Zimmer Biomet Holdings Inc (ZBH) 2004 Q2 法說會逐字稿

This presentation includes certain measures, a reconciliation of such information to the most directly GAAP financial measures along with the other financial and statistical information for the period to be presented on this conference call was included in a press release announcing earnings release which may be accessed from the Zimmer website at www.Zimmer.com under the section entitled investor relations.

All lines have been placed on mute to prevent any background noise.

After the speaker's remarks, there will be a question and answer period.

If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad and if you would like to withdraw your question, press star, then the number two.

Thank you.

I would now like to turn the call over to Mr. Ray Elliott.

Sir, you may begin.

Good.

Thank you, Matthew.

Good morning, everyone.

Welcome to the Zimmer second quarter 2004 conference call.

We're pleased to be hosting this call to discuss a strong second quarter and year to date performance and as well, to reaffirm the belief in our ability to create a great orthopedics business based on third full quarter of combined operations with Centerpulse and plus the addition of Implex.

We continue to make excellent progress within the complex challenges that face us.

Joining me on the call today are Sam Leno, our Executive Vice President and Chief Financial Officer, and Jim Crines, our Senior Vice President and Corporate Controller.

Hopefully you received a copy of last night's earnings release, if not, you can obtain a copy from our website at www.Zimmer.com.

Alternatively, please feel free to contact Sam, Mark Austerman(ph), our IR Manager joining us from Centerpulse in Zurich and now residing in Warsaw, or myself.

We'll begin today's call with brief comments related to our second quarter 2004 and year-to-date including an update on operations followed by a Q&A discussion.

All results discussions are based on an asset method of accounting for instruments and all comments and comparisons are on an adjusted basis .

Unless otherwise specified, the quarter comparisons in sales have utilized Centerpulse's actual second quarter 2004 and 2003.

All discussion unless otherwise noted excludes acquisition integration expenses and inventory step-up.

We will include our usual sequential analysis on a combined basis where they provide useful insight.

We will communicate where helpful references in the quarter to legacy Zimmer and legacy Centerpulse standalone performances to give you historical context.

As with the first quarter 2004, given the effective integration process and the true commingling of expenses and operations, there will be virtually no commentary below the sales line on a legacy basis.

Vowing to relentless external pressure we will reduce our formal comments from an hour and a half to about 50-60 minutes.

We will do our best, though, to maintain high quality disclosure.

Once again, publicly, I wish to thank our new Zimmer team, both Centerpulse and Zimmer employees for the exceptional work in the last nine months and not just the hundred full-time integration people managing more than 3000 integration milestones, but the hundreds of employees who stepped up to the task with many, many hours beyond their regular jobs in the midst of very rapid change.

It's not easy and all of those people are the real heroes.

Also, I want to take this opportunity to officially welcome the team from Implex.

We're proud to have you on board.

At this point, we're very pleased with the results but more on integration later including a 2004 through 2006 update on projected net synergies that will hopefully be useful to you in your models.

As our press release indicated, we take very seriously our commitment to deliver on the expectations communicated both when we became a public company in 2001 and with the acquisition of Centerpulse.

I've been traveling in Switzerland and Italy over the past two weeks and have watched CNBC and the markets with some amazement.

I would respectfully submit as Mark Twain put it so well, rumors of our demise are greatly exaggerated.

In Zimmer's case the concept of guilt by association holds little relevance.

We believe that the orthopedic space is all about choices.

Let me begin with the fundamentals of the Zimmer P&L and balance sheet performance.

Consolidated sales for the second quarter were 737 million, an increase on a combined basis of 14% over prior year and much closer to the first quarter sales than we originally expected.

Our guidance with respect to Europe, distributor returns and one less billing day proved to be in the right range.

However, foreign exchange tailwind provided $8 million less in sales than we forecasted.

As a result of this declining tailwind, we're particularly pleased with being about $4 million over street consensus and about $10 million over the midpoint of the company's guidance.

In the second quarter legacy Zimmer delivered an 18% improvement and legacy Centerpulse business 6% growth.

Importantly, 13 major countries delivered sequential quarterly sales growth, despite the synergies, distributor restucturing and one less billing day.

Worldwide combined sales and constant currency increased 11%, only 1% less than the first quarter.

However, adjusted for day rate sales in the quarter, the rate of constant currency growth was unchanged from the first quarter.

This 14% combined reported volume was composed of real volume mixed growth of 9% in the quarter, the same as it was in the first quarter.

Here's an extremely important point.

For Zimmer, global reconstructive volume and mix growth, i.e. no price, no foreign exchange, was actually up sequentially 1% to 11% growth in the second quarter versus 10% in the first quarter.

Worth seeing a gain.

Real recon procedure and mix growth was sequentially up 1%.

Worldwide price improvement remained firm at 2% and within our forecasted 2 - 3%, but with the Americas at 4%, still better than anticipated.

Here's a few data points for your consideration.

The average price impact for Zimmer in the last four quarters prior to this one in the Americas has been 3.9%.

This quarter it accelerated to 4.2% and this is pure price without mix.

Europe remained in positive territory and price and Japan was negative 4.9% as the April 1 government change took effect.

But it is a biannual change and therefore averages only about 2.5% per year.

In short, Zimmer's positive 2.1% price in the quarter compares to a previous four-quarter average of 2.7%.

If you correctly analyze Japan, our pricing world is at positive 2.4%, dead in the middle of a very acceptable 2 - 3% range that we have forecasted for sometime and virtually unchanged from recent prior history.

Year to date sales are 1.48 billion, up 17% combined and 12% constant currency.

Our plan for the business when we announced the deal and provided guidance was to deliver 10% sales growth the first year or two, basically try to stay in double digits while we completed the integration process.

We're currently well ahead of that pace.

Our combined Americas business delivered excellent growth in the quarter at 16% with the legacy Zimmer at 21% growth and legacy Centerpulse at 3% growth.

Year to date, the Americas growth is consistent with the quarter at 16%.

The new combined Europe performed well above our expectations in the quarter at 10% reported and 3% constant currency.

Adjusted for currency comparisons to prior quarter and distributor realignments, our Europe business remains amazingly solid in the face of considerable change and I expect represents a lot slimmer pickings during the integration than our competition probably expected.

The large legacy Centerpulse Europe business has been flat in constant currency for most of the last two years and accelerated sales this quarter by 3% over that historic average.

On a year to date basis, Europe sales increased 17% on a combined reported basis and 6% constant currency.

We did clean up most of the changes in our European distribution network and at close to the range of sales returns anticipated.

Any remaining distributor reorganization work for the third and fourth quarters is di minimus in nature and not expected to have any material or visible effect on sales or earnings for those periods.

Asia Pacific sales grew by 13% reported, 4% constant currency with little change other than the afore mentioned anticipated Japan pricing offset by absolutely stellar growth in greater China.

On a worldwide basis, it was our reasonable belief that we would significantly lag both global and individual geographic markets in sales growth for about 18 to 24 months from the accusation date of October 2003.

At 17% year to date reported and 12% local currency, this is clearly not turned out to be the case.

At 18% growth in recon year to date, we are at the very least holding our own, but in the end, I believe we are already taking a little recon share of gain.

We anticipated losing $50 million in sales to synergies with about 80 - 85% of that, or 41 million annualized, occurring in the first nine months.

Our actual annualized sales to synergies have been 40.4 million to the end of the second quarter 2004.

While we expect to reach the $50 million or so mark in sales to synergies by year end, we also expect it to be the maximum.

We are beginning to slowly plan modest recovered sales in cross training benefits that should accrue to our favor mostly in 2005.

We're very pleased with the second quarter and perhaps more importantly where we expect to be at the end of the year.

Our increase in guidance of $15 million for the year is actually an increase of $55 million in the underlying business when you consider the $40 million decline related to foreign exchange.

We remain bullish on our business.

I'll return to some detailed sales analysis in a few moments, but in the end, the heart of the deal was devoted to accretive earnings per share over the next several years.

On that note, our excitement remains more than palpable.

Adjusted diluted earnings per share for the second quarter were very strong at 58 cents on 247.9 million average outstanding diluted shares or an expansion worth noting of some 1.5 million shares from prior quarter.

We delivered an EPS increase of 29% over prior year and 3 cents better than the first call consensus EPS estimates of 55 cents.

The 58 cents represents a solid view of the business on an adjusted basis.

The reason I say solid view is simple.

The only two real unusuals in the quarter are the year to date true up of the effective tax rate and the absorbence of short-term Implex dilution offsetting each other at just under a penny of EPS each.

Out second quarter EPS of 58 cents was therefore fully operationally based and represented a 4% sequential increase over the adjusted EPS for the first quarter of 2004.

The story remains clear.

The acquisition of Centerpulse was accretive before the beginning of 2004.

With our new guidance as provided today, we now expect it to be in its first year when combined with our regular efforts, 20% accretive versus Zimmer's standalone 2004 First Call estimate of $1.91 at the time of the acquisition.

Year to date EPS on adjusted basis was $1.14 and up a very strong 33% on 247.2 million average outstanding diluted shares.

We're obviously very pleased with the combined companies efforts to drive each line of the P&L, attack integration synergy opportunities early while simultaneously finding new opportunities for the future and of course emphasize our trademark focus on cash flow and debt paydown.

We have returned to at least one legacy Zimmer milestone in less than one year, the 75 gross, 30 operating and 20% net margin combination.

The combined gross profit margin in the quarter for the new company exceeded our own expectations and expanded a gain to 75.1%, up 50 basis points from our first quarter directly related to geographic and product mix, price, and strong manufacturing cost management performance.

Despite the obviously higher European legacy Centerpulse content we believe that at 75% our gross margin remains one of the best in the industry and now matches the legacy Zimmer business of only a little over one year ago.

Our efforts have only just begun.

SG&A expenses and operating expenses as a ratio to sales are well managed at 40.3 and 45.5% respectively, but appear to have not improved from the first quarter.

This is not the case since we absorbed about $3 million of incremental operating expenses due to the Implex acquisition with no corresponding increase in sales.

This had the effect of elevating expenses by 40 basis points in the current quarter and therefore we are more than 100 basis points better than our first quarter of combined operations.

We expect over the next year or two that our R&D ratio to sales this quarter at 5.2% will return to the 5.5 - 6% range as investments in spine, biologicals and new technology offset eliminated duplicate projects.

Most of the significant SG&A expense reduction opportunities of course incur as part of the integration process.

And I'll cover these in a later section.

It is, however, worth pointing out that over the next two years from January of 2004, we anticipate being able to reduce SG&A by at least 200 basis points.

Combined operating profit in the quarter reached almost 219 million.

We are very excited by the return to a 30% adjusted operating profit ratio to sales in the second quarter, up sequentially by 50 basis points from first quarter 2004 and again back to an original Zimmer performance metric.

Operating profit year to date is 435 million, well ahead of our expectations and with a year to date ratio to sales of 29.4%.

Speaking of original Zimmer metrics, we have always believed at Zimmer that we can produce 40-50 cents of operating profit for each new incremental dollar in sales, provided that there were no unusual period reinvestments in the business.

This philosophy remains at the heart of our thesis in running the new Zimmer.

From our first quarter as a new combined business to the end of what is now our third quarter together, we have produce a sequential gain in sales of almost $36 million and in the same time period a sequential gain in operating profit of almost $23 million for a drop-through rate of over 60%.

This drop-through rate emphasizes the power of both natural earnings capability compounded with the strength of synergies from the deal itself.

There are very few businesses in the world that generate 60 cents of operating profit on each new sales dollars.

