Zimmer Biomet Holdings Inc (ZBH) 2004 Q3 法說會逐字稿

Good morning.

My name is Lynn, and I will be your conference facilitator.

At this time, I would like to welcome everyone to the Zimmer third-quarter 2004 financial results conference call. (OPERATOR INSTRUCTIONS).

This presentation contains forward-looking statements within the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 based on current expectations, estimates, forecast and projections about the orthopedics industry, management's beliefs and assumptions made by management.

These statements are not guarantees of future performance and involve risks, uncertainties and assumptions, including but not limited to, our ability to successfully integrate Centerpulse AG and Implex Corp. that could cause actual outcomes and results to differ materially from those in the forward-looking statements.

For a list and description of the risks and uncertainties, see the disclosure materials filed by Zimmer with the Securities and Exchange Commission.

Zimmer disclaims any intention or obligation to update or revise any forward-looking statement whether as a result of new information, future events or otherwise.

This presentation also contains certain non-GAAP financial measures, a reconciliation of such information to the most directly comparable GAAP financial measures, along with the other financial information to the period to be presented to this conference call was included to the press release announcing our earnings, which may be accessed from the Zimmer Web site at www.Zimmer.com under the section entitled "Investor Relations."

Thank you, Mr. Elliot.

You may begin your conference.

Good morning, everyone, and welcome to Zimmer's third-quarter 2004 conference call.

We are pleased to be hosting this call to discuss the strong third-quarter and year-to-date performance.

This quarter also marks our third full year as a public company and the completion of our first full year combined with Centerpulse.

We continue to make excellent progress against 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.

I hope you received a copy of last night's earnings release.

If not, you can obtain a copy from our Web site at www.Zimmer.com.

Alternatively please feel free to contact Sam, Marc Ostermann or myself.

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

Our results discussions are based upon the asset method of accounting for instruments, and all comments and comparisons are on an adjusted basis.

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

Further, all discussion unless otherwise noted excludes acquisition and integration expenses and inventory stepup.

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

We will communicate for the final time where helpful references in the quarter to Legacy Zimmer and Legacy Centerpulse stand-alone performances to give you historical context.

As with the previous quarters in 2004, given the effect of integration process and the comingling of expenses and operations, there will be virtually no commentary below the sales line on a Legacy basis.

We will try to reduce our formal comments from about one and half hours to about 60 minutes.

We will do our best to maintain a 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 year, and not just the 100 full-time integration people but the hundreds of employees who have stepped up to the task.

It is not easy.

At this point, we are very pleased with the results, but more on integration later.

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.

From the first day of communicating the deal up to including now, we indicated that we would hope to deliver a minimum of 10 percent growth on the top line for the first year or two and 20 percent or more growth on the bottom line for at least 2004 and 2005 and the potential to exceed 25 percent growth for 2006.

We have so far and we expect to do so in both the fourth quarter and future years.

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

Consolidated sales for the third quarter were 700 million, an increase on a combined basis of 13.4 percent over prior year and virtually the same increase as prior quarter.

The 700 million was 8 million or better than 1 percent above First Call consensus expectations.

On a constant currency basis, sales grew 10.2 percent.

Excluding European distributor returns related to restructuring, global total sales grew faster on a day rate basis in the third quarter than they did in the second quarter.

In reconstructive products, combined sales grew 16 percent in the third quarter, exactly the same rate of growth as the second quarter.

Combined reconstructive sales for Zimmer and constant currency grew 12.8 percent, 12.4 percent and 12.6 percent respectively in the first, second and third quarters of 2004.

If we adjust the second quarter for European distributor returns within the integration process, then the second quarter outgrow the first quarter and the recently completed third quarter outgrew them both on a day rate basis.

We see Centerpulse dissynergies that were forecasted along with European returns.

With some embarrassment, we see a $9 million foreign exchange miscalculation for the previous fourth-quarter forecast.

We certainly see both German and Japanese price weakness that was planned and forecasted, but material underlying recon business declining for Zimmer in volume and mix is simply not there.

Because there is so much flux for the first year or so in Centerpulse numbers, if there was underlying decline in the bellwether U.S. reconstructive business, we would see it in the Legacy Zimmer numbers for sure.

But Legacy Zimmer reconstructive sales increased 26 percent in the first quarter, 21 percent in the second quarter and 26 percent in the third quarter -- a 5 percent sequential acceleration in the third quarter versus the second quarter.

Let's return to talking about the quarter gain in total.

This 13 percent combined sales increase was composed of real volume mix growth of 8.1 percent in the quarter, almost the same as the 8.5 percent in the second quarter.

To my earlier comments an extremely important point for combining Zimmer global, not just the Americas, reconstructive underlying volume plus mix growth grew 11 percent in the third quarter versus the same 11 percent in the second quarter.

This is compared to only 10 percent in the first quarter of 2004 and the same as the 11 percent in the fourth quarter of 2003 when we had no sales dissynergies or distributor returns at all.

Here is the key point for us.

Real combined global recon procedure and mix growth has been sequentially solid for the first 12 months of the deal, despite almost $50 million in sales dissynergies and distributor returns combined over that same period.

That's why we feel very good about Zimmer's performance in a complex environment.

Worldwide price improvement remained firm at 2 percent, the same as prior quarter, and within our forecasted range of 2 to 3 percent.

But the Americas improved from 4.2 percent to 4.7 percent, significantly better than anticipated.

Here's a few further price data points for your consideration.

The average price impact for Zimmer in the Americas in the last four quarters prior to this one has been 4.1 percent.

We note with interest several public articles which refer to domestic orthopedic pricing pressure based on anecdotal conversations with a few surgeons.

Few surgeons if any are involved in final price negotiations.

For the most part, these articles are something akin to asking the next three people you meet on the street about the Bush/Kerry outcome, and then concluding that it is statistically significant.

As a reminder, on an importing contractual note, we now have concluded three of our largest hospital buying agreements for hips and knees with pricing conditions consistent with prior years and technology upgrades complying with the compliance.

These agreements are not price increase speculation, but are completed negotiations for several files and institutions for the next two to three years.

