regulatory Affairs Department, including individuals located at different Zimmer facilities. CW14 reported first to Executive VP of Research and Development Cheryl Blanchard and then to VP of Quality Carter. Both Blanchard and Carter reported to defendant Dvorak. 103. CW14 first became aware of the issue with the Pulsavac gun manufactured at the Dover facility in late 2007 or early 2008. According to CW14, Carter and Zimmers corporate headquarters were involved in conducting an investigation of this product. CW14 stated that shortly after the first stain was discovered, a second product was found to have a similar stain. CW14 believed that the second product was also related to a wound debridement system product. CW14 stated that once Carter became aware of this issue with a second product out of the Dover facility, he decided to conduct a more in-depth investigation. CW14 stated that through this investigation, Carter discovered there were other problems at the Dover facility. CW14 stated that these problems were brought to Dvoraks attention through the quality department around the time of the FDAs inspection of the Dover facility, and Dvorak was informed that there were significant issues with the quality systems and that it was recommended by the quality department that the Dover facility be - 38 - shut down until the problem could be satisfactorily addressed; Dvorak agreed to shut down the facility. 104. CW14 stated that Dr. Dorr advised Zimmer of his concerns with the Durom Cup sometime prior to sending the April 2008 letter to the AAHKS. According to CW14, Zimmers practice was to pay attention to concerns raised by doctors. VI. FDA ADVERSE EVENT REPORTS CONFIRM KNOWN PROBLEMS WITH THE DUROM CUP 105. Complaints made to the FDA regarding Zimmers products called adverse event reports confirm defects with its hip product: No. 1 Event Date 12/20/2007 2 3 01/17/2008 03/12/2008 4 03/18/2008 5 6 7 05/06/2008 05/13/2008 05/19/2008 8 05/19/2008 9 05/19/2008 10 05/19/2008 Event Description/Manufacturer Narrative It was reported that the patient complained of hip pain. A revision was done and it was observed the patient had a loose acetabular component with articulate debris in the area of the prosthetic bone surface. The debris resembled fragment bone. It was reported that the patient complained of pain hip. A revision was done and it was observed the patient had a loose acetabular component. It was reported that the device was clinically loose and revised to a tm modular cup. Patient of avn. Radiographs never showed radiolucency around the cup, patient never recovered from pain post-op, start-up pain, pain with movements. It was reported that the device was revised approximately 18 months post-op for pain that did not resolve. At the time of revision, the cup was loose showing no ingrowth. It was reported that the surgeon described as aseptic loosening of the acetabular component, with cellular tissue responses. Loosening/lack of ingrowth. Dr. did a primary total hip in 2008, at hospital using a metasul cup sz. 50. The cup was revised four months later. The cup was loose. It was reported that the device is loose and a revision surgery is scheduled. Well fixed cup on immediate follow-up which turned into a spotty fixation and progressive lines radiolucent around the cup, continuous start-up pain post-op, never recovered from pain. It is reported that the device is loose and a revision surgery is scheduled. Progressive radiolucent lines. Patient had occasional pain for first 3 months, after which started getting start-up pain which became continuous subsequently. It was reported that the device is loose and a revision surgery is scheduled. Progressive radiolucent lines around the cup, continuous pain post-op, pain with activity and movements. Never recovered from pain post-op. Dr. did a primary total hip in 2008, using the metasul cup sz. 50. The cup was revised at about approximately 18 days later, due to the cup being flat and - 39 - No. 11 12 13 14 Event Date 05/19/2008 05/20/2008 07/14/2008 07/21/2008 Event Description/Manufacturer Narrative obviously loose. It was reported that the cup was loosening and lack of ingrowth. It was reported that the cup appeared loose on radiograph Patient indicated pain in hip. A tm modular cup was implanted after the ldh mom was removed. It was reported that the cup loosened and a revision surgery was necessary. It was reported by patient that he underwent a total hip replacement in 2006, utilizing a durum acetabular cup. Post-op, patient experienced pain and was revised in 2008, and loosening of the cup was noted. VII. MATERIALLY FALSE AND MISLEADING STATEMENTS DURING THE CLASS PERIOD A. 106. Materially False and Misleading January 2008 Statements On January 29, 2008, Zimmer issued a press release announcing the Companys financial results for the fourth quarter and full year 2007 and providing guidance of 10%-11% net sales growth and 2008 EPS of $4.20-$4.25 per share as follows: Full year 2008 net sales are expected to be approximately 10 to 11% over 2007, including an approximate favorable foreign currency impact of 2%. Adjusted diluted earnings per share for the full year 2008 are expected to be $4.20 to $4.25, reflecting an increase of approximately 4 to 5% over prior year. The guidance reflects the expected costs for a number of ongoing infrastructure and operating initiatives, including upgrades to the Companys U.S. sales and distribution capabilities, such as inventory tracking and instrumentation; enhancements to information technology and quality systems; increased investments in sales force and other marketing programs in the Spine, Dental and Trauma business units; and startup costs for an expansion of worldwide manufacturing and distribution operations. 107. Later on January 29, 2008, defendants held a conference call with financial analysts who covered Zimmer. During that call, defendants stated: David Dvorak Zimmer Holdings, Inc. President, CEO * * * Turning to our 2008 outlook. We developed our 2008 guidance taking into account our assessment of the market and the opportunities and risks that could impact our performance. Ill now take you through our expectations for our sales and earnings. First, looking at the market for our core reconstructive product categories and geographies, we enter 2008 with positive momentum and underlying market demand for orthopedic devices. When all Company reports are in for 2007, we expect the results will indicate that the global reconstructive market grew in the range of 8 to 10%. We continue to believe this reflects mid single digit growth and - 40 - procedures with the balance due to mix and flat to modest price improvements. We anticipate similar market dynamics in 2008 and slightly higher market growth rates for spine, trauma, dental, and extremities consistent with recent trends. Our outlook calls for top line growth for the year