Zimmer has been at best a very limit user of EBITDA as a comparator.

It's a non-U.S.

GAAP measure that has tended to be overused by industry in general.

Conversely, with the Centerpulse and Implex acquisitions and the relevant implications of both interest and amortization, it will continue to be useful for us in 2004 and 2005.

EBITDA in the second quarter is already 36% as a ratio to sales on an adjusted basis and a significant improvement of 120 basis points sequentially from the first quarter of 2004.

EBITDA is already providing 32 times interest coverage despite this early stage of deal integration.

In the second quarter, actual acquisition and integration costs were reduced by 7 million or almost 25% from the first quarter.

Adjusted net earnings in the period were very strong at 144 million, a magical, at least for us, 20% ratio to sales and a very strong 100 basis points sequential improvement from first quarter 2004.

It's a good beginning when you consider that over the next year or two, we expect to reduce our tax rate to under 30%, delivering significant ongoing leverage effect to net earnings when combined with debt pay down.

As previously mentioned, adjusted diluted EPS in the quarter includes 29% to 58 cents with 247.9 million average diluted shares outstanding at $1.14 year to date.

We're particularly pleased with these results because they once again reflect strong performance on not one or two lines, but rather on every single line of the P&L, while being in a very early stage of the Zimmer and Centerpulse integration and absorbing the Implex acquisition period operating expenses.

We like our current position a lot.

At this point, I'll provide some brief introductory second quarter cash flow and balance sheet highlights.

Cash flow generation through earnings creation and working capital management, has always been our story.

And is perhaps even more important now as a powerful strategy for rapid debt pay down or where appropriate small strategic acquisitions such as Implex.

Combined operating cash flow for the second quarter was again at the extreme favorable end of our expectations, registering 204 million, a sequential increase of $10 million from first quarter.

With $87 million of cash and equivalents on hand, we have a new net debt position of only $782 million, despite the fact that we issued 104 million in cash for Implex during the quarter.

As matter of reference, in the first three quarters of combined operations with Centerpulse we have delivered $565 million in cumulative cash flow.

Shareholders equity has increased to almost 3.5 billion and therefore net debt as a ratio to equity has already been reduced to only 23%.

Our second quarter combined working capital statistics continue to perform extremely well, combined inventory day performance is at the favorable end of Zimmer's normal range and particularly strong for this point in the acquisition.

Our combined inventory days on an apples to apples basis, i.e., excluding any inventory step-up, are at 241 days, or a whopping 16 days better than the prior year preacquisition legacy Zimmer business.

Our industry leading receivables collection will continue to provide support for strong cash flow production in the new Zimmer.

In the second quarter, with a combined effort, we delivered global receivables at a respectable 65 days.

It's good, but we can and will do much better.

Combined U.S. receivables results were very good at 39 days.

We aspire to reach 60 days globally at some point.

With hospitals as our customer and a very large European business, this improvement will be an awesome but doable task.

Let's review the quarter sales in a little more detail.

Second quarter reconstructive sales for Zimmer is the revenue recognition of hips, knees, shoulders,elbows and dental implanted into patients during the reporting period.

For the second quarter worldwide reconstructive sales on a combined basis increased to 608 million, a 16% increase over prior year and constant currency growth of 12%.

Although we make no promises to continue to disclose beyond this quarter, it may be helpful for you to know that the legacy Zimmer had a strong 21% reported recon growth worldwide in the quarter and legacy Centerpulse 7% growth.

As mentioned earlier, excuse me, as mentioned earlier as a key indicator on a sequential basis, global recon volume mix growth for Zimmer increased by 1% from 10% in the first quarter to 11% in the second quarter.

Based on the data for us it is incomprehensible to be effected by recent perceptions about a recon slow down in underlying fundamentals.

Year to date combined recon growth is 18% with the only significant factor between the quarters being foreign exchange.

We are absolutely pleased with these results versus both the total market and key competitors who have already completed their public reports.

Again, it's much to do with expectations.

We fully and reasonably expected to lag the recon market in growth for 18 - 24 months, but at 18% reported year to date, this is clearly not the case.

Let's take a look at each global product category and geographic segment more closely both on a combined basis and, where helpful, respectfully on a legacy basis.

First products.

In the knee category, on a worldwide combined basis in the quarter, knee sales for Zimmer increased once again by 16% versus prior year to 294 million and 13% constant currency.

Virtually the same growth as first quarter 2004 and that's despite the fact that Europe's distributor returns, Japan's by annual pricing and the unispacer are all being very much weighted to knees.

Contributing to the 16% knee growth in the quarter, legacy Zimmer delivered excellent growth at 20%, including a terrific 27% growth in the Americas, and legacy Centerpulse improved to 6%.

On a year to date basis, knee sales have increased by 18% combined, 14% constant currency.

We are pleased to report that for the quarter on a combined basis, all femorals increased by 19%, all articulating surfaces by 18%, all tibials grew 16% and all patellas grew 20%.

From a brand point of view Zimmer's next gen LTS Flex is an appropriate place to start.

The world's top selling high flex knee continued its two-year long trend again with an explosive 56% increase to prior year in the quarter versus 55% growth last quarter and 50% most of last year.

The PS version of this system is now exceeding $80 million in annual sales on a straight line basis.

It's also worth noting that the LPS flex is the knee of choice for our new quad-sparing QS MIS total knee and our brand new LPS flex mobile bearing just completed full U.S.

IDE patient enrollment.

The new Zimmer CR flex may be even more shocking.

With virtually no sales at all in the same quarter last year, the CR flex femorals alone delivered more than $8 million in quarterly sales.

The brand new CR flex mobile bearing is now in full development.

We believe that in kruchiate(ph) retaining units we are growing 5 points faster than the market and with PS and CR combined Zimmer high flex femoral components alone have an annualized sales approaching $100 million.

A few more highlights, Centerpulse's legacy NX knee, up a very strong 28% in the quarter, total UNI knees are up 9%, but with unispacers down 50%.

Total annual sales for Zimmer UNIs continue to be well over $50 million.

The Zimmer RHK rotating hinge continues to take share and increased another 24% in the quarter.

Prolong, our traditional Zimmer cross link polyethylene articulating surface for the knee increased by 89% versus prior year and now represents 50% of all kruchiate retaining articulating surfaces but still only 12% of our now combined Zimmer and Centerpulse PS and CR knee surfaces.

We still expect to have the next gen PS version of prolong available late this year and we sell almost twice as many PS femorals as we do CR femorals, a nice mix story for the future.

Trabecular Metal Monoblock tibial trays of-- continued to take off as surgeons not only recognize the value of the material, but the inherent lack of micromotion, which when present can potentially lead to tibialastiolysis(ph).

Trabecular Metal tibial trays increased by more than 50% in the quarter versus prior year and delivered an annualized run rate of $35 million in sales, but it could potentially be 50 million on the tibial alone if we could keep up with demand.

We are expanding our New Jersey based Trabecular Metal reactor manufacturing capacity to 30 reactor units from the current 18 by the middle of 2005.

Our knee portfolio is straightlining on an annual basis at some $1.2 billion in sales.

There continues to be exciting progress on the Zimmer minimally invasive knee front, particularly in training and I'll update those activities later.

There seems to be a great deal of background noise on hips over the last 30 days, but we are very excited about Zimmer's combined hip results.

The second quarter for Zimmer tells that story well.

On a worldwide combined basis in the second quarter hip sales increased 15% to 268 million and 11% constant currency.

The legacy Zimmer hips grew a terrific 23%, including an important 24% growth in the Americas, while legacy Centerpulse grew at 4%., mostly due to foreign exchange in our heavily skewed European position.

Given that overall global results in hips with particular attention to comparative new products in and Allergan bearings, here is why we continue to be very encouraged with this new company after only three quarters together.

Total primary hip stems grew 19% versus prior year with total hip cups accelerated to 28% versus prior year and 3 points higher sequentially from the first quarter.

Total liner products, polly, metal and ceramics combined grew 23% versus prior year.

In reviewing our brand performance for the quarter, porous stems continue to be very strong at 22% growth.

The versys fiber metal taper stems, which have again shown terrific growth of over 30% in the quarter, fiber metal taper along with the new ML taper are the stems of choice for Zimmer's MIS 2-Incision surgery.

The ML, with no sales last year, very quickly did 3 million in the quarter and brings the combination of fiber, metal and MLs to almost $100 million per year.

As we noted in our press release, MIS brings in business.

Centerpulse's aloe classic taper with nearly a $50 million per year sales base grew extremely well at 23% in the quarter.

It is our intention to provide MIS mini and 2-Incision instrumentation as soon as possible for the legacy Centerpulse aloe classic and CLS brands to dramatically expand MIS in Europe.

Our apollo beaded stem family grew 47% in the quarter and reached nearly $10 million in sales.

Remarkably, at current rates of growth, the porous primary hip stem family of Zimmer products already exceeds an annual run rate of more than $300 million.

Porous revision stems continue to be an area of focus for Zimmer and our sales support that with an increase of almost 21%.

These results include our Zimmer ZMR stem line, reviving to 18% growth, as well as the Centerpulse revitan and revisal brands.

Zimmer brand primary acetabular shells accelerated significantly from prior year with growth of 31% versus 25% growth last quarter.

Including a particularly strong showing from the Centerpulse elefit(ph) shell, up another 20% on a very large base.

But it is Trabecular Metal cups that continue to amaze us, with an increase of 200% or triple sales in the quarter to almost $9 million and quickly becoming, including the revision, a $40 million product line annually.

It is interesting to note that Trabecular Metal product sales, potentially including spine and sports med, are likely to become a $100 million franchise on an annualized basis by the end of next year.

Needless to say, we're very happy with the opportunity to close on our purchase of Implex in April.

Metasul heads continue strong despite impressions in the market to the contrary.

As the metal on metal leader, we grew another 20% in the quarter and here is one of my favorites, of course.

Despite extremely tough comps, significant internal penetration and U.S. ceramic and ceramic competition, premium priced longevity highly crossing polyethylene shell liners increased by yet another 35%.

Since there is little difference between our cross link polly dollar growth and unit growth, it's clear that our continued strong sales represent real surgical procedure penetration.

We believe, based on already reported results, that this is higher than the rate of growth in ceramic on ceramic, despite the fact that longevity crossing polly is now in its fourth full anniversary.

Not only is the growth rate higher then ceramic on ceramic even after four years of sales, but the base of sales is very different.

Our 35% growth for longevity product line when combined with Durasul and other Zimmer ultra bearing surfaces are annualizing for the first time at more than $100 million per year in sales.

Of course we do believe ceramic on ceramic should be a good niche product alternative for the young active patient.

Based upon our own current analysis, we would expect at current prices for ceramic on ceramic to assume about 6 - 7% of the market.

At higher prices, you can't sell it to hospitals for 70 year olds and at much lower prices it's sustainability and profitability come clearly into question due to margins for a distributed product versus a vertically integrated product.

In the spirit of a full offering, we will continue to consider profitable U.S. distribution and complete our ability to offer highly crossing poly, metal on metal, ceramic on ceramic.

Given longevity, Durasul growth combined with Metasul and the clear visibility to recent competitive ceramic on ceramic results, we are not giving up any meaningful sales dollars to anyone else's competitive alternative bearings.

In fact it's the opposite.

This quarter we took share in hip stems, cups and liners by some considerable margin.

Adding to the category of pleasant surprises and nice omen's for the future, the duron(ph) hip resurfacing head and shell fell almost $4 million in the quarter and that's without a U.S. presence and without a new Zimmer MIS technique just under development.