Our ability to carve out unique Zimmer products such as trabecular metal and reduce the number of suppliers, too -- in many cases Zimmer plus one -- will be long-term beneficial.

Europe on the other hand slipped in the negative price at a little better than -1 percent as expected and Asia-Pacific grew slightly -3.8 percent as the first full year of the Japanese government changes of -4.9 percent took effect.

Japan is, however, normally a biannual change and, therefore, averages only 2.5 percent per year.

In short Zimmer's positive 2.1 percent price in the quarter compares to a previous four quarter average of 2.6 percent.

If you correctly annualized the effect of Japan, the U.S. environment as we know it, the negative implication of Germany, and the later date France, our pricing world is and should be approximately 2 percent positive and in the 2 to 3 percent range that we have forecasted for sometime.

On a year-to-date basis sales are at 2.18 billion, up 16 percent combined and 11 percent constant currency.

As mentioned earlier, our plan when we announced the Centerpulse deal was to try to remain at 10 percent sales growth or stay in double-digits for the first one to two years despite sales dissynergies and a larger slower growth Centerpulse Europe.

On a year-to-date basis we are currently well ahead of that pace.

On a geographic basis, our combined Americas business delivered excellent growth in the quarter at 15 percent with the Legacy Zimmer remaining at 21 percent growth and Legacy Centerpulse at -1 percent, reflecting what we believe to be the temporary but full effect of the sales dissynergies.

Year-to-date the Americas growth is 16 percent.

Combined Europe delivered at 9 percent reported.

That is 1 percent below our prior quarter, but essentially the same as prior quarter on a volume mix basis excluding distributor returns.

Adjusted for currency comparisons to prior quarter and short-term distributor realignments, our European business remains solid in the face of considerable change.

On a year-to-date basis, combined Europe sales increased 14 percent reported and 4 percent constant currency.

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

Between parts of Scandinavia not quite complete and Southeast Asia, we expect the negative effect on fourth-quarter sales to be 4 to 5 million and the last of our reorganization work complete.

We simply could not finish negotiations in the third quarter.

In Asia-Pacific sales grew by 13 percent reported, the same as prior quarter but increased by 7 percent constant currently -- a material improvement from the prior quarter's 4 percent.

The anticipated Japan pricing decline was offset by stellar growth in Greater China and Australia/New Zealand.

On a worldwide basis for the total company, it's our reasonable belief that we would significantly lag both global and individual geographic markets and sales growth for the first 24 months from the acquisition date of October 2003.

At 16 percent year-to-date combined and 11 percent local currency, this has clearly not turned out to be the case.

At 18 percent combined growth in recon year-to-date, we're still taking a little share despite integration dissynergies and primarily recon-oriented distributor returns.

We anticipated losing $50 million in sales dissynergies with about 80 to 85 percent or $41 million annualized incurring in the first nine months postacquisition.

Our actual annualized sales dissynergies were 40.4 million to the end of the second quarter and are slightly less than that at the end of the third quarter.

We're beginning to slowly plan modest recovered sales and crosstraining benefits that should accrue to our favor later in 2005.

We're pleased with the third quarter, but realistically the fourth quarter will be our toughest challenge.

In order to reach management's new range of some 775 million to 780 million sales, we now face a comparison to the fourth quarter 2003 that had zero distributor returns.

On top of that, we had a mechanical formula error of $9 million in foreign exchange in our original forecast in the fourth quarter completed at the end of the second quarter.

With our normal hedge program, it has little or no effect on earnings, but it clearly hurts us on the topline.

We can and will reach our 10 percent minimum topline and 20 percent minimum bottom-line in the fourth quarter.

I will return to some detailed sales analysis in a few moments.

In the end, though, the near-term part of the Centerpulse deal was devoted to accretive earnings per share over the first few years.

On that note, as with underlying sales, our excitement remains firm.

Adjusted diluted earnings per share for the third quarter were very strong at 56 cents on 248.2 million average outstanding diluted shares or an expansion of almost 2 million shares from the beginning of the year.

We delivered an EPS increase of 30 percent over prior year and 3 cents better than the First Call consensus EPS estimate of 53 cents.

Our third-quarter EPS of 56 cents was fully operationally based with no meaningful unusual items to discuss.

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 when combined with our regular efforts more than 20 percent accretive to Zimmer's stand-alone 2004 First Call estimate of $1.91 at the time of the acquisition.

Based on our current number of diluted shares outstanding and current First Call EPS estimates, that represents almost a $100 million increase in net earnings in 2004 versus Zimmer stand-alone.

Year-to-date EPS on an adjusted basis was $1.70 and up a very strong 32 percent on 247.3 million average outstanding diluted shares.

We are obviously very pleased with the combined companies efforts to drive the P&L, attack integration synergy targets early while simultaneously finding new opportunities for the future.

Of course, we always emphasize our trademark focus on gross profit margins, earnings contribution from new sales and cash flow.

We have certainly surpassed in only one year at least one Legacy Zimmer milestone -- the 75 percent gross, 30 percent operating and 20 percent net margin contribution.

Combined gross profit margin in the quarter for the new company exceeded our own expectations and expanded the gain to an all-time record 76.8 percent, up a whopping 170 basis points from the second quarter directly related not only to geographic and product mix but particularly strong manufacturing and management.

Despite the European Legacy Centerpulse content, we believe that at almost 77 percent our gross margin is certainly the best in the industry.

Our efforts have only just begun.

SG&A expenses and operating expenses as a ratio of sales were well-managed at 40.9 and 46.8 percent respectively, reflecting the sequential ratios associated with the softer summer but also the continued absorption of approximately $3 million of incremental operating expenses due to the Implex acquisition.

We expect over the next year or two that our R&D ratios to sales this quarter at 5.9 percent will remain in the 5.5 to 6 percent range with investments in spine, biologicals and new technologies.

Most of the significant SG&A expense reduction opportunities occur as part of the integration process, and I will cover these in a later section.

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

Combined operating profit in the quarter reached 210 million.