of 10 to 11% net sales on a reported basis and adjusted earnings per share of $4.20 to $4.25. Sales will be driven by new product introductions and further market penetration by key products launched in 2007, as well as the positive effect of a weaker U.S. dollar abroad . . . . * * * Jim Crines Zimmer Holdings, Inc. EVP-Fin., CFO * * * We are changing our approach by only issuing full year guidance. We want to guide the Street as we run the business which is with the longer term perspective and accountability for annual performance. For 2008, we will provide some more detailed guidance with regard to our spending plans and also share with you our thinking on margins and expense ratios. This should give you more information than you have had in the past to help with your models. We hope for now this will strike the right balance between your need for detail and our desire to stay focused on our longer term goals and objectives. As David mentioned, after reviewing market dynamics and our relative opportunities and risk we expect to deliver 10 to 11% top line sales growth in 2008 and adjusted earnings per share in a range of $4.20 to $4.25. 108. Following defendants false guidance, they continued to mislead investors in response to analyst questions as follows: Bob Hopkins Lehman Brothers Analyst Okay, and then finally just to be clear on the philosophy around guidance, I think you were pretty clear on this but these are not aspirational goals, these are things that you expect to meet or exceed; is that correct? David Dvorak Zimmer Holdings, Inc. President, CEO That is correct. * * * Matt Miksik Morgan Stanley Analyst Okay, and then just one last question, just in the past couple of quarters, I think its fair to say that it sounds and looks like youve learned some lessons in terms of forecasting and providing guidance and perhaps managing the business as well. I just wanted to ask if theres anything that you see yourself doing differently - 41 - over the next, as you talk about your quarter and your guidance today or going forward, based on what youve learned say in the last nine months? David Dvorak Zimmer Holdings, Inc. President, CEO Well, Matt, we obviously went through an extremely methodical process to put our 2008 plan together. We described that process broadly to people that weve met with and really all of that hard work puts us in a great position and provides us with nice momentum coming out of the fourth quarter, so were anxious to execute on these plans and optimistic that the were going to have a good year in 2008. * * * Joanne Wuensch BMO Capital Markets Analyst Okay and this question has been sort of asked a couple of different ways but I want to really get my arms around it which is that in the second quarter, the Company met expectations and then guided lower and in the third quarter they met expectations and guided lower and now in the fourth quarter you beat expectations and guided in line with the Street. If you had to say what happened between the last conference call and this conference call, could you just put a couple of items that the may give you some increased confidence in the way of the financial guidance is being provided? Thank you. Jim Crines Zimmer Holdings, Inc. EVP-Fin., CFO Sure, as David explains, weve had the opportunity to go through a very detailed review of our business unit and corporate operating plans, were very pleased frankly with the performance in the fourth quarter relative to our earlier expectations. We see our supply chain and our sales and distribution networks responding to the increase that were seeing in demand across the quarter. That together with the process that we went through gives us the confidence that we have going into 2008 that we will meet or exceed the financial targets that weve set for ourselves. * Tao Levy Deutsche Bank Analyst All right, and you mentioned you talked about investing in compliance and systems. Do you currently have any issues with the FDA, any warning letters, that usually takes a few months for those to be posted, that they may have been issued or 483d? David Dvorak Zimmer Holdings, Inc. President, CEO We dont have any warning letters at this point. * * - 42 * * * Bill Plovanic Canaccord Adams Analyst Great, thank you, just a few questions, clarification questions for me here. First of all just in terms of the double digit earnings growth 09 off of 08, is that off of the 4.20 to 4.25 guidance? David Dvorak Zimmer Holdings, Inc. President, CEO Thats correct. 109. As a result of these statements, Zimmers stock price increased from $68.08 to $77.03 in one day, a 13% increase. 110. On January 30, 2008, Zimmer presented at the Wachovia Healthcare Conference. At the conference, defendant Crines stated: [S]ummarizing our guidance for 2008, we guided to top line of 10% to 11% reported growth. That does include about 200 basis points from currency, so it would translate into 8% to 9% constant currency growth and adjusted earnings per share of $4.20 to $4.25. That reflects about a 4% to 5% growth in adjusted earnings per share over 2007 and includes significant obviously incremental expenses associated with the infrastructure and operating initiatives, as well as monitor and related compliance expenses. * * * Within our core franchise, we would expect to be able to achieve at least low doubledigit growth in earnings going into 09 and have the opportunity to leverage some of these investments beyond 2009. 111. Defendant Crines also stated at the same conference that: We have as well, we look at our hip growth and our performance relative to some of our competitors who have reported higher rates of growth with their hip portfolios would acknowledge that we have not achieved the level of penetration with our alternative-bearing offerings that is near or consistent with what those companies have achieved. That represents a future opportunity for us, one that we need to address in a couple of different ways. With what we have to offer, we do have a large diameter head metal-on-metal offering. Some of the feedback that were getting from the field would indicate that it is a bit challenging to implant, and there are some things we can do in the way of surgical technique training that ought to help us with that level of penetration. As well, there are some things that we would look to do within our development efforts that honestly would not impact on 2008 but would begin to help us out in 2009, get after that opportunity in a more aggressive way. * * - 43 * Again, for that reason, we have a significant portion of our R&D spending focused on maintaining and hopefully enhancing our leadership position in hip and knees across the world . . . . * * * Just touching on the infrastructure and operating initiatives we have underway, we announced yesterday that were looking to expand our international manufacturing capacity by about 100,000 square feet. We are also centralizing our distribution operations in Europe. We are taking the opportunity, as we build out additional manufacturing capacity, to invest in and upgrade our quality systems infrastructure across all of our facilities. Were making some pretty significant investments directed at providing better support to our U.S. sales and distribution efforts, putting more instruments, more inventory out into the field, and also providing them with some more significant incentives particularly focused on that trauma product line. B. 112. Reasons Why January 2008 Statements Were Materially False and Misleading The statements made by defendants in 106-111 above were each materially false and misleading when made. As set forth in I., IV.