In upper extremity joints, Zimmer's bilianicflato(ph) shoulder has continued to grow worldwide with a 17% increase in the second quarter while the former Centerpulse anatomic system also showed double-digit growth.

Combined extremity sales continue to exceed $60 million on an annual basis.

On a worldwide basis is the second quarter, trauma sales grew 11% combined, 8% constant currency, similar to prior quarter.

Given some competitive constant currency growth of mid single digits for the quarter, we are reasonably pleased.

With locking plates not anticipated until late 2004, some other new product successes have been forced to do the heavy lifting.

The ITS t-nail went from almost no sales to annualized 10 million plus product line and improved in the quarter by 172% growth.

For a reference, ITS t-type nail continue to be reimbursed in the U.S. at higher rates than compression hip screws, adding to their attractiveness.

All Zimmer brand IM, or intramedullary nails, jumped by 26% in the quarter versus prior year.

But former Centerpulse's cerus(ph) titanium lateral starting point femoral nail is a great addition to our lineup and should be well received in the U.S. with approval anticipated in the second half of this year.

Cerus nails in Europe and elsewhere are up 38% in the quarter.

Several other sub segments within our trauma product line are delivering excellent results as well.

Our Zimmer ZPS plates and screws continued their strong penetration against the trauma market leader with 29% growth in the quarter and our trans fixed external fixation system grew by 59%.

But our large period tickler plating line, facing tough locking plate competition, grew by only 4% and thus represents a notable, but temporary short coming.

Trauma sales year to date were up 13% in a combined basis and 9% constant currency.

We should be mostly satisfied with those results, but we're not.

Our Zimmers fine division increased sales by 2% in the quarter to a consistent 34 million as we anticipated, essentially flat to prior year and local currency.

Cage sales held up over $10 million for the quarter, again, and losses to prior year have now been reduced in the quarter to about $400,000 a month after several quarters of very steep decline.

The new Trinica selector anterior low profile cervical plate system has helped drive cervical sales up by 19% in the quarter and Denasis(ph), our dynamic stabilization system provide a 38% increase to almost $15 million as a brand annually.

We're also pleased with the approval of our TM 500 and DBR 11Trabecular Metal spine rateval(ph) body replacements.

Distributor locations were provided with inventory late in the quarter.

All new Trabecular Metal cages for Europe were launched at Spine Week held in Portugal during June.

I had the opportunity to be in Portugal at the launch meeting and our booth was packed with interested observers.

In its first quarter, albeit a very shot one, Trabecular Metal provided almost $1 million in new spine sales.

However, as we've noted to you several times, until we combine Trabecular Metal with the new spine pipeline and a few small distribution or technology acquisitions, we expect spine to remain roughly flat due to the predominance of cages in our mix.

In our orthopedic surgical products division, sales increase 4% for the quarter to 52 million, led by orthopad, our pre-operative auto transfusion system designed specifically for orthopedics.

Orthopad sales increased by 30% in the quarter and continue to generate sales approaching 25 million annually.

Our Limatec arthraspian(ph) haul power tool business in Japan, though, was light in the quarter with few large volume shipments and a major reason for the patient care softness in the quarter.

Our OSP division has now reached $200 million in sales on an annualized basis and sales on a year to date basis combined are up 9%.

In our dental division, sales remain robust with 25% growth reported to 31 million in the quarter and a sequential increase of 13% that appears to be higher than prior-- that appears to be similar to prior year.

Sales were led by 70% plus growth in the standard and taper Swiss plus design implants and 50% plus growth in dental biologicals.

In prosthetics, the internal hex, a product line stable, grew 33%.

Let's switch to our new product development update.

Prior to the acquisition, the legacy Zimmer had more than 30 active major million dollar plus projects in the pipeline and more than 60 active projects in total.

In our efforts to consolidate new development our databases have now been combined and each project reviewed on merit.

We have resigned the new combined Zimmer pipeline to a whopping 146 projects, all managed by software from our proprietary sophisticated focus tracking system.

Of the 146 projects, 38 are in hips, 35 are in knees, 7 in extremities, 22 in trauma, 4 in ortho guidance, 6 in OSP, 18 in spine, 9 in dental, and 6 in biologics.

Of these projects in total, 20 are MIS related and 13 involve the use of Trabecular Metal.

People ask about our success over time in the last few years.

It's the pipeline. 146 active new product projects and consistently delivering 18 - 20% of sales each year from a rolling 36-month list of new products.

That's 500 - $600 million in sales organically in new products each and every year.

Let's look briefly at the geographic segments.

As with product segments we'll try to provide combined second quarter information with individual legacy highlights where useful.

First in the Americas.

The combined Zimmer Americas had another strong showing in the second quarter.

Revenue for the quarter was 432 million up 16% over prior year and sequentially up 2% over the first quarter.

The composition of our growth retrospectively was as follows.

The legacy Zimmer business delivered an excellent 21% sales improvement while the legacy Centerpulse delivered 3%, impacted by both unispacer reductions and temporary sales to synergies.

As with prior quarter, 12% of our growth in the combined Americas was driven by increases in unit volume and mix and 4% growth was derived from price increases.

Our Americas reconstructive growth in the quarter was 20%, sequentially up 3% from prior quarter and delivered 342 million in sales.

This would imply that in the Americas during the quarter, Zimmer had approximately 16% gains in pure reconstructive surgical procedure units and mix.

As a matter of reference, the legacy Zimmer business grew recon at a very strong 25% and the legacy Centerpulse at 6%.

In our combined 20% Americas reconstructive growth, knees delivered excellent results with a 21% increase to prior year to 186 million, including an all time best 27% knee growth from the legacy Zimmer Group.

Next GNL PS flex Trabecular Metal tibial components, Centerpulses natural knee and next gen LCCK revision knees all made substantial contributions to the Americas knee performance.

Hips in the Americas increased 20%, sequentially up an important 5% from last quarter to 127 million.

Said differently, our absolute dollar growth in the Americas for hips was more than $20 million higher this quarter than the same quarter last year.

Hip performance in the Americas as previously mentioned benefited from across the board solid growth in primary porous stems, revision, Trabecular Metal cups, highly crossing poly both longevity and durasul, augmented by multiple new product releases.

Our dental business in the Americas grew a solid 22% in the quarter, up to $19 million rounding out reconstructive.

Based upon our results and the already released public reports of our three major competitors, Biomet, J&J Depuy and Striker, as well as the remaining market players, we believe that perceptions of market doom and gloom are simply not supported by the data.

The reported market growth in domestic reconstructive products for the quarter has remained firm to slightly up at approximately 16 - 17%.

Therefore Zimmer Americas reconstructive, which we anticipated lag in the Americas' market for a year or so, we-- would appear to be outpacing that market growth still by 20% or more in the quarter and year to date.

Our recon growth has been broad based.

In the quarter for the new Zimmer distributor group, including the additions of our friends from Centerpulse, 21 of 30 distributors grew hips at 20% or better, up from 15 of 30 last quarter, and 17 of 30 distributors grew knees in the quarter at 20% or better, also up from 15 of 30 last quarter.

Americas trauma product sales on combined basis improved in the quarter by 7%.

On an important contractual note, we have concluded a new two-year supply agreement with Veterans Administration or VA Hospital buying group for hips and knees with favorable pricing and technology upgrades combined with compliance.

Our ability to carve out unique Zimmer products and techniques, such asTrabecular Metal, crossing polly and MIS, not only improves our pricing, but can also be of marketing and patient benefit to the buyer group members.

We expect to conclude a similar win-win scenario for the premier buying group later this summer.

Here's a statistic we continue to be proud of on behalf of both legacy Zimmer and legacy Centerpulse Americas businesses.

The new combined Americas operating profit margin in the second quarter 2004 came in at 52.3% or 226 million in profit, a 140 basis point, or $11 million sequential improvement from first quarter 2004.

As a matter of reference, the legacy Zimmer business had the same 52.3% that we have already returned to only one year ago.

Once again, as it was for legacy Zimmer it, is for our new combined Americas business. 50% plus earnings ratios are the real payoff from new products, market share gains and efficient operations.

Europe actually had a good second quarter 2004 considering the fact that material changes and foreign exchange, distribution restructuring and reduced billing days might make it appear otherwise.

In the quarter, European revenues were 198 million, up 10% combined, 3% constant currency.

A theoretical add back of both distributor returns on the lost billing day would have easily allowed Europe to exceed the prior quarter constant currency growth of 6%.

Constant currency growth in Europe was derived from 3% volume mix, slightly positive price.

On the product front, reconstructive implants on a reported basis delivered sales of $180 million in the quarter, a solid 9% growth in light of previously discussed one time issues.

With competitive reconstructive numbers for Europe already reported for the second quarter from high single digit to low double digit ranges, it's clear we are not significantly lagging the European reconstructive market.

Positive gains in the quarter reflect a continuing acceptance of both Durasul and longevity highly crosslinked polys, the increased impact of minimally invasive hips in Europe, multiple first quarter 2004 new product releases from Winterthur and ongoing market share gains for the next gen knee brand.

To round out recon, about 30% of dental division sales are contributed from Europe and second quarter reported sales increased by an excellent 27%.

Combined trauma this quarter with more than 1,000 ITS nails placed in Europe already grew again by 26%.

Spine sales in Europe picked up significantly in the second quarter in local currency dollars to record a 27% gain.

We are seeing the expansion of new products such as Trabecular Metal cages on a geographic expanse of denasis providing solid improvements.

If we look at the combined Zimmer Europe for the quarter, several of the country businesses performed well on a sales growth basis versus the competition.

Portugal at 90% growth and the UK at 46% growth were exceptional, as were Belgium, Netherlands, Spain, Russia, central eastern Europe all in the high double digits.

We make particular mention of Germany, our largest European operation with over 200 million in annual sales, and despite a tougher new DRG environment and complex integration delivered double-digit growth, an excellent showing.

While Europe will be difficult challenge for the near-term this is an exciting ongoing sales story for us with tremendous future potential.

For the quarter, the combined Europe improved operating profits to $65 million and a solid operating profit ratio to sales of 33%, but obviously this ratio still has the opportunity to materially expand even further as infrastructure and operating synergies are implemented over the next two years.

Maybe we've all become jaded and lose a little perspective. 60 or 70, $80 million in quarterly European operating profit should throw us.

But legacy Zimmer Europe prior to 1998 at the beginning of the turn around used to lose $5 million per quarter in operating profit.

In Asia Pacific revenues in the second quarter were 108 million, up sequentially by 3% and indicating an increase of 13% on a combined basis and 4% constant currency.

These results are not dissimilar from prior quarter and inconclusive of the Japan price cuts.

Asia pacific had flat prices in the first quarter as we anticipated, but improving healthcare budgets have created the 1% positive growth excluding Japan.

We informed you last quarter Japan pricing was thought to be coming in at minus 4% to minus 6% for 2004 and 2005.

Our final information as applied to Zimmer's mix should generate declines at the favorable end of the curve over the rest of the year.

This is a very manageable outcome.

We continue to believe that the Asia-pacific market is growing in mid single digits and local currencies and as a result we appear to be holding share during a difficult time.

In the second quarter our combined Asia pacific business was led by reconstructive growth of 13%, with hips and knees at 14% and 9% growth respectively.

We expect Trabecular Metal tibial components will recently release next gen CR flex knee and the strength of the Centerpulse natural knee for krucit retaining procedures to improve knee contribution.

Hip sales improved considerably at 14% growth with the addition of the Centerpulse brands and MIS driven expansion.