We are very excited by the return to a full 30 percent adjusted operating profit ratio to sales in the third quarter, up sequentially by 40 basis points from the second quarter of 2004 and almost 100 basis points from the first quarter.

Operating profit year-to-date has reached 645 million, well ahead of our expectations and now with a year-to-date ratio of sales of almost that same 30 percent.

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

It is a non U.S.

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

However, with the Centerpulse and Implex acquisitions and the relevant implications of both interest and amortization, it will continue to be useful for our shareholders during 2004 and 2005.

EBITDA in the third quarter is already 37 percent as a ratio to sales on adjusted basis, a material improvement of 80 basis points sequentially from the second quarter and almost 200 basis points improvement for the beginning of the year.

As a matter of reference, EBITDA is already providing 33 times interest coverage after only one year of debt paydown from the deal closing.

In the third quarter, actual acquisition and integration costs were reduced by $13 million or down by more than 50 percent versus the second quarter to only $12 million.

Adjusted net earnings in the period were very strong at 140 million, the magical 20 percent ratio to sales and the strong 50 percent basis points sequential improvement from the second quarter 2004.

Our third-quarter tax rate improved by 80 basis points to 30.9 percent.

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 percent and, therefore, deliver significant ongoing leverage effect to net earnings.

As previously mentioned, adjusted diluted EPS in the quarter increased 30 percent to 56 cents, but 248.2 million average diluted shares outstanding and $1.70 year-to-date.

We are pleased with these results because they once again reflect excellent progress only after one year of the Zimmer/Centerpulse integration.

We like the trend, and we are very comfortable with our public commitments.

At this point, I will provide some brief introductory third-quarter cash flow and balance sheet highlights.

Cash flow generation from earnings creation combined with working capital management has always been our story.

It is perhaps even more important now as a powerful strategy for rapid debt paydown and a source of acquisition capital.

Combined operating cash flow for the second quarter was at the extreme favorable end of our expectations, registering a record 206 million and our second consecutive quarter over 200 million.

With 62 million of cash and equivalents on hand, we have a new net debt position of only 618 million.

As a matter of reference in the first year of combined operations with Centerpulse, we have delivered $773 million in cumulative operating cash flow.

Shareholders equity has increased from 745 million one year ago to 3.6 billion, and therefore, net debt as a ratio to equity has already been reduced to only 17 percent.

Our third-quarter combined working capital statistics continue to perform well.

Combined inventory days performance is within Zimmer's normal range for the summer period and particularly strong for this point in the acquisition.

Our combined inventory days on an apples-to-apples basis, i.e. excluding any inventories step-up, were at 277 days, four days above last year but with substantially higher new product builds and much more of a European weighted summer sales denominator due to the addition of Centerpulse.

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

In the third quarter, we delivered global receivables at a respectable 63 days, a nice improvement of two days from prior quarter.

Combined U.S. receivable results were still good at 40 days but up one day from prior quarter.

We aspire to reach 60 days in global AR at some point.

With hostiles as our customer and a very large European business, the improvement will be tough but doable.

Payable days were well-managed at 68 days and appropriately as always above receivable days.

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

Reconstructive sales for Zimmer is the revenue recognition of hips, knees, shoulders, elbows and dental and planned into patients during the reporting period.

For the third quarter, worldwide reconstructive sales on a combined basis increased to 573 million, a 16 percent increase over prior year, the same combined increase as the second quarter but as mentioned earlier an important sequential constant currency accelerated growth to 13 percent versus 12 percent in the prior quarter.

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 very strong 24 percent reported recon growth worldwide in the quarter with knees at 25 percent and hips at 22 percent respectively.

Year-to-date combined recon growth remains at 18 percent.

We're pleased with the progress contained in these results versus both the total market and key competitors who have already completed their public reports.

Legacy Zimmer recon growth of 24 percent comfortably beats everybody despite tougher comps and the growth is measured against an annualized recon base of over $1.5 billion.

The combined Centerpulse/Zimmer effort remains cumulatively on plan and on schedule.

We will effectively develop our former Centerpulse base of business over the next year or two.

We have proven with Legacy Zimmer that we're capable of doing so.

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

First, products.

In the knee category, on a worldwide combined basis in the quarter, knees sales for Zimmer increased by 16.4 percent versus prior year to 281 million and 14 percent constant currency.

An important 1 percent acceleration versus the second quarter.

And that is despite Europe's distributor returns, Japan's biannual pricing decrease, and the former Centerpulse UniSpacer all being very much weighted to knees.

The Legacy Zimmer business grew 25 percent in knees, including our best ever 30 percent increase in the Americas.

On a year-to-date basis, knees sales have increased by 18 percent combined and 14 percent constant currency.

Both numbers consistent with the prior year quarter year-to-date results.

We're pleased to report that for the quarter on a combined basis all femorals increased by 19 percent versus prior year, all articulating surfaces grew 17 percent, all tibials grew 21 percent and all patellas grew 23 percent.

From a brand point of view, Zimmer's NexGen LPS-Flex is an appropriate place to start.

The world's top-selling high-flex knee continued its two-year long trend to gain with an explosive 71 percent increase to prior year in the quarter versus an average growth of 55 percent in the last two quarters and 50 percent most of last year.

It's no coincidence that the LPS-Flex is the knee of choice for our new MIS Mini and quad-sparing QS MIS total knees.

Additionally our brand-new LPS-Flex mobile bearing completed full US IDE patient enrollment and is now in the follow-up analysis stage.

The new Zimmer CR-Flex may be even a more special story.

With virtually no sales at all in the same quarter last year, the CR-Flex femorals alone delivered sales of more than $9 million in the third quarter and a 10 percent sequential growth to the previous quarter, despite the generally softer third-quarter summer period.

The new CR-Flex mobile bearing is now in full development.

We believe that in cruciate retaining units we are still growing at least 5 percentage points faster than the market, and with PS and CR combined, Zimmer high-flex femoral components have annualized sales of more than $100 million.

A few more highlights.

Legacy Centerpulse's MX (ph) knee was up a very strong 30 percent in the quarter, exceeding last quarter's 27 percent increase.

We will be marketing MX (ph) as a key quad-sparing offering in Europe.