-VI., the true facts, which were then known to or recklessly disregarded by defendants were that Zimmers Dover, Ohio manufacturing facility had suffered massive quality systems problems which materially impacted the Companys operations and financial performance, including net sales growth and EPS. As set forth in 3, 19-26, 45, 47, 55-77, 82-83, 94, 103, 150-151, defendants knew but failed to disclose that: (a) (b) The Dover facility was antiquated as a direct result of the lack of improvement and had suffered massive quality problems; Defendant Dvorak deliberately did not invest in the quality systems at Dover because the financial and investment targets of the Company were not being met; The Company had recalled OSPs, manufactured at the Dover facility as late as December 2007; In mid-January, following the recall, the FDA performed a week-long inspection of the Dover facility and observed several quality control problems. Subsequently, the FDA issued several 483 letters; By the end of January, production had been halted at the Dover facility, and the Dover facility was not shipping product thereby impacting sales growth; and - 44 - (c) (d) (e) (f) 113. OSPs from the Dover facility were on backorder and OSP sales were declining. In addition, the above-statements were each materially false and misleading because defendants knew months prior to the issuance of Zimmers statements of severe problems with the Durom Cup which would decrease sales and increase expenses as a result of: (a) several surgeons concerns with the Durom Cup, including concerns regarding patient suffering and injury requiring revision surgeries, see 4-6, 27-31, 40-44, 46, 49, 84, 92-93, 104-105, 120; and (b) Zimmers prior negative prior experience with the Durom Cup as described in 46. C. 114. Materially False and Misleading March and April 2008 Statements On March 18, 2008, defendants participated in a Cowen and Company Health Care Conference. Defendants mislead the market as follows: Jim Crines, EVP Finance, CFO, Zimmer Holdings: . . . * * * We manage over 130,000 SKUs. Its a very large and complex portfolio. We have manufacturing and quality systems infrastructure supporting the manufacturing, and delivery, and distribution of those devices around the world, and our products are sold in over 100 countries. And given the size and complexity to this portfolio, the company has recently undertaken a major investment initiative to upgrade manufacturing quality systems, IT systems, infrastructure, investments that we believe will put this company in a position to take full advantage of the growth opportunities that we see in this market in the years to come. * * * We also, as we look at our hip portfolio, recognize and would acknowledge that we have some challenges and opportunities . . . . * * * We have a large diameter head device that we have offered in the U.S. and we understand that there are some challenges, some technique challenges with that device. So there are some things that we need to do in terms of providing training to orthopedic surgeons and some things that we can do, as well, from a development perspective, to address some design differences with respect to our device and how it matches up with competitive devices. Thats something that will take a bit longer. But certainly, the training is something that we can begin to address already in 2008. - 45 - * * * We have, as we talked about on our fourth quarter call [have] three, major priorities for 2008, the first of which is to meet or exceed our financial commitments for this year. 115. On April 3, 2008, Zimmer issued a press release which stated: Zimmer Holdings, Inc. . . . announced today that it has taken a number of actions to improve quality systems at its Dover, Ohio facility, which manufactures Zimmer Orthopaedic Surgical Products (OSP). The Company recently conducted a review of quality systems at the Dover, Ohio OSP facility and initiated voluntary product recalls of certain OSP products manufactured at the Dover facility that the Company has determined do not meet internal quality standards. In addition, the Company has voluntarily and temporarily suspended production and sales of certain OSP products manufactured at the Dover facility. The suspension will permit the Company to focus the OSP organization on the needed improvements to manufacturing and conduct enhanced quality training for employees. The Company has notified the U.S. Food and Drug Administration (FDA), distributors and end-users of the recalls. These recalls do not affect the Companys core hip and knee implants business. The OSP division produces a variety of patient care items used to support orthopaedic surgery, including disposables used in blood management, surgical wound site debridement and cement accessories. In 2007, Zimmer reported revenues from its OSP and Other product category of $234 million, less than half of which were generated by products affected by the recalls and suspension. These actions are expected to adversely impact 2008 OSP revenues by $70 to $80 million. Additional detail on the expected impact will be provided during the Companys first quarter investor conference call on April 24, 2008. 116. Subsequently, on April 24, 2008, Zimmer issued a press release announcing its first quarter financial results as follows: Guidance The Company updated its full year 2008 sales guidance and reaffirmed its earnings guidance. Reported sales for 2008 are expected to increase by 10 to 11% over the prior year. This sales guidance reflects a reduction in constant currency growth to 6 to 7%, countered by favorable foreign currency, now estimated at 4%. Full year 2008 adjusted diluted earnings per share are expected to be in the same range as previously issued guidance of $4.20 to $4.25. These estimates include impact of previously announced actions at the Companys Ohio-based Orthopaedic Surgical Products operation. These actions are expected to adversely impact 2008 - 46 - adjusted diluted earnings per share by $0.18 to $0.20, including $0.07 related to inventory charges, idle plant costs and other nonrecurring expenses. The Company expects this impact to be offset by reductions in planned operating expenses, share repurchases and other actions. 