You may recall that last year we reported the legacy Zimmer business is flat in local currency for Asia pacific hip sales.

Trauma's shown improvement with a combined 12% increase in the quarter due to better attention to specific Asian style ITST nails.

While our dental business is small in Asia pacific, it did deliver another strong 37% sales increase in the quarter.

Austrial Asia once again delivered a double-digit constant currency growth for all Zimmer products segments combined in the second quarter.

Greater China, which we expect will reach $30 million in sales this year, delivered more than 80% constant currency growth.

Displaying excellent earnings drop-through from sales, Zimmer Asia pacific business delivered $45 million in profit in the second quarter, they're up 42% operating profit to sales ratio.

Let's move from products and geographies to hot topics.

Given our new time constraints, I'd like to narrow that discussion down to only two topics, minimally invasive activities and of course an integration update.

Firstly, minimally invasive solutions.

We continue to be very pleased with the progress in our six year old MIS program.

During this section of the call we'll update you on several different aspects of the program.

The Zimmer institute continues to be an incredibly busy with an amazing 605 surgeons, PAs and nurses trained on the MIS 2-Incision hip and MIS Quad-Sparing knee year to date at only 13 internal or contracted Zimmer institute locations including Warsaw, Johns Hopkins, Vancouver, Tucson, St. Louis, Budapest, Astonia, Paris, Innsbruck, Singapore, Bangkok and both Melbourne and Perth in Australia.

You may recall the figure for surgeons, PAs and nurses at the end of the first quarter was only 276.

If we can increase our Zimmer institutes by one to two locations now per quarter and maintain external contractors and license cadaver availability, we still have a solid shot at achieving our target of 1400 surgeons and staff trained in 2004.

In June alone we trained a record 125 surgeons worldwide on the 2-Incision and quad-sparing.

Our surgeon to surgeon visits year to date have reached 271 by our hard working U.S. surgeon consulting group, including 10 trips to Europe and Asia and 19 proctoring visits.

Of the 271 visits, 103 have been for MIS 2-Incision, 117 for MIS mini hip, 33 for mini incision knee and 18 for MIS unis, the Quad-Sparing trips are just beginning to accelerate.

We are grateful for their time and assistance.

Zimmer's surgeon to surgeon open requests, including proctoring, continue to rise and currently stand at 633, dominated by 335 requests for 2-Incision and Quad-Sparing.

Visits are now scheduled out a minimum of three months.

July is a bit of a historic month.

We should complete our 1,000th MIS 2-Incision and/or quad-sparing in Europe and we sold our first $100,000 of MIS Navigation software, not hardware.

We are no Microsoft, but it's a beginning.

In U.S. utilization during the first quarter, we had 20 of 29 distributors, all legacy Zimmer reporting 13% utilization of the 2-Incision hip and 60% utilization of reduced incision size hips, or minis.

We now have added eight more distributors and have 28 of 30 reporting, but of course the numbers dilute because you're adding the Centerpulse distributors that up until recently have little or no exposure to any Zimmer MIS.

Based upon the second quarter, MIS 2-Incision is 8% and 40% for the mini, this compares more rationally in total with our own belief that on a national basis, one out of ten surgeries is currently 2-incision and five out of ten are reduced incision size.

We anticipate having approximately ten published papers and reports on Zimmer MIS by mid 2005.

We are excited to report that over the next year we will introduce two new additional true MIS hip techniques to expand the horizon for both the patient and surgeons and continue to drive share to Zimmer.

One of the new techniques, the OCM, tested in Paris with eight competitive surgeons, result in convincing six of the surgeons to continue to try Zimmer products.

We currently have 330 European surgeons requesting proprietary Zimmer MIS hip training on the Centerpulse Aloe Classic and CLS stems.

We're extremely pleased with the market share potential MIS ultimately represents for the future.

What we are confirming daily is what we anticipated all along, unique sophisticated skill sets transfer and a technique that sets surgeons apart due to patient benefits attracts a lot of face time.

Even if everyone doesn't convert to Zimmer MIS, it opens the doors to places we weren't previously invited.

Let's shift attention to a brief look at integration update of the 3180 scheduled milestones required to execute the entire integration as we know it, we have completed 1312.

Sales to synergies now total 40.4 million annualized, equal to the anticipated amount at this point in time and on track to reach 50 million or so by year end.

During the second quarter we generated major savings from the absolute closure of the original Centerpulse Zurich head office, large plant and headcount reductions in administrative functions and a consolidation of many duplicate facilities.

We have begun the transfers of production processes to Winnether, Warsaw and Puerto Rico.

We have written a detailed integration plan for Implex and appointed a team to execute the transition.

Most important, I'd like to update you with respect to our forecast relative to net synergy projections through the end of 2006 versus those contemplated with our offer to purchase Centerpulse.

Last quarter we advised you that we felt we would be closer to the 8 million - 90 million range by the end of 2006.

The original range you may recall was 70 - 90 million.

We are now increasing the expected synergies to 102 million for the end of 2006.

Other figures that may prove useful for your models are as follows.

The new net synergies figure for 2004 is favorable 12 million versus an original 1 million and for year end 2005 net synergies of 63 million versus the original 56 million.

The improvement for 2004 has been included in the new guidance provided today off-set by the slight dilution for Implex not formally included previously.

Before I turn it over to Sam for his comments, let me reiterate a point on behalf of Zimmer and perhaps for some of our competitors.

We're in operating rooms every day, sometimes me included.

And this is as exciting a growth market now today as it has been for each of the last few years.

At least for Zimmer, declines in foreign exchange tailwind should not be confused with the underlying fundamental procedure mix and pricing power we continue to see in our business.

Interestingly enough, although Sam will cover guidance, the company's fourth quarter sales growth projections in constant currency as contained in the last night's press release are the strongest of the year, easily exceeding the first quarter.

Sam?

Thanks, Ray.

The second quarter of the new year proved to be just as exciting with the first with the integration of Centerpulse well under way and the acquisition of Implex complete.

As mentioned in last quarter's earnings call, the inclusion of Centerpulse in our financial results of this year makes reported comparisons to last year rather difficult to understand.

As a result, I will attempt to clarify both year to year and sequential quarter comparisons by describing both reported and adjusted results.

Several factors contributed to our strong second quarter financial results, including the underlying sales growth for both Zimmer and Centerpulse legacy products, was better than expected and more than compensated for the reduced growth benefit of foreign currency fluctuations.

We continued to overachieve the timing for realizing synergies associated with the integration of Centerpulse into Zimmer.

Careful expense management resulted in our continued ability to improve operating margins while leveraging sales growth, and finally, sales dis-synergies are materializing at a bit of a slower rate than expected.

In our press release last night we included in tabular form reported sales growth as well as sales growth on a combined basis as if Centerpulse had been included in our sales results for both the second quarter and the first half of 2003.

In the second quarter reported sales of $737 million represented 79% growth over prior year and when comparing these results against the combined sales of $648 million for the second quarter of 2003, sales increased 14%.

Contributing to this growth were 2% from pricing, 3% from foreign exchange and 9% from volume mix.

Within this 14% combined sales growth for the quarter, the Zimmer standalone product portfolio continued with strong growth that we had seen all of last year, finishing the quarter with 18%growth over prior year.

The Centerpulse standalone product portfolio also grew at a faster rate than expected at 6% over prior year.

At the end of the first quarter we included in our second quarter's sales guidance of 725 - $730 million, an assumption that changes in foreign currency would contribute 4.5% or $29 million to our sales growth for the quarter.

With the strengthening of the U.S. dollar against most currencies in the second quarter, foreign currency movement only contributed 3%, or $21 million to our second quarter sales growth.

With $8 million less contribution from foreign currency, we still overachieved the top end of our second quarter guidance by $7 million.

This means that our underlying sales performance contributed over 2 percentage points of growth beyond our expectations.

For the first six months revenue increased 85% over prior year on a reported basis and 17% on a combined basis, incorporating Centerpulse sales for the first six months of 2003.

Contributing to this growth were 2% from pricing, 5% from foreign exchange and 9% from volume and mix.

Other than sales , the Zimmer Implex sales in the first six months of 2003 were negligible.

And as a result there was no need to include pro forma adjustments to sales for 2003 for Implex.

In the area of foreign exchange, the U.S. dollar strengthened against most currencies in the second quarter compared to the first quarter, including 4% against the euro, 2% against the Swiss Frank, almost 2% against the yen, 2% against the pound sterling, 6% against the Australian dollar and 3% against the Canadian dollar.

If foreign currency exchange rates remain unchanged from Q2 levels for the balance of the year, foreign currency movement would contribute $13 million or 2% to our third quarter sales growth, negative $2 million or minus three tenths of 1% to our fourth quarter sales results and finally, $70 million or 2.7% to our full year 2004 sales growth and guidance over 2003 combined sales.

Reported gross profit margin for the quarter was 72.6%.

U.S.

GAAP purchase accounting requires that the inventory acquired with the Centerpulse and Implex acquisitions be stepped up to market value as of the acquisition dates.

Stated differently, the normal manufacturing margin associated with the acquired inventory is not recorded to the P&L.

This step-up is then expensed as a noncash charge to the P and L, as the inventory to which it was associated is sold.

After the step-up has been fully expensed, the reported gross profits will return to normal manufacturing margins.

The total Centerpulse inventory step-up recorded as of October 2nd when the acquisition was completed was $95 million.

In the second quarter, $19 million of the inventory step-up was expensed to cost of goods sold and had a negative impact on gross profit margin of 250 basis points.

This $19 million pretax expense, $12 million net of tax, equates to an EPS reduction of 5 cents in the second quarter.

Excluding the effective inventory step-up expense the gross profit margin for the second quarter was 75.1%, which we believe is the highest in the industry, even with a lower margin contribution of Centerpulse.

The remaining $7 million of Centerpulse related inventory step-up will be recorded to the P&L as noncash expenses during the next two quarters.

The inventory step-up associated with the Implex acquisition is only $7 million.

On a year to date basis, reported gross profit margin was 71.5%.

In the first six months, $50 million of the inventory step-up was expensed and had a negative impact on gross profit margin of 340 basis points.

This $50 million pretax expense, $30 million net of tax equates to an EPS reduction of 12 cents in the first six months.

Excluding the effect of the inventory step-up expense, the gross profit margin in the first of the year was 74.9%.

Reported operating expenses for the second quarter were 48.8% of sales and included and reported operating expenses for the quarter were acquisition and integration expenses totaling $24 million pretax, $16 million net of tax or 6 cents in earnings per share.

These expenses include distributor termination costs, integration related consulting and professional fees, severance and other integration related expenses.

Excluding the impact of the acquisition and integration expenses, the adjusted operating expenses as a percentage of sales were 45.5%.

On a year to date basis, reported operating expenses were 49.2% of sales and included and reported operating expenses for the first six months were acquisition and integration expenses totaling $56 million pretax, $36 million net of tax or 15 cents in earnings per share.

Excluding the impact of the acquisition and integration expenses, the adjusted operating expenses as a percentage of sales were 45.5%.

Reported operating profit margin was 23.8% for the quarter and excluding the impact of the inventory setup and the acquisition and integration expenses, adjusted operating profit margin was 29.6% or 50 basis points greater than the first quarter while year to date reporting operating profit margins were 22.3% while adjusted year to date operating profit margins were 29.4%.

On May 24th, we renewed our $400 million, 364 day credit facility and amended our 5 year term facility at $550 million, while taking advantage of the more favorable pricing spreads available in the market to companies with our strong credit profile.