Total UNIs are still up only high single digits, but with UniSpacers down 50 percent and the new Zimmer high-flex UNI just released September 1, we expect the double-digit growth curve to return.

With that said, total annual sales for Zimmer UNIs continue to be well over $50 million.

The patented Zimmer RHK rotating hinge continues to take share and increased sales 28 percent in the quarter versus 24 percent last quarter.

Our new most segmental oncology system from the Legacy Centerpulse business increased by 40 percent in the quarter.

Prolong, our traditional Zimmer crosslink polyethylene articulating surface for the knee with sales of over 5 million per quarter, increased by 59 percent versus prior year, and now represents 50 percent of all cruciate retaining articulating services but still only a little over 12 percent of our combined Zimmer and Centerpulse knee surfaces.

What a great opportunity, and we still expect to have the NexGen PS version of Prolong available late this year.

Since we sell almost twice as many PS femorals as we do CR femorals, it's a nice mix story for the future.

Trabecular metal mono block tibial trays have continued to takeoff as surgeons not only recognize the value of the material but the inherent lack of micromotion.

Trabecular metal tibial trays increased by 55 percent in the quarter versus prior year and delivered an annualized run-rate of 35 million, but it could be potentially easily $50 million on the tibial alone if we can keep up with demand.

As I mentioned last quarter, we've now approved and initiated expansion of our new Jersey-based Zimmer Trabecular metal technologies manufacturing capacity to 30 reactor units from the current 18 by the middle of 2005.

We expect to comfortably exceed $100 million in Trabecular metal sales for 2005.

There continues to be excellent progress on Zimmer minimally invasive knee front, particularly in training, computer-assisted developments and instrument demand, and I will update those activities later.

Let's switch to hips.

There's been a great deal of background noise on potentially reduced industry hip demand over the last two quarters, but we continue to be pleased with Zimmer's combined hip results.

The third quarter for Zimmer tells that story well.

On a worldwide basis combined, in the third quarter hip sales increased 14.1 percent to 250 million and 10 percent in constant currency.

The 14.1 percent growth this quarter against tough comps compares to 14.5 percent last quarter.

Legacy Zimmer hips grew a terrific 22 percent, including an important 20 percent growth in the Americas, while Legacy Centerpulse grew at 4 percent consistent with prior quarter.

We continue to be very encouraged with this new company after our first-year together.

Total primary hip stems grew 15 percent versus prior year with total primary hip cups increased by 24 percent versus prior year and porous stems continue to be very strong at 17 percent growth.

The fiber metal tapers, along with the new ML taper, are the stems of choice for Zimmer MIS UNI and 2-Incision hip surgery.

In the third quarter, these two stemmed families grew by 32 percent, bringing the combination of fiber metal and MLs almost 100 million per year annualized.

The entire core stem market is definitely not growing at 32 percent per quarter.

As we noted in many of our press releases, for Zimmer, MIS brings in new business.

Centerpulse's Alloclassic taper with nearly 50 million per year sales base grew exceptionally well at 29 percent in the quarter, up from 23 percent in the previous quarter.

It is our intention to provide MIS Mini and 2-Incision instrumentation as soon as possible for the Legacy Centerpulse Alloclassic and CLS brands to dramatically expand MIS, particularly in Europe.

Our Versys beaded six, eight and 10 inch stems grew at more than 40 percent in the quarter, continuing to take share from the beaded stem market leader.

At current rates of growth, the Zimmer porous primary hip stems exceeded an annual run-rate of more than $300 million.

As mentioned, Zimmer primary acetabular shelves accelerated significantly from prior year with growth of 24 percent.

Porous cups increased 24 percent with strong showings from the Legacy Centerpulse Alloclassic CSF and CLS perturno (ph) cups, up 50 percent and 40 percent respectively.

Trabecular metal modular cups continue to amaze us with an increase of almost 700 percent or eight times last year's sales in the quarter.

Needless to say, we are very happy with the purchase of Implex in April.

Here's one of our favorites, of course.

Despite the extremely tough comps, significant internal penetration and U.S. ceramic-on-ceramic competition, good old premium priced Longevity Highly Crosslinked Polyethylene polyethylene liners increased by yet another 27 percent -- this after four years from product introduction.

Since there is little difference between our crosslinked poly-dollar growth and unit growth, it's clear that our continued strong sales represent real surgical procedural penetration.

Not only is the growth rate higher than other comparable alternative bearings, but the base of sales is very different.

Our Longevity product line, when combined with Duracell and other Zimmer alternate bearing surfaces, annualize at more than $100 million per year in sales.

We do believe ceramic-on-ceramic can be a good mutual product alternative for the young active patient.

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

Based upon our desire to provide a full-service offering of alternatives and as per our press release, we have reached a satisfactory financial arrangement with CeramTec AG for the supply and distribution of product for the Trilogy system in the U.S. and Canada.

Subject to reasonable and normal regulatory process approvals, we would expect to marketing the products in the second half of 2005.

Zimmer will offer all three alternative bearing services.

In upper extremity joints, Zimmer's Bigliani/Flatow shoulders continue to grow worldwide with a 22 percent increase from the third quarter.

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

On a worldwide basis from the third quarter, Trima (ph) sales grew only 2 percent.

Given some competitive midteens growth for the quarter, we should continue to lose some share until we deliver new products for 2005.

With our unique locking plates not anticipated until late 2004 through mid 2005, some other new product successes have been carrying the load.

The ITS' nails went from almost no sales to an annualized 10 million plus product line and improved in the quarter with 140 percent growth.

For reference ITS type nails continue to be reimbursed in the U.S. at higher rate than compression hips screws, adding to their attractiveness.

All Zimmer brand IM intermediary nails jumped by 23 percent in the quarter versus prior year.

The former Centerpulse Sirius 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 fourth quarter of this year.

Our Zimmer plates and screws in total, though, are only -1 percent, cardi (ph) articular plates plus 7 percent and compression hips grew -7 percent.

The weighting of these categories offsets the other gains.

We expect to have the previously mentioned locking plates, restore our new wrist fixator, super condylar femoral nailing, and our new rotator cuff patch already to go in the early to mid 2005.