117. Later that day, defendants held a conference call with financial analysts who covered Zimmer. During that call, defendants stated: David Dvorak Zimmer Holdings, Inc. President, CEO * * * We previously explained that we developed our guidance taking into account our assessment of the market and the ongoing opportunities and risks that could cause and impact our performance. Our outlook called for top line growth for the year of 10 to 11% net sales on a reported basis. As we indicated in our fourth quarter call, sales will be driven by new product introductions and further market penetration by key products launched in 2007 and this year, as well as the positive effect of a weaker U.S. dollar a broad. Our guidance for top line growth remains in the 10 to 11% range on a reported basis. The previously announced impact on OSP revenues is expected to be offset by the positive effect of a weaker dollar. In addition, as the year began, we projected earnings per share between $4.20- and $4.25 based on those expectations. Weve maintained that guidance today, after taking into account the negative financial impact well experience as a result of lost sales, inventory losses, and remediation costs in our OSP business. We have also now factored in the anticipated positive financial impact of a number of other planned actions that that Jim will describe in your detail which are expected to offer the negative impact of the OSP situation. On our fourth quarter earnings call, Jim and I previewed a number of significant infrastructure initiatives that will position us to respond to the growing medical needs of an aging population. Chief among these are the investments were making to ensure that we maintain state-of-the-art quality systems and processes in all of our business operations globally. Our ongoing commitment to quality will be unyielding as we continuously improve our quality systems. To that end, our infrastructure investment plans for 2008 are in part directed at opportunities to enhance quality systems across our entire manufacturing network and to ensure the quality systems and practices in all divisions meet or exceed our standards as well as those of agencies that regulate us. As a result of this endeavor, in the first quarter we initiated a comprehensive remediation effort at our OSP division in Dover, Ohio, including voluntary product recalls of certain OSP products, voluntary and temporary suspension of manufacturing and sales of certain products, facilities equipment and procedural upgrades, enhanced quality training for OSP employees, and appointment of a new Divisional President. While were clearly disappointed by the OSP situation, we believe the actions weve taken demonstrate the seriousness with which we take quality systems matters and were keeping the FDA informed of all of our actions. - 47 - * * * Jim Crines Zimmer Holdings, Inc. CFO * * * Now, Id like to provide an update on guidance for 2008. As reported in our press release on April 3, OSP related actions are expected to adversely impact 2008 OSP revenues by 70 million to $80 million. These actions are expected to negatively impact 2008 adjusted earnings per share by $0.18 to $0.20 including $0.07 related to inventory charges, idle plant costs, and other nonrecurring expenses. Approximately $0.03 of the full year effect is reflected in our first quarter results. We expect this impact to be offset by reductions in planned operating expenses, share repurchases, and other actions. 118. On the same April 24, 2008 conference call, analysts openly questioned not only the timing of defendants disclosures but the previously undisclosed financial impact on Zimmers earnings: Bob Hopkins Lehman Brothers Analyst Okay and then one other question I have and Im just curious about the timing of things. Obviously on the fourth quarter call, you guys gave very bullish report, a very bullish tone and yet when we look back at the timing of the FDA recall announcement as it relates to OSP, that was sort of in full swing as you were giving that guidance but it wasnt disclosed, and now were hearing that its an $0.18 to $0.20 headwind for the full year. Im just wondering why didnt you disclose it on the first, on that call on the fourth quarter especially now knowing that its going to be such a major headwind for the full year? David Dvorak Zimmer Holdings, Inc. President, CEO Yes. We had identified a particular recall problem and acted upon that promptly and obviously, the problem was much deeper than what we knew at the time of the call, so work was under way but the scope of that issue had not been defined as of the first quarter call, and so weve reported out on the magnitude of that issue as soon as it was defined, Bob. D. 119. Reasons Why March and April 2008 Statements Were Materially False and Misleading The statements made by defendants in 114-118 above were each materially false and misleading when made. As set forth in I., IV.-VI., the true facts, which were then known to or recklessly disregarded by defendants were that Zimmers Dover, Ohio manufacturing facility had - 48 - suffered massive quality systems problems which materially impacted the Companys operations and financial performance, including net sales growth and EPS, and the Company would not meet guidance in the face of increased expenses and lost sales as a result of the known defects with the Durom Cup. As set forth in 3, 19-26, 45, 47, 55-78, 82-83, 90, 94, 102-103, and 150-151 with respect to Zimmers Dover facility and 4-6, 27-34, 36, 40-44, 46, 49, 84-85, 92-94, 104-105, and 120 with respect to the Durom Cup, defendants knew but failed to disclose that: (a) (b) The Dover facility was antiquated as a direct result of the lack of improvement and had suffered massive quality problems; Defendant Dvorak deliberately did not invest in the quality systems at Dover because the financial and investment targets of the Company were not being met; The Company had recalled OSPs manufactured at the Dover facility as late as December 2007; In mid-January, following the recall, the FDA performed a week-long inspection of the Dover facility and observed several quality control problems. Subsequently, the FDA issued several 483 letters; By the end of January, production had been halted at the Dover facility, and the Dover facility was not shipping product, thereby impacting sales growth; OSPs from the Dover facility were on backorder and OSP sales were declining; Going into March and April, OSPs were still backordered and customers placing orders for OSPs would be given some unspecified later date; Zimmer stopped providing training in OSPs to distributor sales representatives through the Institute; The Dover facility remained shut down after the January 2008 FDA audit; Due to the halt in manufacturing, OSP sales declined steeply; Defendants