As a result, we were able to reduce libor spreads by an additional 25 basis points on the $550 million borrowings against the five-year facility.

With our continued strong operating and free cash flow, we paid down debt by $91 million in the second quarter to $869 million and reduced interest expense for the quarter to $8.3 million, and that's down $1.5 million from the 9.8 recorded in the last quarter and down $1.9 million from the $10.2 million expensed in the fourth quarter of 2003.

On October 2, 2003, we completed the Centerpulse acquisition, as you know, and drewdown $1.357 billion of initial acquisition debt with interest rates of libor plus spreads ranging from 87.5 to 112 basis points.

Our operating cash flow has been strong for the last nine months since the completion of the Centerpulse acquisition, including making good use of the acquired net operating losses from Centerpulse.

During that time frame, we also paid out $104 million of acquisition costs for Implex and an additional $18 million to complete the Centerpulse and InCentive acquisitions, including the compulsory squeeze out process to acquire the remaining 1.3% of Centerpulse shares that were not previously tendered.

Including all these factors, we paid down almost $500 million of debt since the acquisition date.

Our previous expectation was at Centerpulse related acquisition debt would be paid down fully by the end of 2006.

But as a result of our increasingly strong cash flows, we now believe that we can paydown all our net debt, including the additional $18 million in debt incurred to complete the Centerpulse acquisition and the $104 million to acquire Implex, by the middle of 2006, or possibly sooner.

Since the acquisition, we have spent $233 million on integration and acquisition costs. $135 million of those costs have been expensed to the P&L with $24 million being expensed in the second quarter and $56 million expensed during the first six months of this year.

We expect to expense $99 million during the full year 2004 with $27 million targeted to be expensed in Q3 and an additional $16 million in the fourth quarter.

Zimmer's's effective tax rate for the first six months was 31.4% on reported pretax earnings and 32.5% on adjusted pretax earnings, excluding the effect of the inventory step-up and acquisition and integration expenses.

I mentioned on previous calls that we are actively working on developing and implementing a more tax efficient global business structure that would go into effect beginning in the last half of this year.

I'm pleased to say the implementation has begun and will continue to be rolled out over the balance of this year and into 2005 and 2006.

APB 28 requires that the expected full year effective tax rate be recorded on year to date earnings.

With only the work done to date, we have been able to lower our full year estimate effective tax rate to 32.5%.

Additional work throughout the balance of 2004 should give us the ability to lower the rate further to approximately 31 - 32% for the full year, but there is still much work to be done before this lower rate can be achieved.

Because our first quarter effective tax rate was 33.3% on adjusted pretax earnings, in order to report 32.5% for the first six months the second quarter rate was 31.7%.

Reported earnings per share for the second quarter were 47 cents.

Excluding inventory step-up and acquisition and integration expenses, second quarter adjusted earnings per share was 58 cents, that's 3 cents over the top end of our previous guidance, 3 cents over First Call consensus estimates and 29% over prior year of 45 cents.

Included in the quarter was approximately one cent of dilution from the Implex acquisition and the EPS effective recording a 31.7% effective tax rate in the second quarter compared to the year to date rate of 32.5% was approximately 1.7 million, or seven tenths of a cent per share.

This added tax benefit, therefore, offset the short-term dilution from Implex.

Turning to the balance sheet, we continue to deliver excellent working capital management, which contributed to our strong operating cash flow for the quarter.

Our combined day sales outstanding for the quarter was 65 days, one day higher than the first quarter and this increase in day sales outstanding from the first quarter is due to the inventory buyback associated with the restructuring of our distribution network in Europe that we discussed at length during our first quarter earnings call.

Days inventory on hand were 241 days, excluding the effect of the inventory stepup, This represents a 13 day increase from the 228 days reported at the end of March and is primarily due to the buildup of inventory necessary to support the introduction of new products to be launched throughout the course of 2004 and into 2005.

But also due to the inventory buyback from restructured European distributors.

As mentioned previously, the 241 days of inventory is 16 days better than the 256 days reported by the legacy Zimmer division -- company a year ago.

We expect days on hand to increase to the 250 - 260 day levels at various points throughout the year in advance of new product productions globally.

Operating cash flow was a healthy $204 million for the quarter and $398 million for the first six months.

Major contributors to our strong cash flow in the quarter were better than expected earnings, excellent working capital results and the continued monetization of a portion of the acquired Centerpulse tax attributes.

Capital expenditures for the quarter were $55 million consisting of $37 million for instruments and $18 million for all other property, plant and equipment fix asset additions.

Free cash flow, which is operating cash flow less capital expenditures, was $149 million for the quarter and $293 million for the first six months.

As a result of the Centerpulse and Implex acquisitions and the related $623 million of amortizable intangibles recorded at the transaction dates, amortization expense for the second quarter was increased to $11.5 million.

As a side note, depreciation expense was $34.1 million for the quarter.

Turning to guidance.

Due to the strength of our operating performance in the second quarter together with our expectation of continued strengthening in the second half of the year, in our press release last night we announced that we are again increasing our sales and earnings guidance for the full year 2004.

We have incorporated several factors into our sales and earnings expectations for the balance of the year.

First, our third quarter historically has been the most seasonally effected quarter as surgeons and patients take their summer vacations.

This is especial dramatic in several European countries and with Centerpulse now in our results for the first time at the recorder, the European affect will be more pronounced.

As I mentioned earlier, as a result of the U.S. dollar strengthening in the second quarter against most foreign currencies, the effective foreign currency fluctuations on our third quarter sales results will be less than both the first and second quarters of this year if rates hold at the second quarter levels for the balance of the year.

Next, as we near completion of our non-U.S. distributing integration plans, we will see a larger portion of the expected $50 million in sales to synergies in the last half of the year within the first half.

Since our previous guidance discussed during our first quarter conference call, the U.S. dollar has strengthened against most foreign currencies as I mentioned before but as a result, the full year growth effect from foreign currency fluctuations and our full year sales forecast has declined from $113 million computed at the end of the first quarter to approximately $70 million at the end of the second quarter.

As a result of our strong second quarter sales performance and our expectations for the balance of the year, we're increasing our full year sales guidance.

Full year sales are projected to be in the range of $2.940 billion to $2.965 billion, a net increase of $15 million over our previous guidance.

Including the $40 million reduction expected from the foreign currency tailwind since the first quarter, this really represents an increase of $55 million from our underlying businesses.

Reported diluted earnings per share are expected to be in the range of $1.86 - $1.90 reflecting estimated acquisition and integration expenses of $65 million and inventory stepup expenses of $35 million net of tax.

Adjusted diluted earnings per share projected to be in the range of $2.26 to 2.30, an increase of 6 cents over previous guidance.

Third quarter 2004 sales are expected to be in the range of 685 million - $695 million and fourth quarter sales are expected to be in the range of 775 -$790 million.

For those of you working on quarterly Zimmer models for the balance of this year, our combined sales for the third quarter of 2003 were $618 million.

Diluted earnings per share for the third quarter of 2004 are expected to be 43 cents to 45 cents on a reported basis and 51 cents to 53 cents adjusted, excluding inventory stepup expenses and acquisition and integration expenses of $3 million and $18 million respectively after tax.

Diluted earnings per share for the fourth quarter of 2004 are expected to be 56 to 58 cents on a reported basis and 61 cents to 63 cents adjusted, ahead of First Call consensus estimates of 61 cents.

These estimates, again, exclude inventory stepup expenses and acquisition and integration expenses of $2 million and $11 million respectively after taxes.

As a result of our success in staying focused on our integration synergy opportunities, we are now confident that we will achieve synergies in excess of the high end of our expectations for 2004 and the full year run rate in 2006.

For 2004, we expect to achieve net operating profit synergies of $12 million, including both the negative effects of sales dis-synergies and the positive effects of expense synergies.

This compares favorably to the net benefit of $1 million communicated many times previously.

By 2006 we believe that we can achieve positive expense synergies in excess of $100 million, an increase of at least $10 million over the top of our previous expectations of 70-$90 million.

In summary, the second quarter was an outstanding quarter.

We completed the acquisition of Implex, we renewed our 364 day credit facility and lowered our cost of debt.

We continued to track ahead of schedule with the integration of Centerpulse, without sacrificing our focus on sales growth, operational discipline, working capital management or cash generation.

We over achieved our sales earnings and operating cash flow expectations for the quarter.

We achieved 75% gross profit, 30% operating profit and 20% net income margins as a combined company.

We have increased our sales and earnings guidance for the second half of this year and we've increased the expected full year 2006 benefits of the expense synergies to over $100 million.

We have increased our operating cash flow expectations and believe that we can now pay down not only the Centerpulse related debt, but also the additional Implex acquisition debt by the middle of 2006, at least six months ahead of schedule or possibly even sooner.

We've created an integrated R&D pipeline that is bigger, better and more focused than ever, laying the groundwork for an even better 2005 in a market that is just as robust as ever.

And now, we would be happy to take your questions.

Matthew, I'll turn the call back to you .

(Caller instructions) We will pause for just a moment to compile the Q&A roster.

And our first question comes from Bob Hopkins from Lehman Brothers .

Thank you and good morning.

Hi, Bob.

I guess the most important question I want to ask is, Ray, relative to your questions about Europe and talking about challenging near-term outlook but a tremendous amount of opportunity longer time.

Can you just play that out a little bit more in terms of what the plan is between now and when you think growth can accelerate and where do you think growth in Europe can go and profitability in Europe can go over the next couple of years?

Okay.

Thanks, Bob.

I think as we work through our process, we obviously just completed most of the distributor reorganizations.

We have our facilities coming into play now where we're combining facilities.

We have cross training that is behind the U.S., but still up at about the probably a 50% level now.

I'm speculating on that.

We have virtually no, at this point available to the field, mass entree of MIS instrumentation, as an example for Aloe Classic and CLS hips which are huge penetration products in Europe, in excess of, I think it's, I can't remember what the numbers are now, in the millions and millions of penetration.

You can tell from the surgeons over 300 surgeons requesting.

So I think the trends there are fine.

On a by country basis, other than the DRG system in Germany which remains a mystery, I think almost to everybody at this point, including the German administration, the rest of the countries look favorable.

Price still looks to be holding together in a positive sense.

So from our perspective, the growth opportunity there is excellent from a sales point of view.

Again, the underlying, and this is the trap I've talked about so many times of the psychology of foreign exchange, people get accustomed to seeing certain numbers.

The underlying recon growth, the underlying sales growth is still extremely strong from Zimmer's perspective and we are ahead of local currency rates for our combined key competition.

The answer to the question on op earnings has come up many, many times.

We used to run at about 20% at Zimmer, but we had a much smaller business with regulatory in every country and so on.

We're currently at 33.

We should easily get to 35.

I -- I believe that Europe, you know, out over a couple of years can get up into the 40-42 if you're really running an efficient operation.

But that -- that takes a lot of work to get there.

That makes you comparable to Asia-pacific when Asia has better pricing.

And what kind of growth rate should we assume for Europe for the European business in 2005?

Well, I, I will do that when we do 2005 guidance, Bob.

We're not prepared to do that right now.

The underlying growth rates we have right now continue strong, but I think we want to get, you know, as we always do and as any other company does, I think you want to get another quarter under our belt before we start giving you '05 guidance.

Right.

Okay, well, I didn't mean to ask for specific '05 guidance, but I'm just trying to get a sense of given the changes that are going on in distributors when we can start to see the uptick in growth rates that we're expecting.

I know we're expecting it over time, but just trying to be a little more specific in terms of when we think we can see a nice uptrend.