Until then we can expect growth from flat to mid single digits.

Our Zimmer spine division sales declined by 2 percent in the quarter to 32 million and positive 3 percent year-to-date as we continue to anticipate essentially flat to prior year sales by year-end.

Cage sales declined to 9 million for the quarter.

The new Trinica Select, our interior low-profile cervical plate system, delivered a 60 percent plus increase in the quarter, and Dynesys, our dynamic stabilization system, provided a 33 percent increase to almost 15 million annualized.

With the approval of our TM 500 and DVR 11 Trabecular metal spine for tibial body replacements, we registered more than $1 million in new sales again in the quarter.

However, as we have noted several times, until we combine Trabecular metal with the new spine pipeline and the few small technology acquisitions, we expect spine to remain roughly flat due to the predominance of declining cage in our sales mix.

Excluding acquisitions, we expect to reach low double-digit spine growth run-rates by the second half of 2005.

In our orthopedic surgical products division, sales increased a solid 8 percent for the quarter to 53 million led by OrthoPAT, our perioperative autotransfusion system designed specifically for orthopedics.

OrthoPAT sales increased by 38 percent in the quarter and continue to generate sales of over 25 million annually.

Our Linbetech (ph) arthroscopy and endoscopy businesses in Japan improved to a combined 20 percent growth, while global wound care increased by 12 percent.

Our LSP division has now reached $200 million in sales on an annualized basis.

In our dental division, sales remain robust with 29 percent growth reported to 30 million in the quarter.

Sales were led by biologics, up 191 percent; implants, up 16 percent, and surgical products, up 17 percent.

Let's switch our new product development update.

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

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

We've redesigned the new combined Zimmer pipeline to 146 projects with over $1 million of development cost each and some 163 projects in total.

Of the 146 projects, 38 are in hips, 35 are in knees, seven in extremities, 22 in trauma, 4 in Ortho Guidance, six in LSP, 18 in spine, 9 in dental, and 6 in biologics.

Of these projects, more than 60 percent involve new innovations, new platforms or new technology.

Here's just a sampling of the products we expect to release at varying stages during 2005.

A new Trabecular metal Acetabular System; 40 millimeter Trilogy Longevity; compatible Metasul heads with Trilogy; a natural hip for Japan;

Alloclassic and CLS MIS hip instruments; the new Revatin (ph) porous stem from Windothru (ph); new Birch Snyder (ph) cages;

CR-Flex mobile outside the U.S.; our new Flex UNI but this time with Trabecular metal; the next wave of MIS quad string instruments;

Trabecular metal augments; tibial cones and femoral cones;

LPS-Flex with Prolong Highly Crosslinked Polyethylene;

MIS instruments for the Natural Knee; a new Natural Knee patella femoral joint;

Trabecular metal glynoit (ph) and humeral cones for a new advanced Bigliani/Flatow shoulder; an atomic inverse shoulder; the Zimmer rotator cuff patch; elegenic (ph) digits for Europe; the long list of trauma products already mentioned including unique peri-locking (ph) plates; the new elastomeric self-management pain device; a new ATS 3000 tourniquet; a long list of dental products and of course new and more Dynesys and Trabecular metal in spine.

New product projects are expected to consistently deliver 18 to 20 percent sales each year from a rolling 36-month list of new products.

That is $500 to $600 million in sales organically each in every year.

New products for the third quarter represented 18.9 percent of sales, up almost 100 basis points on a ratio basis from the first-half.

Let's look briefly at geographic segments.

As with product categories, we will try to provide combined three-quarter information with individual Legacy Company highlights where useful.

First in the Americas, the combined Zimmer Americas had another strong showing in the third quarter.

Revenue for the quarter was 430 million, up 15 percent over prior year and sequentially very close to the 432 million in the second-quarter sales.

The composition of our growth retrospectively was as follows.

The Legacy Zimmer business delivered an excellent 21 percent sales improvement, while the Legacy Centerpulse delivered -1 percent impacted by both UniSpacer reductions and temporary sales dissynergies.

10.4 percent of our growth in the combined Americas was driven by increases in unit volume and 4.7 percent growth was derived from price increases.

Our combined Americas reconstructive growth in the quarter was 20 percent and delivered 342 million in sales.

This would imply that in the Americas during the quarter Zimmer had better than 15 percent gains in pure reconstructive surgical procedure units and mix.

In our 20 percent Americas reconstructive growth, knees delivered excellent results with a 21 percent increase to 190 million or a sequential growth of 4 million from the second quarter.

NexGen LPS and CR-Flex Trabecular metal tibial components, Prolong articulating surfaces, Centerpulse's Natural Knee and NexGen LCCK revision knees all made substantial contributions to Americas knee performance.

Hips in the Americas increased 17 percent to 124 million.

We are very pleased with combined Centerpulse and Zimmer hip growth in the quarter of 17 percent.

Hip performance in the Americas benefited from across the board solid growth in primary porous stems, revision, Trabecular metal cups, Highly Crosslinked Polyethylene, both Longevity and Duracell, augmented by multiple new product releases.

Our dental business in the Americas grew an outstanding 35 percent in the quarter to 19 million and well above the market.

Based upon our results in the already released public reports of our three major competitors -- Biomed, J&J DePuy and Stryker -- as well as the remaining market players, we believe that perceptions of domestic orthopedic market doom and gloom for Zimmer are once again simply not supported by the data.

The reported market growth in domestic reconstructive products for the quarter has remained firm at approximately 16 percent.

Zimmer combined Americas reconstructive would appear to be outpacing that market growth rate in the quarter by a least 2 points of growth in knees and 4 to 5 points in hips.

Our recon growth has been broad-based.

In the quarter for the new Zimmer distributor group, including the addition of our friends from Centerpulse, 20 of 30 distributors grew hips at market or better and 15 of 30 grew hips at twice the hip market growth rate or better. 17 of 30 distributors grew knees in the quarter at market or better, while 16 of 30 grew at 20 percent or better and five of 30 distributors group knees at 30 percent growth or better.

