ZIMMER HOLDINGS, INC. AND SUBSIDIARIES 2003 FORM 10-K CONTRACTUAL OBLIGATIONS CRITICAL ACCOUNTING ESTIMATES The Company has entered into contracts with various third parties in the normal course of business which will require future payments. The following table illustrates the Company’s contractual obligations: The financial results of the Company are affected by the selection and application of accounting policies and methods. Significant accounting policies which require management’s judgment are discussed below. Excess Inventory and Instruments – The Company must determine as of each balance sheet date how much, if any, of its inventory may ultimately prove to be unsaleable or unsaleable at its carrying cost. Similarly, the Company must also determine if instruments on hand will be put to productive use or remain undeployed as a result of excess supply. Reserves are established to effectively adjust inventory and instruments to net realizable value. To determine the appropriate level of reserves, the Company evaluates current stock levels in relation to historical and expected patterns of demand for all of its products and instrument systems and components. The basis for the determination is generally the same for all inventory and instrument items and categories except for work-in-progress inventory, which is recorded at cost. Obsolete or discontinued items are generally destroyed and completely written off. Management evaluates the need for changes to valuation reserves based on market conditions, competitive offerings and other factors on a regular basis. Centerpulse historically applied a similar conceptual framework in estimating market value of excess inventory and instruments under International Financial Reporting Standards and U.S. generally accepted accounting principles. Within that framework, Zimmer and Centerpulse differed however, in certain respects, to their approaches to such estimation. Following the acquisition, the Company determined that a consistent approach is necessary to maintaining effective control over financial reporting. Consideration was given to both approaches and the Company established a common estimation technique taking both prior approaches into account. This change in estimate resulted in a charge to earnings of $3.0 million after tax in the fourth quarter. Such change is not considered material to the Company’s financial position, results of operations or cash flows. Income Taxes – The Company estimates income tax expense and income tax liabilities and assets by taxable jurisdiction. Realization of deferred tax assets in each taxable jurisdiction is dependent on the Company’s ability to generate future taxable income sufficient to realize the benefits. The Company evaluates deferred tax assets on an ongoing basis and provides valuation allowances if it is determined to be ‘‘more likely than not’’ that the deferred tax benefit will not be realized. Federal income taxes are provided on the portion of the income of foreign subsidiaries that is expected to be remitted to the U.S. The Company operates within numerous taxing jurisdictions. The Company is subject to regulatory review or audit in virtually all of those jurisdictions and those reviews and audits may require extended periods of time to resolve. The Company makes use of all available information and makes reasoned judgments regarding matters requiring interpretation in establishing tax expense, liabilities and reserves. The Company believes adequate provisions exist for income taxes for all periods and jurisdictions subject to review or audit. Commitments and Contingencies – Accruals for product liability and other claims are established with internal and external counsel based on current information and historical settlement information for claims, related fees and for claims incurred but not reported. An actuarial model is used by the Company to assist management in determining an appropriate level of accruals for product liability claims. Historical patterns of claim loss development over time are statistically analyzed to arrive at factors which are then applied to loss estimates in the actuarial model. The amounts established represent management’s best estimate of the ultimate costs that it will incur under the various contingencies. 28 Less Than 1 - 3 4 - 5 After Contractual Obligations Total 1 Year Years Years 5 Years Long-term debt $1,103.0 $100.0 $655.3 $347.7 $ – Capital leases 6.1 1.3 3.7 1.1 – Operating leases 77.2 23.0 32.3 9.2 12.7 Purchase Obligations 13.3 13.3 – – – Other long-term liabilities 352.6 – 139.9 42.0 170.7 Total contractual obligations $1,552.2 $137.6 $831.2 $400.0 $183.4