Well, relative to the distributor take backs, it takes us the third quarter to get through and we start to see the benefits because we're picking up the margin obviously in the fourth quarter.

I mean that one's easier to answer.

The absolute total uptick is going be relevant to our ability to deliver MIS over there, our ability to cross train reps to the 100% point so they are comfortable in surgeries, our ability to -- we're just doing a very detailed analysis on price by account because obviously, between the two of us, any time we're in an account together historical, one company was getting a higher price than the other by definition.

So price over there, we still think is an opportunity on a by account basis.

All of those things, I think for the most part accrue to 2005 with the exception of the margin pickup in the distributors.

And last question on ceramic on ceramic, did I hear you correctly in say that the preferred pathway now in the U.S. is more likely to be a distribution pathway?

Yeah, I don't think it's any-- I don't think there was ever any choice because I think what I said of our choices that we had, the idea of doing an IDE was out of the question.

I don't think the market for it is going be strong enough to be worth doing an IDE, so therefore you're into the distribution profile.

Again, and I don't want to detract from it too much, I think it's a good product, but I think it's ability to penetrate much beyond where it is today, you know, leaves to some question.

Thanks very much.

Okay.

The next question is from Katherine Martinelli with Merrill Lynch.

Just a question, Ray, on 2005, your comments about the anticipated synergies.

Should we still be assuming EPS is up somewhere in that 20-25% vicinity and 25% plus for 2006, even after we adjust for the changes in '04?

Absolutely.

I've been reading some of these sort of quick model analysis with people kind of seeming to pull back from that and we cannot figure that out for the life of us.

Sitting here, obviously, we're biased, but there is absolutely no change in our 20-25 and 25 plus as we look at, you know, underlying sales growth, skipping foreign exchange for a second because the most part we have been hedged.

So we're looking at constant currency growth rates that are attractive and improving, despite what the doom and gloom seems to say.

Expanding margins, obviously as Sam commented, rapid debt paydown and therefore interest effect and a tax rate that we're trying to get below 30%.

So to us, nothing's changed.

Maybe, Ray, just to get a little bit more details in terms of what people should be thinking about for some of those synergies in '05, '06, recognizing part of it's going to come from your debt repayment, but is it more the gross margin line, is it more the SG&A line, because you've done some things like closing the head offices, but could you just give us a little bit more detail in terms of some of the specifics that will drive those operational synergies?

Sure.

Do you want to do it or me?

Let me take a crack at it.

I think the story is different, Katherine, for each of the two years. '05 we should see pretty much wrapping up all the operating expense synergies that we're going to see.

And we said all along that the reason it is a three year rollout for synergies is because of the manufacturing tail.

It takes us a while to drive the best practices and to do the product shifting among the manufacturing network and the close down Austin by the end of 2005.

And once we start making product in a more cost effective way, including insourcing what is currently being outsourced, it still takes, because we have 250 days of inventory roughly, it still takes that almost 90 days to flush through the system before it actually sees itself in the P&L.

So in '06, the vast majority of the incremental synergies will be in fact in cost of goods sold.

Okay.

So maybe a little bit more at the op line, or at the SG&A line for '05 and we should be thinking about gross margin improvements even from you -- at the levels you're at right now in '06.

Is that fair?

That's fair.

And then I apologize if I misheard, but I thought you said 8% of your hip business in the U.S. was the 2-Incision and if I looking through my notes, it was 13% in Q1.

Are you seeing physicians gravitate more to the mini procedure, maybe just flush that out a little bit or if I'm totally wrong on the numbers, I apologize.

No, you're right on the numbers, but the denominator has changed.

The only database system we had was with the Zimmer, the legacy Zimmer distributors.

So obviously they have had MIS for sometime.

We have 13% MIS in the first quarter and you're quite correct .

What we did in the second quarter is we were able to take our data tracking system and train and implement it with the seven Centerpulse distributors we've brought on board.

So in the spirit of complete reporting, we now have-- we didn't get them all done.

We got 28 of 30 distributors reporting now, seven of whom came from Centerpulse who have virtually no 2-Incision in their areas because obviously they weren't with Zimmer, so what we've done is effectively self diluted ourselves by going to a full database so we're now at 8% because we've added them in.

And that is temporary, first of all, mathematically correct.

It's -- it's temporarily understating it because we're obviously going to start to get a great deal of penetration from our very hungry Centerpulse distributors who won't have 2-Incision instrumentation. t it is mathematically and technically correct what I said, and do you have it correct.

And they will have those instruments?

They are flowing out now as fast as we can get them.

We're putting out -- on a sets basis we're putting out 200 - 300 sets per month, but then everybody has to come for training.

Sales reps have to be trained on MIS 2-Incision as well as PAs, nurses and surgeons.

So, you have to, in fact -- sitting down here at lunch yesterday were about 30 people from Centerpulse in getting training, to give you an example.

So that 13% we saw was more reflective of just the old Zimmer distributor base.

It was the old Zimmer distributor base because that's all we had.

And I think--I still think, as I mentioned in the commentary, my own gut feeling is that right now that it's about right.

Well, one out of every ten, I would say, is a 2-Incision and about four to five out of every ten is a mini.

And I think my own sense of being out in the market regularly, that's a pretty - those are pretty good numbers.

That's about right.

Great.

Thanks so much.

Okay.

Your next question is from Mark Landy with Susquehanna Financial Group.

Good morning, guys.

Good morning, Mark.

Hi, Mark.

Just to follow up where Katherine left off, could you maybe detail the pull through that you're getting from the Zimmer institutes and what type of end roads are you making into your competitor's products?

I think on the in-roads basis, I think our -- our numbers of surgeons coming in is-- I'll do it this way because I'm not sure I can answer you technically correct.

The answer this way, when we started it was 100% Zimmer and we kind of went to 90/10, we're at about 70/30 now.

A much, much larger portion of the surgeons coming in to be trained are competitive or at least to the extent they don't use majority Zimmer they use majority somebody else.

I think the other way we measure it, Mark, is in the -- we measure in the context of how I just answered Katherine, but we also measure in the sales of the products that are dedicated to that.

The fiber metal has been around a lot of years.

It had very stable 8-10% growth per year.

You know, it's growing at 25 and 30 and 40% a quarter.

It's now up to 100 million in sales.

The ML paper, which is a different philosophy but we thought would be a nice addition, just went from zero to $3 million in the quarter overnight.

The product's never even been on the market before.

So I think as we look at product growth, the other way we look at it is what are the growth rates in high concentration MIS areas and what are the market share rates that we've just disclosed.

As an example, on hips, you know, we're up 21%, Centerpulse included, in the quarter in the U.S..

The hip market in the U.S. is not growing 21% and there is obviously no foreign exchange in that.

That's pure.

So, I mean, that's really working out.

Then just maybe a point of clarification, Sam.

Would I be incorrect in thinking that gross margins are going to be, you know, in excess of 76%, closer to 77% as we approach 2006?

Well, we don't give guidance, as you know, at that level, Mark, but I think you can't get to the -- to the growth rates in earnings and the kind of drops we're talking about off of the sales expectations without having improved margins, but it's not just operating margins.

It's -- it's having the benefit of having a fixed base of amortization, for example, of the intangibles.

That's good leverage for us.

It's a paydown of debt and therefore lower interest.

It's the lowering of the tax rate.

It's the whole potpourri of issues, not just -- not just gross profit.

I think, too, if I can add to that.

You know, we're sitting here today with a spine business that's flat, that's not a surprise to us.

We expect to be flat for the year until we do a number of things, but spine margins are the highest of any of the margins amongst product categories typically.

It's certainly true with us.

Our knee -- our knee penetration rates in Europe has huge potential.

MIS, you know, we don't discount for MIS.

I mean, unless there is some kind of buying deal or group deal, we don't discount.

We continue to do and negotiate contracts despite what you may hear in the market.

We continue to get very strong pricing product carve outs so we don't see price, you know, going away.

So as we look at the margin opportunity to Sam's point, it's really multi faceted, but those things are all moving in our favor.

And while we won't give you specific line item guidance, you know, the trend is clearly positive.

Say nothing of the synergies I mentioned to Katherine that will take place in gross profit in 2006.

Yeah.

Okay.

Thanks, guys.

Okay, Mark.

Your next question is from William Plovanic with First Albany capital.

Great, thank you.

Good morning.

Good morning, Bill.

Just wanted to get a little clarity on the rollout of the MIS instrumentation in Europe.

When do you expect to fully roll that out?

It's going be through, all the way through 2005.

We're just starting-- the legacy Centerpulse had such huge penetration with their Aloe Classic and the CLS that there just -- I just went to a European operations review session a week and a half ago, actually all three of us here did.

And it's number one on the list of what they are clamoring for that we need to get done for them.

So it now has been moved up, way over the top of the development list here.

We have a lot of existing vendors to make it, as do they in Switzerland and neighboring countries, but the sheer volume of instruments we have to deliver for them.

On the other hand, the potential to grow, you know, we've seen it here.

The potential to attract business we don't have today and to get into accounts where we frankly haven't been invited in before is also very, very, very, very large.

I just received a phone call, actually, from a huge account, one of the biggest in the world in fact, the top ten hospitals in the world, that's European based that said the same thing.

You guys get us the instrumentation.

You know, we can make things happen for you here and really attract some strong patient growth.

But it's a huge instrument process and I think it will take all of '05 to get it all done.

Just a followup.

When would you actually start on the rollout?

Give us an idea of, you know, the size of it on the number of instruments that you would have to roll out, and then what type of penetration rate, you know, are you retrofitting fitting those instruments for the implants.

What type of penetration rates do the implants you're talking about have into that market?

The existing market shares for Centerpulse prior to this were in the 20s.

We obviously think we can grow that penetration rate as we've proven that we have and can in the U.S..

In terms of the instrument sets, I don't know the absolute set count.

The sets are being designed and not yet produced, but designed as we speak right now in our development area.

I don't know, I would have to look it up, Bill.

I don't know the absolute plan set count that we're looking at.

It's in the hundreds and hundreds, if that's of any help.

And you would expect rollout by the end of this year or this really kicks in in '05?

No, it's '05.

It's '05.

We would not -- we'll get some out this year, but we will not-- you have to remember, it's not just dropping them out there.

We have to take them out with our consulting surgeons and let them work with them for a few weeks and then make modifications.

It's an iterit of process that you don't just make the instruments and drop them out there.

So I would suggest to you that rollout is not till '05.

Great.

Thank you.

Okay.

Your next question is from Glenn Reicin with Morgan Stanley.

Good morning, folks.

Good morning,Glenn.

Two questions.

Just want to know, you gave us a lot of granularity on specific products.

Is there any way that you can give us for hips, say, what you think your estimate is for highly cross linked polyethylene porous surfaces and metal on metal products?

What penetration is what the growth is for those product segments and then on knees do the same thing for, say, porous coatings and mobile bearing products?

The penetration rate right now for cross link poly for durasul and longevity is about 85%.

I usually do that, Glenn, but we've tried to cut the call down, so something has to give.

So I didn't give that material -- those kind of penetration rates.

I do not know the penetration rate for metal on metal.

I will look that up and we can certainly make people aware of that.

I'm not-- I don't know the number off the top of my head.

Porous has increased a little bit.

It's up about two points, which is -- which still leaves us with about ten points of growth, assuming the market's around 70-- market potential's around 75-78

This in hips?

percent.

This is in hips.

Metal cross link poly, porous, am I missing one?

Did you give me another one there?