Here is a static we continue to be proud of.

The new combined Americas operating profit margin in the third quarter of 2004 came in at 51 percent or $219 million in profit. 50 percent plus earnings ratios are the real payoff for new products, market share gains and efficient operations.

The Zimmer Americas group has consistently delivered 50 percent plus operating profit.

Europe in the third quarter, net of distributor returns and in constant currency, had similar results to the second quarter.

In the quarter, European revenues were $167 million, up 9 percent combined and slightly above even in constant currency.

The theoretical add-back of distributor returns would help reconcile results to prior quarter, but some differences in results relate to price.

Prices in the quarter for Germany and Austria declined by 4.1 percent and 2.5 percent respectively.

This correlates to our forecasted declined from even to -1 for Europe in total.

While we do not expect it to improve, neither do we expect it to materially affect our entire business.

We have for a long time anticipated German DRG and buying groups, as well as French tariffs in our forecast of global 2 to 3 percent price growth.

What we did not know exactly was when.

On the product front, reconstructive implants on a combined basis delivered sales of 150 million in the quarter with Legacy Zimmer up 21 percent reported and Legacy Centerpulse up 4 percent.

With competitive reconstructive numbers for Europe already in most cases reported for the third quarter in the high single digits, it is clear that excluding the distributor reorganizations we're not dramatically liking the European reconstructive market at all.

Positive gains in the quarter reflect the continuing acceptance of both Durasul and Longevity Highly Crosslinked Polyethylenes, the increased impact of minimally invasive hips in Europe, and ongoing market share gains from the NexGen knee brand.

To round out recon, about 30 percent of dental division sales are contributed from Europe, and the third-quarter reported sales increase was a little over 10 percent.

Spine sales in Europe, although modest, picked up sharply again in the third quarter to record almost a 30 percent gain.

We're seeing new products such as Trabecular metal cages and the geographic expansion of Dynesys 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.

In constant currency, Portugal at 30 percent growth and the UK at 19 percent growth were exceptional, while strong sales results were delivered by Belgium, Netherlands, Scandinavia, Switzerland and Central and Eastern Europe, all in the high double digits.

We made earlier mention of Germany, our largest European operation, with over 200 million in annual sales with a tougher new DRG environment and complex buying groups fell to -4 percent price impact versus prior year.

Results in Germany may vary by competitor depending upon which public and university hospital groups phase fully into the DRG integration program at any point in time.

But regardless of price, Zimmer continues to grow on a constant currency basis in Germany.

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

For the quarter and despite the typical slow summer season, the combined Europe improved operating profits to 52 million and a solid operating profit ratio to sales of 31 percent.

This ratio still has the opportunity to materially expand even further as infrastructure and operating synergies are implemented over the next two years.

In Asia-Pacific, revenues in the second quarter were 103 million, indicating a combined increase of 13 percent consistent with prior quarter, but an important sequential constant currency growth of 7 percent versus only 4 percent last quarter.

These results are particularly noteworthy since they are inclusive of the Japan price cuts.

Asia-Pacific had flat to 1 percent positive price in the first two quarters of 2004.

We informed you last quarter that Japan pricing was thought to be coming in at -4.5 percent for 2004/2005, and our final information, as applied to Zimmer's mix, is generating -3.8 percent.

This continues to be a manageable outcome.

We believe that the Asia-Pacific market is growing at mid to high single digits in local currencies.

As a result, we appear to be holding share during our first year of integration.

In the third quarter, as with the prior quarter, our combined Asia-Pacific business was led by reconstructive growth of 13 percent with hips at 14 percent and knees improving to 10 percent growth.

We expect Trabecular metal tibial components, the recently released NexGen CR-Flex knee and the strength of the Centerpulse Natural Knee for cruciate retaining procedures to continue to improve knee contribution.

Hips sales are very acceptable for now at 14 percent growth with the addition of the Centerpulse brands and MIS driven expansion.

Trauma continues to show improvement with a combined 11 percent increase in the quarter due to better attention to specific Asian style ITS t-nails (ph).

While our dental business is small in Asia-Pacific, it did deliver another very strong above market 39 percent sales increase after 37 percent last quarter.

Australasia once again delivered a strong performance with a mid double-digit constant currency overall growth for all Zimmer product segments in the quarter.

Greater China, which we expect will exceed 30 million in sales this year, delivered a solid 20 percent constant currency growth, and Korea, after the anniversary of the government's 12 percent price cut, returned to form with a 20 percent growth.

Displaying excellent earnings drop-through from sales, the Zimmer Asia-Pacific businesses delivered $42 million in third-quarter earnings or a 40 percent operating profit to sales ratio.

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

Given time constraints, I would like to narrow that discussion down to only three topics -- mix, minimally invasive activities and, of course, an integration update.

Just a brief look at mix since we did not cover that topic last quarter.

First, Highly Crosslinked Polyethylene liners.

In the Legacy Zimmer, we continue to run significant penetration rates this quarter as with previous quarters and stabilized at about 88 percent.

However, the primary future opportunity rests with Legacy Centerpulse at only 53 percent global penetration.

Or said differently, the combined new Zimmer is really only at 75 percent.

Europe is the primary target with only 42 percent combined penetration.

Trabecular metal continues at only 4 percent to total hip penetration.

This figure reflects capacity constraints relative to the existing reactor manufacturer base.

As mentioned previously, we expect the 18 new reactors or 150 percent capacity increase to be progressively onboard from late 2004 and completed by May 2005.

This will help deliver better than $100 million in Trabecular metal sales next year.

Porous versus cemented primaries.

On a year-to-date basis, porous stems as a percent of total primary stems have increased to 57.9 percent for Centerpulse and Zimmer combined and still about 10 percent where we feel the market is -- below where we feel the market is.

Based upon history, the market could very well reach 78 to 80 percent, and therefore, Zimmer continues to have significant expansion capability.

Revision as a percent of total sales scrapped up to 5.1 percent as a percent of total units or a little above half of the market potential.