failed to disclose the known financial impact to investors of the OSP recall and Dover quality system deficiencies, including lost customers; (c) (d) (e) (f) (g) (h) (i) (j) (k) - 49 - (l) There were increased concerns raised by surgeons regarding the Durom Cup, including concerns regarding patient suffering and injury requiring revision surgeries; Defendants knew of Zimmers prior negative experience with the Durom Cup; and There was a noticeable decrease of sales of the Durom Cup. (m) (n) E. 120. Materially False and Misleading May and June 2008 Statements On May 6, 2008, defendants made a presentation at the Deutsche Bank Health Care Conference. At that conference, defendant Crines stated: We have talked in the past about a segment subsegment of the hip portfolio growing at a faster rate than the overall hip portfolio, that subsegment being the alternate bearing offerings that address the needs of a younger patient, where theres an expectation with, for example, the metal-on-metal offerings, that surgeons will be able to achieve better longevity with those devices. In our particular case, we have this Durom cup, which goes with out Metasul large diameter heads. That is our metal-on-metal offering here in the U.S. And, as Im sure many of you know, there have been questions raised by one surgeon in particular in the U.S. concerning high failure rates that hes experienced with about 165 patients, I believe, he has reported. Hes had at least 10 early failures that hes referenced in a letter that he sent out to the Hip and Knee Society and another four patients that he believes hes going to have to revise. At this point I can tell you that we take these issues very seriously. Well have a team of very senior research people meeting with this surgeon and getting beginning to get access to data on these patients so they can begin the analysis of what may have led to the early failures that hes experienced with this device. I will tell you that this device, this construct, has been in the market here in the U.S. since the second half of 2006. There are many surgeons that have had very good clinical results with this device. Its been in the European market for over three and a half years. Theres independent registry data as an example, the Swedish registry thats tracking over 200 patients and out three and a half years is reporting 99.5% survivorship with this device. So what was reported in this letter from this particular surgeon at this point I can tell you is somewhat isolated it would appear to be somewhat isolated to this particular surgeons experience. I will also tell you that we did receive somewhat similar indications in the European market in the early part of 2007 with a couple of surgeons in France. We were able to trace their experiences to issues with the technique that the were using. This is a cup that once its seated up into the acetabulum cannot be repositioned. And we have had situations where this particular situation in France where a couple of surgeons had experienced early failures as a result of the technique that they were using where they were repositioning the cup after it had been seated up into the - 50 - acetabulum. So we were able to address that particular issue with surgical technique training. Thats an issue I can tell you that we paid a lot of attention to here in the U.S. as this product has been launched into the U.S. Theres a lot of information thats provided to our sales reps, training thats provided to our sales reps, so theyre able to convey to any surgeons that are using this device the importance of following the technique. 121. Analysts asked defendants the following questions during the May 6, 2008 conference call: Tao Levy Deutsche Bank Securities Analyst, Moderator I mean, what struck me as we were digging over the weekend regarding this issue, and I had never heard of Dr. [Dorr] personally before, but we talked to a few surgeons over the weekend. Some of them refer to him as the father of hip arthroplasty. Hes very well regarded. And it seems like from his letter, at least, that he did have an early dialog with Zimmer, and I dont know what really happened there, but felt that he needed to go out to the public. Do you care to get into the relationship that you have with this surgeon? I understand he is a consultant for Zimmer, a fairly well-paid consultant, or was. Jim Crines Zimmer Holdings, Inc. CFO Well, the issue what were focused on are the issues that he raises concerning his clinical experience. And, as I said, we take that very seriously. Were going to have a team of very senior people working with Dr. Dorr to get an understanding of what may have contributed to the failures that he has experienced. Concerning his motivation to address this issue the way that he has, thats not something I want to speculate on. Youd have to talk to Dr. Dorr. I understand in his letter, which Ive seen, he references his prior experience with the InterOp cup. And those of you who dont know the story concerning the InterOp cup, that was a Centerpulse product that failed in large numbers of patients. And that may have that experience that he had had back then and that was as a result of a manufacturing issue with that cup certainly may have weighed, I understand, from what he put in his letter, into his thinking behind putting a letter out to his peers. Tao Levy Deutsche Bank Securities Analyst, Moderator But as far as Zimmer is concerned, I mean, in terms of the product properly manufactured, working well with the proper technique, data out of Europe and out of Australian registries, no reason to pull this thing off the market. Its still a very good product. Jim Crines Zimmer Holdings, Inc. CFO We have no plans at this stage to recall this product. - 51 - * * * Tao Levy Deutsche Bank Securities Analyst, Moderator So to follow up on the prior question, so how does this play out now here in the U.S.? The letter goes the surgeon, prominent surgeon, puts out a letter to gets sent out to his peers. I know its early, but have you gotten any other feedback from surgeons, either positive or negative, that have actually seen that as well but just havent talked about it yet? Jim Crines Zimmer Holdings, Inc. CFO Well, at this stage I can tell you that we have received lots of calls, but its we need to give our technical people the opportunity to get in and get busy with Dr. Dorr and his partner in understanding, as I said, what may have led to and what may have contributed to the failures that he has experienced. And until such time as we can complete that analysis and respond to his letter with our findings, theres really again, we have to hes raising an issue, a clinical issue. We have to treat that very seriously, and were not going to speculate on what might be leading to those failures until that analysis is completed. So theres not much that we can tell those surgeons. 