For hips, you were saying highly cross link, porous, metal metal, knees.

Oh, knees, knees.

On knees the one that we look-- porous to cemented knees is not at this point a relevant comparison because cemented knees dominate the marketplace.

Although we obviously believe with Trabecular metal porous tibials that's going to change, but right now the percent is single digit and porous-- on articulating surfaces for highly cross link polyethylene for us it represents about 12% of our total articulating surface sales and units at this point.

So obviously we have a huge potential to grow that.

That's primarily because PS outsells CR two to one for us and we don't have the PS product out yet.

So we're CR dominant.

I can't tell you what the market penetration is for articulating surfaces.

You would have to ask each of the companies.

I don't -- I don't have any data that allows me to calculate that.

So you would have to ask the other companies to get the total.

Okay, and then on trauma, surgical and spine, can you just give us the U.S. and European numbers for those product categories.

The-- you mean the sales numbers?

Yeah, that was not in the press release.

You just gave us worldwide numbers for those categories.

What are you -- what are you -- tell me what you're looking for again.

Just the US and

Do you want to geographic breakdown?

Yeah, the geographic breakdown.

Well, I haven't got them right in front of me.

We'll have to -- we'll have to give you a call back on it, Glenn.

I haven't got it here.

Okay, I'll call you later.

Yeah, I can slip through the binder, but it's going to use too much time up here.

Okay.

Thank you.

Thanks.

The next question is from Mike Weinstein with JP morgue.

Hi, it's actually Taylor Harris here for Mike.

Hi, Taylor.

Hi, there.

So a followup to Glenn's question.

Just on the U.S. knee business for former Zimmer distributors, the growth has been high 20s last few quarters and I'm just wondering if you could roughly give us the -- the breakdown of the contributors to why that growth is so much above the market, that would be great.

Yeah, sure.

I think it's a number of -- it's a number of things, but it's certainly three things for sure.

Number one, the-- if you've got a high flex knee growing at 50% a quarter, which we have had for two years now, the high flex knee is a premium knee and therefore the pricing on it , and keep in mind our dollar growth-- our growth rates and our market shares are all done in dollars, not in units, you get tremendous growth rates when you sell premium products.

To that, now, we've added two other component pieces of significance.

One-- prolong articulating surfaces which also have a significant premium to standard poly, and then the real kicker now is monoblock tibial Trabecular Metal trays, which have a very large premium and rightly so.

I'm happy to defend it.

If you add all that in and then add in the fact that our revision knees are growing at a very high rate and revision billouts tend to be a higher rate than primary billouts, if you add all those factors together, you end up with some very attractive rates, provided that you're taking market share.

The final comment I would make is very much like MIS hip, the training profile for MIS quad-sparing, the number of surgeons coming in, people we've not had the chance to work with before and the number of our key surgeons moving to mini or quad-sparing type knees, which the high flex knee, premium knee with all the goodies on it, is the dedicated knee, dramatic expands your growth.

So, you know, there is lots of very trackable, good reasons for this.

Great and so specific to the high flex knee, where are you, do you think, on the penetration of that market opportunity?

Oh, well, if you think about it as-- as billings versus total billings on a global basis, we bill about $100 in high flex versus a 1.2 billion in the knee category, so one could argue, depending upon how you want to do the numbers, that it's 10-12%.

Okay.

Or less than 10%, I should say.

Great, and then just finally, cross training in the U.S., where are you at this point?

I think you said 50% roughly in Europe, but how about in the U.S.?

And then at what point do you think the growth rates for the former Centerpulse distributors start to creep up toward the Zimmer distributors and I'll drop?

Thanks.

Okay.

We are -- we're probably 75% now.

We were sort of, I think I said 60-70% the last time people asked us which was pretty much a quarter ago.

So we're probably and I'm speculating because I don't add it up in absolute sales reps and whatnot.

Our sales folks keep an eye on it.

But I would say we're somewhere in that neighborhood.

So, let's say it takes you another -- the rest of the year to get to pretty much to 100%.

The thing you have to be careful of is, this is about confidence in the operating room.

I mean, obviously we're dealing with real live people here that are open on a table and our reps and our support people have to not only be trained, they have to have confidence in it, they have to have perhaps the corresponding rep from the other legacy company at their elbow for a few surgeries.

I really think this takes a year before people get confidence, particularly more complex surgeries like a revision.

We've accounted for all of that.

When we did the deal, we expected to have about a 10% growth, as I've mentioned many times.

We're running so far ahead of what we've ever told people in the -- in the past and we have not yet completed cross training.

So the benefits of that clearly aren't in there, but I-- you know, it's going to be through to '05 and into '06 as people's confidence grows every day as they do additional surgeries every day.

Great.

Thanks a lot.

Okay.

Your next question is from Ben Andrew with William Blair.

Good morning, just a couple of quick questions on the insurance side.

I think you talked about having three large insurance companies on board at the end of the first quarter.

Can you update us on where that's at and what's happening with physician payment rates?

We can.

Again, that's one of the areas I trimmed out just for time purposes.

We have a number of new companies we're negotiating with.

We have new approvals from a variety of smaller companies.

No big-- I don't think there's any big additions in the quarter that I'm aware of.

We continue to apply on an individual or group company basis for increased surgeon payouts.

Those have varied at this point from anywhere to like a 10% premium to in some cases double the payouts.

So if you think of a surgeon getting in the neighborhood of $1200-1500 per total joint surgery, it's a significant premium in the sense of another 1,000 or $1500.

Don't think there's any big additions in the quarter, although I'll go back and check them, but I don't think there is.

Okay.

Great.

Thank you.

Next question is from Rick wise with Bear Stearns.

Good morning, Ray.

Good morning, Rick

A couple questions.

First, on spine, you've mentioned the contribution Trabecular Metal is going to make and the need to combine it with a couple of quote, I think you said technology acquisition first.

Could you just expand on that and help us understand what you need to do and how long it takes and where you are in that whole process.

Sure.

You know, we're all-- we're like everybody else, I mean, we're always looking at small acquisitions.

I said technology, not because we wouldn't buy a company that had, you know, administrative staff and infrastructure.

It's just we don't particularly need that.

We really look for technology products and for, you know, less infrastructure because we have that in our business.

There are about 130, what you would call small spine companies around.

We are not as focused right now on the dis-situation although there are some of those companies out there.

We're more focused on augmenting our existing cervical and thorical lumbar product lines, strengthening pedical screw offerings, adding to the ability to move spine to MIS, as an example, so if you look at the companies out there, several of whom we're looking at and talking to and these all tend to be deals that are very much like the size of Implex.

I mean there's-- we're not looking at anything big and, frankly, we don't want the indigestion right now.

It's going to take us a year, as I said, to get Trabecular Metal rolling, get a couple of these deals in place to augment the product line.

There's also a little bit of biologicals out there that we're interested in as well and we continue to try and expand our development with Tutigen(ph), which we happen to own a piece of through Centerpulse and some other sources of biological, because I think there's good opportunities there.

But, you know, this business has-- and we knew this going in.

This business has been so caged dominant that until we do all those things, you know, it's tough to move the sales needle because the cage thing always-- always hold you down.

But, it's not new news.

It's something, obviously, we've known when we went in.

Second question, make sure I'm understanding.

You talked about 21 of the 30 hip distributors in U.S. growing 20% or better, if I heard you correctly.

Does that incorporate Centerpulse's distributors as well, number one, and maybe in answering that, two questions.

One, what are the-- what do you need to get the -- since you're making, clearly making progress there since the first quarter, what do you need to get the remaining nine guys to do to get to that 20% plus level and, two, just in general, you have answered it in some ways.

Can you talk about this legacy Centerpulse 6% growth in U.S..

Where does it go and how long, you know, where does it go over the next one, two years in terms of growth?

What would you expect by the time we get out to '06 in terms of growth?

Okay.

Yeah, you were correct in the numbers. 21 out of 30 over 20%, which is actually very strong performance.

It's-- I mean the simple answer to get the other ones up is they need to sell more, but new products coming out, excuse me, training, additional training on cross training of products, particularly the Centerpulse guys on the impact and value of MIS.

You know, these are all areas that we need to develop.

We have -- we've had a longstanding track record, have been able to really manage and work with distributors closely and get them all to maximum performance levels, so I'm not, you know, I'm not overly concerned about that.

The 6% Centerpulse in the U.S. we are pleased with and I guess this is where we-- it's kind of like the guidance thing on the foreign exchange.

This is where we get sometimes a different viewpoint.

Not because we're biased and work here every day. 6% includes a bunch of decisions on our part, a number of dis-synergies which we will claw our way back and gain surgeons back, it includes unispacer, which we elected to trim down the sales opportunity on, number other things.

The 6% for us looks exciting because what it says is at the -- at the worst of times, at the peak of the dis-synergies when you've made product changes and dropped products out of the product line and so on, you're still growing at 6% in a business that for them was only growing at 12-13.

So the way we look at this is we have the opportunity to get them back up into double digits before very long.

I would certainly think in '05 and again, it's speculative at this point until we do our full analysis and our guidance to you and we continue to drive Zimmer extremely well and the cross benefit in training their people and getting them selling more and vice versa, and our sales force starting to drive some of those big European stems into the US market, some of which have great philosophies and great backgrounds, we still love this deal.

The numbers all still look good.

So, you know, again, I'm not pollyannish.

I just don't get what all the gloom and doom is about.

Ray and Sam, it's actually Milton here.

Just had one last question.

I know you've enjoyed some good pricing increases on the Centerpulse implant side, just to bring the ASPs more in line with, I guess, the Zimmer implants, but of the Centerpulse knee growth, that 6% that you mentioned and the Centerpulse hips of 4, can you just give us an idea of how much of it was price increases?

Thanks.

We don't break out price by category, but I would correct an assumption, Milton.

We haven't done-- the price we're getting now is price that we're out negotiating on a normal basis.

So that 4%, for instance, in the Americas, continues to be our own strong work combined Centerpulse and Zimmer.

We actually have not done or benefited from cross negotiation of price between accounts that I was referring to in either Europe or in the U.S. at this stage because that is not what we want after first.

We went after, you know, cross training and other things.

So there is no benefit you've seen from that, yet, because we haven't done it yet.

Okay.

Thank you.

Okay.

Your next question is from Steven Lichtman with Banc of American Securities.

Great.

Thank you.

Hi, guys.

Hi, Steven.

Ray, you touch on this previously but I was wondering if you just flesh out, give us a sense of what you're seeing in the field in terms of top line synergies, not o the dis-synergies side but on top line synergies, and the opportunities there.

We are -- we are with the people that we train first in cross training, we're certainly starting to see one and we're starting to see it, I think, for the most part, I would suggest in two ways.

Centerpulse folks really going after MIS hip, followed by quad-sparing, followed by high flexion, all of which are premium products and premium introductions, pretty high price, high quality opportunities.

On the Zimmer side, because the -- finding those people that want to use anatomical hips, as an example, anatomical shoulders, this is harder work on the Zimmer side for people to find those opportunities and then to start to move in on some of those sales.

So I think we will start to see, you know, more on the Zimmer side at this point.

The other big thing, you know, you see is some of the key surgeons that came from Centerpulse, some of the big well known folks are having a big influence, Aaron Hoffman, Larry Dore, these people are having a huge influence on allowing us to get into geographic areas with Zimmer products where Centerpulse had geographic strength.

Utah would be a classic example.

Southern California was -- was a -- was somewhat of a wasteland, comparatively speaking for Zimmer and that's certainly not the case anymore.