As we look at 56 percent in Highly Crosslinked Polyethylene, a demand constrained 4 percent in Trabecular metal, 58 percent in porous and 5 percent in revision, and we combine those figures with expanded use of high-flexion, MIS and a premium based pipeline, it is really hard to develop a case for Zimmer that does not support a strong mix component for the next several years.

Here's a brief update on integration.

Of the 3314 scheduled milestones required to execute the entire integration -- that is up from last month's 3180 -- we have completed almost 1800 of them.

Sales dissynergies now total approximately 38 million annualized incurred or anticipated.

We believe annualized positive synergies will reach our latest indication of $100 million.

Our integration activities update includes the design of a single new product development process in tracking the system across all divisions, the transfer of all Austin research to Warsaw and Winterford (ph) excluding biologics, and the establishment of global research teams.

We have completed instrument and inventory audits globally while simultaneously combining facilities in Italy, the UK, Spain, Belgium, Holland, Switzerland, Australia, Korea, China and Canada.

We have changed distribution models in seven countries with two smaller changes yet to be completed in parts of Scandinavia and Southeast Asia.

We have utilized almost 200 surgeons amongst others in detailed interviews to conduct brand and competitive evaluations, establish world teams in marketing, a global marketing portal and a corporate Web site that effectively combines the two companies.

We have merged all medical education, training, and Zimmer Institute organizations.

Our new corporate image takes the best from European and North American advertising and design.

We have physically broken ground and have still in place on the Warsaw and Puerto Rico expansions with (inaudible) architects drawings under review.

North American distribution and customer service is fully consolidated.

A new reduced cost master agreement for all air and ground shipments is being negotiated to our satisfaction.

Sample forgings and castings for Warsaw and Winterford (ph) have already been built.

All forecasting for North America has been centralized into Warsaw.

In human resources we have integrated the entire U.S. payroll and benefit systems, designed the global compensation system, rolled out the employee stock plan, implemented a global headcount tracking and data system and completed multiple cultural baselines between the two Legacy companies.

In finance, we have a new global planning process and financial structure, converted centerfolds from IAS to GAAP, integrated the treasury function, created a worldwide Legacy Centerpulse audit, completed a three-year global tax planning and restructuring vehicle, and developed a consolidated byline item grand monthly sales, units, price volume, mix system with forecast capability.

Lastly but hardly least, our relentless information technology team has already completed more than 50 projects in 20 different countries.

Now let's turn to Minimally Invasive Solutions.

We continue to be really excited about the progress in our six-year old MIS program.

During this section of the call, we will update you on several different aspects of our MIS program.

The Zimmer Institute continues to be incredibly busy with 909 surgeons and 190 physician assistant nurses for a total of 1081 OR staff trained on the MIS 2-Incision hip and MIS quad-sparing QS knee year-to-date at 13 Zimmer Institute locations.

With increased momentum on QS quad-sparing training, we still have a solid opportunity at achieving our target of 1400 surgeons trained in 2004.

In September we broke our own all-time record by one and trained a record 126 surgeons worldwide on the 2-Incision and quad-sparing.

At our September 20 course, we took time with our staff and surgeons to celebrate the 100th MIS 2-Incision training class since its inception and our 1000 surgeon trained year-to-date on all MIS courses.

Separate and distinct from these efforts, we brought 200 nurses from around the country into the Zimmer Institute at the Johns Hopkins University School of Medicine to specifically expand their understanding and knowledgebase with MIS.

Our surgeons' surgeon business year-to-date have reached 343 by our hard-working U.S. surgeon consulting group, including 11 trips to Europe and Asia in September alone and 28 proctoring visits in the U.S. to support MIS on-site with newly trained surgeons.

QS quad-sparing MIS knee training is really taking off with 353 surgeons recently trained along with 94 PAs and more than 230 Zimmer associates.

Surgeon MIS open requests, including proctoring, continue to rise and clearly stand at 694, split almost 50-50 between hips and knees.

The remaining available 54 classes for Zimmer MIS surgeon training through the Christmas break are now booked solid.

We completed our first MIS 2-Incision and quad-sparing courses in Paris where the materials, coursework, lectures and surgery were 100 percent completed in the French language.

We will operate 12 additional European courses between now and year-end in Budapest, Paris, Innsbruck and Vienna.

Our Zimmer medical education system itself is expanding.

Our curriculum development group will design a global instructional design platform for delivering high-quality MIS education around the world with common facilitator guides, evaluations, and a new online Internet precourse program exclusive to the Zimmer Institute.

Utilization of MIS hips continues strong at 47 percent with the 2-Incision increasing by 1 percent.

Here is our two biggest pieces of news on MIS hips.

After eight months of clinical evaluation, the U.S., Australia, Austria and Israel, the first worldwide release surgery of Zimmer's computer-assisted version of the 2-Incision total hip was successfully performed last week by Dr. Mark Hartzband at New Jersey's Hackensack University Medical Center in a little over one hour.

The world's first 2-Incision computer-assisted training courses will follow in the near-term at the Zimmer Institute in Warsaw.

These specific computer-assisted surgery applications and the instruments are exclusive to Zimmer and designed only to work with our system.

The system provides real-time rendered three-dimensional models of RAS and implants to support amongst other things outputs leg length and opposite measurements for preop and postop comparisons, as well as working windows or the changing incision locations unique features within the MIS system enable precise alignment through our minimal incisions.

As promised about two years ago, our development of electromagnetic image tracking or EM is nearing completion and potentially allows for portable non-line of site tracking, making smaller incisions, smaller instruments and smaller implants a practical reality only from Zimmer.

Both technologies were developed with our partner Medtronic.

Equally exciting and compatible with our CES development in December of this year we will deliver the Zimmer single incision MIS anterior-lateral.

What is new about it?

Well certainly not the entry point or the incision size, but once again it's all about patient quality of life.

We believe the new Zimmer MIS anterior-lateral as studied will deliver dramatically improved single incision patient benefits unlike anyone else.

Speaking of hip studies, we have now completed 505 subjects enrolled in our MIS early patient outcome study and more than 1805 cases reported in our 2-Incision index case report to study complications.