122. stating that: Durom Acetabular Cups contributed to new product sales for the three month period ended March 31, 2008 and Durom-related procedures generally account for 5 to 10 percents of our hip sales in the U.S.; however, sales of this product during the remainder of 2008 may be adversely affected as a result of certain reports of unusually high rate of revision . . . . * * * On May 12, 2008, Zimmer filed its Form 10-Q for 1Q08 which misled investors by Gross profit as a percentage of net sales was 76.0 percent in the three month period ended March 31, 2008, compared to 78.3 percent in the same 2007 period. The primary contributors to the decrease in gross profit margin were the increase in period over period hedge losses, increased inventory charges due to the OSP related actions and an increase in excess inventory and obsolescence charges . . . . * * * We are conducting an on-going investigation into certain reports of an unusually high rate of revision of the Durom Acetabular Cup. We have not completed our review and analysis of the relevant data and we will continue to investigate to try to determine what factors may be contributing to these reports of a higher revision rate. Depending upon the outcome of our investigation, this matter could result in product liability lawsuits and claims, safety alerts or product recalls - 52 - which, regardless of their ultimate outcome, could have a material adverse effect on our business and reputation. 123. $66.85. 124. On June 18, 2008, Zimmer made a presentation to investors at the William Blair & On this news, Zimmers stock price dropped approximately 4% from $69.56 to Company Growth Stock Conference. At that conference, defendant Crines stated: We have, at the moment some challenges within our hip portfolio. I think most are aware of the letter that went out from an individual surgeon concerning our Durom cup product. Thats our large diameter head, metal on metal offering thats going into again, this younger patient segment of the hip market. That is, I would acknowledge, probably the fastest growing segment of the hip market. In this letter, the surgeon raised concerns, questions about this particular device and the experience that he has had with it. We have an ongoing investigation. Our technicians within our research organization are getting out and meeting with other users of this device and studying the results that those other users have had with this device. And as we work our way through this investigation, if we come across any issues or concerns with respect to patient safety, well take appropriate action. At this time we have had no indication that there are any issues with patient safety. The investigation is still ongoing and we expect to be able to provide a more detailed update with respect to conclusions that the team reaches on our secondquarter investor call. F. 125. Reasons Why May and June 2008 Statements Were Materially False and Misleading The statements made by defendants in 120-124 above were each materially false and misleading when made. As set forth in I., IV.-VI., the true facts, which were then known to or recklessly disregarded by defendants were that Zimmers Dover, Ohio manufacturing facility had suffered massive quality systems problems which materially impacted the Companys operations and financial performance, including net sales growth and EPS, and the defendants knew that the Company would not meet guidance in the face of increased costs and lost sales as a result of the known defects with the Durom Cup. As set forth in 3, 19-26, 45, 47, 55-78, 82-83, 90-94, 102- - 53 - 103, and 150-151 with respect to Zimmers Dover facility and 4-6, 27-34, 39-44, 46, 49, 84, 85, 92-94, 104-105, and 120 with respect to the Durom Cup, defendants knew but failed to disclose that: (a) (b) (c) The Dover facility was antiquated as a direct result of the lack of improvement and had suffered massive quality problems; The Company had recalled OSPs manufactured at the Dover facility as late as December 2007; In mid-January, following the recall, the FDA performed a week-long inspection of the Dover facility and observed several quality control problems. Subsequently, the FDA issued several 483 letters; By the end of January, production had been halted at the Dover facility and the Dover facility was not shipping product, thereby impacting sales growth; OSPs from the Dover facility were on backorder and OSP sales were declining; Going into March and April, OSPs were still backordered and customers placing orders for OSPs would be given some unspecified later date; Zimmer stopped providing training in OSPs to distributor sales representatives through the Institute; The Dover facility remained shut down after January 2008 FDA audit; Due to the halt in manufacturing, OSP sales declined steeply; Defendants failed to disclose the known financial impact to investors of the OSP recall and Dover quality system deficiencies, including lost customers; There were increased concerns raised by surgeons regarding the Durom Cup including concerns regarding patient suffering and injury requiring revision surgeries; Defendants knew of Zimmers prior negative experience with the Durom Cup; and There was a noticeable decrease of sales of the Durom Cup. (d) (e) (f) (g) (h) (i) (j) (k) (l) (m) G. 126. The End of the Class Period On July 11, 2008, the headline of a news story by Jon Kamp of the Dow Jones Newswires read: Earnings Preview: No Holiday Lull in US Med-Device Sector 2Q. The article stated: - 54 - Orthopedic companies Stryker Corp. (SKY) and Zimmer Holdings, Inc. (ZMH) will be closely watched for details on some product-related problems, however. The issues include a recall of replacement hip parts at Stryker that dampened first-quarter hip sales, and potential problems with a Zimmer hip part that a doctor raised publicly in April. 127. On July 22, 2008, Zimmer issued a press release announcing the Companys financial results for the second quarter of 2008 stating: Durom Acetabular Component Zimmer is temporarily suspending marketing and distribution of the Durom Acetabular Component (Durom Cup) in the U.S. on a voluntary basis, while the Company updates labeling to provide more detailed surgical technique instructions to surgeons and implements its surgical training program in the U.S. The Durom Cup will continue to be marketed without interruption outside the U.S. While many surgeons have had success implanting the Durom Cup since it was launched in the U.S. in 2006, a subset have reported cup loosenings and revisions of the acetabular component used in total hip replacement procedures. These results contrast with product experience in Europe, where post-marketing data continue to show excellent clinical outcomes since the product launched in 2003. Following a comprehensive review of clinical experience and product conformance to specifications in the U.S. and Europe, Zimmer