Florida is the same thing with the huge strength that George Ethridge, the Centerpulse distributor, has in Florida.

So, I think -- I think those are some of the, at least some of the product areas.

Trauma in OSP, we have to expect to be really big pleasant surprises.

I think people have estimated that we would get trauma and OSP business a little early in this process because the cross training is not quite as necessary or as heavy.

It's necessary, but not as heavy.

But I think people need to realize it still takes time to get OSP business and trauma business converted over to Zimmer from ex-Centerpulse areas of strength.

It just doesn't happen overnight.

Okay.

Great.

Just two quick questions for Sam.

Did you mention on the European distribution restructuring that that would creep a little bit into the third quarter and then just secondly, on the EPS guidance, does that include a tax rate of about 32.5 in each of the third and fourth quarters?

I'm going to take the first one first.

What we mentioned was that we were largely complete with the European distributors and then you spill over what would really be de minmus into the third and forth quarter and have no effect on us really.

The tax rate though, if you take apart what I said, we're at 32.5% year to date now and we think we can drive it down somewhere between 31-32% for the full year, which means that in order for the full year to be that, the last quarter would have to be a whole lot better than 32.5 or even better than the range of 31-32 in order to get the full year benefit down into that range.

So we do have some upside in Q3 and 4 with the tax rate.

Should we think, though, at this point given where you're at 32.5 for the third and then the -- and then the difference in the fourth?

I don't know that we can answer that question yet because it has to do with how much work we will get done between now and the end of the third quarter.

We are always obligated to record what we believe will be the effective tax rate for the year, but only based on the work that's been done.

Okay.

So there is a very detailed road map that we're negotiating through over the balance of the year.

It really depends on that.

Fair enough.

Thanks, guys.

Yeah.

Next question is from Mark Mullikin with Piper Jaffray.

Great.

Good morning.

Good morning, Mark.

Morning.

Ray, could you just comment a little bit more about the changes to the German DRG system and what impact that's having on the orthopedic market there and on Zimmer specifically.

The DRG system is a phase-in system that's about halfway phased in now, although I think the German government is having, as you read some of the articles over there and what not, they are starting to have some second thoughts in the administration and hospitals are having a difficult time managing it.

It is a -- it's a hybrid-- we haven't got time to get into the detail here, I'll be happy to do it offline.

But it's a hybrid combination of Australia and the U.S. system.

We think that it has a net negative, slight net negative effect on price, but because of the way the DRG's are structured and where we are positioned with Centerpulse it may actually have a positive effect on our volumes, but I think it has a slight negative effect on price on our mix.

Now, you know, you got to look, you got to ask every company that question because I can only answer, you know, relevant to the mix of products we've got and where MIS comes in and where our premium products play relative to the willingness of the DRGs to fund those kind of technologies.

So -- so, you know, that's kind of the-- I'm giving a very broad answer because I at this point I can't give you much else.

Okay, and then just one question for Sam on the debt.

What's the average interest rate at this point?

It-- the average interest rate varies between about 3% and 3.5 all in, which is the cost of debt as well as the amortized expenses associated with having capitalized the transaction.

And to what extent do you mitigate the impact of rising interest rates with swaps, et cetera, do you do any of that activity?

We do not, no.

We think our rates are still quite good and our debts coming down fast enough, we don't speculate with swaps.

Okay.

Thank you.

You're welcome.

Your next question is from Mike Matson with Wachovia Securities.

Hi.

Good morning.

I was wondering if you could maybe talk a little bit more about what you see from a revenue standpoint, kind of offsetting this loss of your currency tailwind.

Is there any one thing that you can point to or is it really just from these -- from the end of the revenue dis-synergies from the acquisition?

Well, are you talking about our revenue going up in constant currency?

Is that what your question is?

Yeah, well, I mean, you obviously had a pretty big currency tailwind over the past.

Yeah.

And it sounds like you're expecting some additional growth to come in and kind of offset that.

Is that fair?

Well, I think what we're seeing is -- is that for Zimmer, we don't see the underlying fundamentals of the industry declining at all.

We think there is a little bit of understandable psychology to seeing a decline in rates, even though it was quite predictable on foreign exchange.

And what we're seeing for Zimmer is between the combination of new products, sales synergy recovery, release of, you know, the -- we got a huge pipeline as we've just mentioned, cross selling, you know, all of those things we've talked about and the underlying fundamentals of the industry.

We do not see a change that's negative.

In fact, we see slight increase in the underlying fundamental growth of the industry for Zimmer and what we're saying relative to foreign exchange, because we've been for the most part hedged, we concentrate our effort on looking at what constant currency growth, market share gains, and growth against the underlying fundamentals and the marketplace and of course, obviously EPS share profitability.

So this-- the -- the feeling right now and you can see it in the markets, et cetera, that orthopedics, or I won't speak for orthopedics, but I'll speak for Zimmer, that there is this underlying, gee, the bubble is breaking, the good times are gone, we regard as absolute nonsense.

It's simply while that may be a feeling that's out there, the underlying data, as I've just present to you, suggests that that's absolute nonsense.

The fourth quarter, as projected in constant currency now, is our strongest quarter of the year and is stronger than the first quarter.

It's up around 13% if you do the math on constant currency and our second quarter was sequentially higher than our first quarter, not just in the U.S., but globally in reconstructive.

So, you know, it's a very touchy and frenetic market right now.

And we understand that.

You know, we've really truly do, but it doesn't mean it's correct.

The data says it's wrong.

At least the data for Zimmer, anyway.

And, Mike, one more way to clarify, perhaps, and get at your question is when we put our guidance together coming into the second quarter, the top end of our range was $730 million and that included $29 million of tailwind from foreign exchange.

We beat that top end by 7 million and overcame the $8 million reduction as well.

So we're actually underlying performance in the second quarter was $15 million stronger than what we thought it was going to be, jut in one quarter.

Okay.

That gave rise to us being able to look at continuation of that strength and building a bit more by increasing our total underlying performance forecast for the year by 55 million and then against that, take away $40 million for the reduction in the tailwind.

Yeah, that's the right answer.

We actually believe we've increased our guidance to the market by $55 million in underlying performance, which to us is the most important thing.

If you net that out, Sam's quite correct.

You net it out to 15, which is still a significant increase in sales guidance.

We're, you know, we're -- we're understanding of kind of the psychology of the market right now.

On the other hand, we're dumb founded relative to Zimmer.

I mean we really are.

But, so be it.

Okay.

I guess kind of what I was getting at though is you're making good points obviously, but the $55 million, is there any kind of one thing that you can point to where that's coming from or is it just kind of across the board growth, above and beyond?

Yeah, no, it's new products.

It's market share taking with MIS and new products, which is, you know, which is a huge part of our story.

I mean it's, it has been for five years.

I don't honestly see any change in that.

I mean that's what we're all about, is building premium products, therefore driving up the dollar per sale but being able to prove that those premium products have characteristics inherent to then that benefit the patient and the surgeon, driving higher sales dollars and market shares and then reinvesting the money back into a big pipeline.

I mean, it's the same formula we've used since 1997.

Okay.

One of the things we had to face too when we put our guidance together last night and for the balance of the year, is we've updated our guidance and that guidance is being compared against the street, which set their numbers a quarter ago also when the tailwind for foreign exchange was higher.

So we don't believe the street has actually had the opportunity to lower their expectations for us until--

Relevant to foreign exchange.

Yeah, yeah.

All right.

And one more quick question .

Back to your spine business, when do you see the growth kind of accelerating in that, what are your plans looking forward over the next couple of years?

Well, assuming -- we have to make some assumptions here and the assumptions are that assuming cages are leveling off as we speak, assuming we continue to add sales reps, as we have been, assuming Trabecular Metal, you know, products get on the market here, we've got four approved right now, but obviously we have many more than that, assuming we can go out and do a couple of those small technology acquisitions that Rick talked about, that have sales associated with them, assuming it's just not pure technology, there's some associated sales, you know, that we want to get to where we're getting 10, 12, 15% growth on a run rate basis, you know, at some point in next year.

Right now we're incapable of doing that because the amount of cage dominance is so high in the business that you can't do it overnight.

Again, that's always been in our forecast, there's no news there.

But we can't grow the spine business 100% organically, even with Trabecular Metal, which we love.

You can't do it 100% organically and we never planned to when we bought Centerpulse.

All right.

Thanks a lot.

That's all.

Our final question comes from Jason Wittes with Leerink Swann.

Couple of points of clarification.

Sure.

First off, in your guidance, if I understand correctly, the guidance you gave assumes a 32.5% tax rate, but you say you may be able to get it lower than that, which would obviously create some upside.

Is that the correct way to be thinking about it?

Actually the guidance assumes the tax rate for the full year between the range of 31-32%. 32.5 is where we are year to date, but our guidance incorporates some added benefit in the back part of the year, Jason.

Okay.

That would be in the fourth quarter, we wouldn't necessarily see a correct in the third.

It may be in the third.

It may be partly in the third, partly in the fourth.

It remains to be seen based on how much additional work we can get done putting together our new structure throughout most of Europe.

Okay.

Understood.

Okay.

And also in terms of how much impact the reorganization had, I think you said 40.4 year to date.

If I were just to look at this quarter what is the breakout for that?

I'm trying to remember.

Last quarter was 36-- I would have to look it up, Jason, but I think last quarter was 34 or 36 million.

I -- I'm lost between the two numbers.

Run rate.

Run rate, and we're at 40 million now.

So it's obviously slowing.

This is the third quarter.

So this is only about six or so million, approximately?

Yeah, something like that.

I'll get you an accurate number, but that's going to be pretty close.

Thanks.

And also, did I hear correctly that you missed a day in Europe?

Is that for sales.

We missed a day -- almost a day globally, but we heavily missed a day in total.

It's about $10 million.

10?

It varies-- the reason I'm hesitating is because I can't -- I don't want to say we miss a day in Europe, because you have to look at it by country, but the affect overall when you throw the U.S. in is about right around $10 million and we projected about 7-$10 million on distributor returns and then Sam's already identified what was, what, $8 million in foreign?

Mm-hmm.

Foreign exchange.

So if you think though those factors, that will get you to where you want to be on a normalized basis.

Okay.

And last question, in terms of your hedging strategy, you're basically expect to be fully hedged in '05?

We're hoping that we can be a lot more fully hedged than we are right now.

As you know, we were pretty fully hedged on the Zimmer front because we're selling products out of the U.S. into foreign currencies and we're able to put in intercompany transaction or cash flow hedges for those.

Because of the nature of the Centerpulse business with manufacturing taking place in a non-U.S. currency country, there is no way to effectively hedge that without speculating or gambling, so we don't do that.

Gotcha.

We are working on some alternatives, though, that may give us the ability with our new business structure that supports our lower tax rate.

We may also be able to construct our operations in the way that gives us the ability to hedge the Centerpulse European manufactured products much the same way we hedged the U.S. today, but we'll know more about that next quarter.

Okay.

Thank you very much.

You're welcome.

Ladies and gentlemen, we have reached the end of the allotted time for questions and answers.

Gentlemen, are there any closing remarks?

No.

I think we've hopefully covered everything, hopefully cutting down our -- cutting down our presentation as we predicted would make no change to anything because the question and answer period went up.

So I'm not sure we accomplished much, but we appreciate all the attention.

As always, we're around for your additional questions if we didn't give you enough detail in this one, and we appreciate you sticking in there with us.

Thanks a lot.

Ladies and gentlemen, that concludes Zimmer's second quarter 2004 financial results conference call.

We thank you for your participation.

You may now disconnect.