has found no evidence of a defect in the materials, manufacture, or design of the implant. The Company has identified that surgeons who regularly achieve the desired outcome with the Durom Cup consistently execute crucial technique steps and place the cup in a specific manner. Following its review, Zimmer has determined that revised surgical technique instructions and a surgical training program are required to more consistently achieve desired clinical results in the U.S. The Company has shared its review and conclusions with the U.S. Food and Drug Administration and will continue to update the Agency. While the Company believes the likelihood of currently implanted patients requiring revision is low, Zimmer has sent a letter to U.S. surgeons advising them to stop implanting the Durom Cup, until the updated labeling is issued providing more detailed surgical technique instructions and they receive training. Additional information is being made available at http://www.zimmer.com/. Guidance The Company is revising its guidance and expects full-year 2008 sales growth to be in a range of 8.5% to 9.0% over the prior year, which reflects constant currency growth of 4.5% to 5.0%. This compares with prior guidance of 10% to 11% reported and 6% to 7% constant currency growth over prior year. The adjustment to sales guidance includes a projected loss of $20 to $30 million in hip product sales pertaining to the Durom Cup in the U.S., weakness in U.S. Dental - 55 - revenues and slower than anticipated uptake on certain new products. Adjusted diluted earnings per share for the full year are expected to be in a range of $4.05 to $4.10, as compared to prior guidance of $4.20 to $4.25. Revised earnings guidance gives effect to the reduction in sales from prior guidance as well as an increase in operating expenses associated with the global implementation of the Companys enhanced compliance program. Further details regarding the revised guidance will be discussed during tomorrows investor conference call. 128. As a result of these disclosures, Zimmers stock price declined from $70.88 to $66.01, a 7% drop in one day, as artificial inflation came out of the stock price. 129. On July 23, 2008, defendants held a conference call with financial analysts who followed Zimmer. On that call, defendants stated: David Dvorak Zimmer Holdings, Inc. President CEO * * * As we communicated last night, we have completed an extensive investigation into the performance of the Durom Cup here in the United States, following reports of cup loosenings and revisions of acetabular component in some patients who have undergone total hip replacement. While many US surgeons have had success with the Durom Cup since its launch, a subset have experienced elevated revision rates. This observation clearly contrasts ongoing positive clinical experience in Europe, where the product has been available since 2003. We launched a rigorous investigation, which included a thorough review of manufacturing processes, design specifications, production documentation and clinical experience in the US and Europe. Based on the results of that investigation we will temporarily suspend marketing and distribution of the Durom Cup in the US. We will update labeling to provide more detailed surgical technique instructions to surgeons and prepare to implement a comprehensive surgical technique training program for the US. We have reviewed our investigation and conclusions with the US Food and Drug Administration, and are actively communicating with surgeons now through multiple channels to explain this field action and identity and address their related needs. Were also communicating with customers around the world to clarify that the Durom Cup will continue to be marketed and distributed outside the United States without interruption. - 56 - Our primary objective in taking prompt action based on the results of our Durom investigation is to ensure better clinical outcomes for patients. We believe that the likelihood of currently implanted patients requiring revisions is low. But we want to make sure that we are clear with our US surgeons that they should stop implanting the Durom Cup until we issue the updated labeling that provides more detailed guidance on surgical technique, and until they receive training. We also, of course, want to make sure we support surgeons in every way we can as we implement these actions. With this goal in mind, we will provide clinical management guidelines to assist surgeons in the ongoing evaluation of patients currently implanted with the Durom Cup. Within the next several weeks we will issue a further communication to US surgeons that provides them with updated labeling, including more detailed surgical technique instructions. We also are working with experts in Europe and the United States to develop a robust surgical skills training curriculum. Following initiation of the new training program, the Durom Cup will be made available to US surgeons again as they complete training. Were confident that these measures are the prudent and responsible course of action. And we are committed to conducting them in a manner that demonstrates our deep commitment to patients and our customers. * * * We made good progress during the quarter on our quality systems upgrades. With respect to our orthopedic surgical products operation in Dover, Ohio, our remediation plans continue as scheduled. And we expect to have most, if not all, of OSP products back in production by the end of this year, many in the next two or three months. * * * During the quarter Jim, Cheryl and I, as well as many other members of our senior management team, personally met with over 100 surgeons. We explained the chronology of events of the past year or so, where we are today, and how we believe our surgeon relationships will carry forward. While this process certainly has not been easy, and we have addressed many tough and fair questions, I will tell you that it is great to be reengaged with our surgeon community. * * * I will now turn to our updated guidance for the full year 2008. Jim will provide more details momentarily. Due to the developments in the second quarter, including Durom, we are revising our expectations for 2008 fully full year sales growth to 4.5% to 5% constant currency. - 57 - Were also lowering our adjusted earnings guidance for the full year to be between $4.05 and $4.10 per fully diluted share. * * * Jim Crines Zimmer Holdings, Inc. EVP Finance, CFO * * * Sales of $1,080 million for the quarter represent an increase of 11.2% reported and 5.5% constant currency. These results, among other things, reflect the benefit of one additional selling day in the quarter compared to same period in the prior year, strong underlying unit growth in knees in all three of our operating segments, and lower OSP, Durom and dental product sales. * * * In the US Durom Cup sales volume was off 26% from our first quarter in response to reports of loosenings and revisions. Durom Cup sales units outside the US grew by over 10% in the second quarter compared to same period prior year. These results, absent Durom-related losses, reflect steady growth across our primary hip portfolio, including porous primary stems and our Trilogy and TM Acetabular Cups. * * * The OSP and other category was down 15.6% in the Americas, declined 26.8% in Europe, and was down 17.3% in Asia-Pacific compared with the prior year period. * * * Now I would like to provide an update on guidance for 2008. We expect to deliver topline sales growth in 2008 of 8.5% to 9% compared to the original 10% to 11% range. And adjusted earnings per share in the range of $4.05 to $4.10. Our sales guidance anticipates approximately 4 points of growth to come from foreign currency, and therefore assumes a constant currency growth rate of 4.5% to 5%. The adjustment to our sales guidance includes a projected loss of $20 million to $30 million in hip products sales, pertaining principally to Durom Cup in the US, weakness in US Dental revenues, and slower than anticipated uptake on certain new products, partly due to delays in offering training programs in support of the new products introductions. * * * - 58 - Tao Levy I I was wondering maybe if you could spend a few minutes going through you did mention as we move into 2009 some of the headwinds you are facing in 08 start to disappear. I was wondering if you could quantify the three main areas and the impact that youre seeing this year, and what percentage of that could disappear in 09? I would love it if you could hit Durom, OSP and the compliance monitors. Jim Crines Zimmer Holdings, Inc. EVP Finance, CFO This is Jim. First of all, with respect to I guess will start with OSP. As David indicated and I indicated in my comments, were on schedule with our remediation efforts. Expect to be back in production of those patient care products between now and the end of the year. And have the opportunity to go back into the market as those products come back online. Going into 2009 we would look to get back as much of that $70 million to $80 million as we lost as we possibly can. We wouldnt expect to get [it] all back. But we will certainly be back in the market with those products and pursuing opportunities to regain share in that segment. * Bruce Nudell UBS Analyst I have two questions actually. The first just pertains to Durom itself. In your background you mentioned 1.1% failure rate for people who knew what they were doing and around 6% for groups that really werent following the protocol exactly. What is the aggregate what is the anticipated aggregate revision rate, early revision rate with the product, given the disparities in training? And how much reputational damage could do that cause, given the 13,000 implants that have taken place to date? David Dvorak Zimmer Holdings, Inc. President, CEO Im going to let Cheryl respond to that question. Cheryl Blanchard Zimmer Holdings, Inc. Chief Scientific Officer I think the best way to answer that question is, first of all, to understand that what our analysis tells us to date is that the likelihood of currently implanted patients requiring revision is going to be low. I will tell you that in our detailed analysis of the clinical aspects of those investigations, you did see in the backgrounder piece that in the group that had - 59 * * success with the device that they had about a 1.1% revision rate, while the other groups were at 5.7%. It is very difficult for us to project out where we think those numbers are going to go eventually. What I can tell you is that we were able to discern the there were some specific elements of surgical technique and cup placement that are the items that really make the difference in terms of those clinical outcomes. I think it is difficult to comment on the last part of your question, which is reputational damage. I think that will frankly be determined by the actions that we have taken today and our level of being proactive as we move forward, trying to work with surgeons to help them get through this difficult situation with their patients. We absolutely recognize that for those patients that are involved that there will be some items that we will need to help them with, and were going to be proactive about that. * * * Michael Jungling Merrill Lynch Analyst * * * Secondly on Durom, the $20 million to $30 million worth of sales, can you indicate how much that is in terms of annual sales? I think it is pretty much the entire amount. * * * Jim Crines Zimmer Holdings, Inc. EVP Finance, CFO This is Jim. With regard to Durom, as we indicated in earlier comments, it represents about 5% to 10% of our hip revenues in the US. It happens to be the case as well outside the US. If you look at how, and we look at how that product was growing coming into the year, coming out of the first quarter before reports of loosenings and revisions, we were trending clearly to the high end of that range. And the $20 million to $30 million, again principally associated with Durom, does get you to two-thirds to the full amount. But as I indicated, with regard to the hip franchise theres also the impact that some disruption that training is having on the new products that we reintroduced in the hip portfolio, namely the M/L taper with Kinectiv and the Fitmore and the EPOCH devices, that were focused on in the second half of year as well. - 60 - 130. On July 23, 2008, analyst Ben Andrew of William Blair & Company issued a report on Zimmer which stated: Zimmer announced it is suspending the marketing and distribution of Durom in the United States, which has been the major concern for investors in the past couple months. 131. On July 29, 2008, The New York Times published an article entitled, A Call for a Warning System on Artificial Joints, which stated: Dr. Lawrence Dorr, a nationally known orthopedic surgeon in Los Angeles, realized last year that something was very wrong with some of his patients. Months after routine hip replacements, patients who had expected to live without pain were in agony. The pain was grabbing me around the back, said Stephen Csengeri, who is 54, and a lawyer from Torrance, California. Dr. Dorr found he had implanted the same metal hip socket in each patient. Several needed surgery again a replacement for their replacement. The doctor first told the devices manufacturer, Zimmer Holdings, last year about his concerns but nothing happened. Then in April, Dr. Dorr, who was a highly paid consultant for Zimmer, sounded an alarm to colleagues in a professional association and soon heard back from doctors with similar experiences. I saw one of Zimmers engineers at a meeting, and I told her that you should pull this cup because you are crippling patients, Dr. Dorr said. 132. On Aug...
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