We currently have 17 planned or approved MIS hip studies alone, including index case studies, three multicenter perspective randomized reviews, two abductor muscle strength studies, an evaluation of blood assessment versus traditional techniques using CPK as a measure soft tissue damage, retrospectives on patient gate and quality of life, an elderly fracture hip cohort, 2-Incision with image guidance and of course economic value added comparisons.

The results are excellent with one glitch.

It's tough to find large groups of patient to undergo traditional open surgery on the understand the process (technical difficulty)-- of MIS patients.

We expect to have more than 10 MIS tapers in our salesforces and surgeons' hands next year.

Let's shift our attention to MIS knees. 300 quad-sparing instruments sets have been deployed and 80 per month will be deployed until year-end for a total of more than 600 sets this year.

In addition to the 600 sets, some (inaudible) new additional instruments have been added to existing kits to help convert them to many MIS knee sets.

This paves the way for surgeons to learn minis through Zimmer before advancing to the more complex quad-sparing.

In October we will release our national and regional PR campaign for quad-sparing, including low-cost TV, newspaper and magazine coverage in 12 major cities with some of the most authoritative surgeon names in the business talking about the patient opportunity.

Our consumer education binders and DVDs will all tie back to Zimmer's 1-800-find-MIS and pacewithlife.com.

Our national quad-sparing campaign chairman is Dr. Alfred Tria, Professor of Orthopedics at the Princeton's Robert Wood Johnson School of Medicine.

Dr. Tria will appear with his patients.

More good news in knees, similar to hips, rest with comparative assisted techniques.

In the late fourth quarter, we were released on a limited basis following our national campaign, the new Zimmer MIS quad-sparing image guided knee solution.

The software is uniquely designed amongst other things to aid the surgeon in the accurate placement of the femoral and tibial cutting guides.

As with hips, the quad-sparing image guidance system was developed with our partner, Medtronic.

And as with hips, we are initiating several scientific papers.

Lastly on MIS, let's talk about economics.

In a study just presented at Harvard, if 57.5 percent of patients actually received Zimmer minimally invasive hips and 30 percent of those receive Zimmer 2-Incision techniques, the estimated annual savings to the U.S.

Healthcare system would be a whopping 1.03 billion.

Despite normal average selling prices for the implants, this data is similar to our own beta site study trends to date on more than 500 procedures indicating the utilization of in this case specifically the Zimmer MIS 2-Incision, could have saved as much as $3000 per surgery.

By looking at total procedure dollars and converting to Zimmer 2-Incision and we hope also Zimmer MIS anterior-lateral, the argument on a macro basis about the increased cost of orthopedic implants goes away.

We would have created enough productivity value to in theory make the stem free.

It's a story that Zimmer will be uniquely taking to hospitals as part of our new MIS economic value added story.

And now I will turn it over to Sam for his comments.

As Ray indicated and as you saw in our press release last night, we delivered another excellent quarter in sales, margins, earnings and cash flow.

As we have said each quarter since the acquisition of Centerpulse, the inclusion of Centerpulse in our financial results this year makes reported comparisons to last year 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.

Sales growth will be measured against the pro forma sales for last year, including Centerpulse.

References to earnings for this year will exclude acquisition and an integration costs, as well as inventory stepup expenses.

Several factors contributed to our excellent third-quarter financial results, including the underlying sales growth for Zimmer Legacy products being better-than-expected.

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 sales (inaudible) materialized but in total were less 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 third quarter and the first nine months of 2003.

In the third quarter, reported sales of $700 million represented 76 percent growth over prior year, and when comparing these results against the combined sales of $618 million for the third quarter of 2003, sales increased 13 percent.

Contributing to this growth were 2 percent from pricing, 3 percent from foreign currency, and 8 percent from volume and mix.

Within this 13 percent combined sales growth for the quarter, the Zimmer standalone product portfolio continued with the strong growth that we have seen all of last year, finished in the quarter with 20 percent growth over prior year, while the Centerpulse standalone product portfolio grew at 2 percent over prior year.

Due to a lack of R&D investments by Centerpulse in this quarter and nonbiological recon and spine products during the three years proceeding the acquisition, the Centerpulse product portfolio has grown slower than Zimmer and the market.

During the first 12 months since our acquisition of Centerpulse, the Centerpulse growth rate as planned has also been effective by the sales dissynergies resulting from the integration of the two companies.

This makes comparison to the third quarter of last year where we had no sales dissynergies realized as of that point very difficult.

For the first nine months, revenue increased 82 percent over prior year on a reported basis and 16 percent on a combined basis incorporating Centerpulse's sales for the first nine months of 2003.

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

In the area of foreign exchange, the U.S. dollar on average held pretty constant against most currencies throughout the third quarter of this year compared to the second quarter.

Similarly the U.S. dollar on average held constant to most currencies between the second and third quarters of last year.

If foreign currency exchange rates in Q4 remain unchanged from current levels, foreign currency movement will contribute approximately 1.5 percent to our fourth-quarter sales growth and about 3.5 percent to our full year 2004 sales growth over 2003 combined sales.

I will be addressing guidance for 2005 in a few moments, but while we are on the topic of foreign currency, if today's foreign currency exchange rates were to hold through the balance of 2005, the effect on 2005 sales growth over 2004 would be approximately breakeven.

I mentioned in previous calls that as a part of our overall integration of Zimmer and Centerpulse businesses in Europe we are developing and implementing a more tax efficient structure in Europe.

This new structure now provides us with the ability to hedge European intercompany sales transactions similar to the way in which we hedge U.S. intercompany sales transactions with the use of simple forward contracts.

I'm very pleased to say that in the third quarter we began to implement our new hedging strategies for Swiss-based intercompany transactions.

We now have over 80 percent of our forecasted Euro/dollar intercompany transactions hedged for the balance of 2004 and for all of 2005.

We also have over 70 percent of our forecasted Swiss Frank dollar intercompany transactions hedged for the balance of 2004 and for all of 2005.

We have already begun to hedge a portion of our forecasted 2006 transactions because we have a 24-month horizon on our hedging strategies.

These hedged contracts are an effective tool to minimize the short-term impact on earnings of rapid movement in foreign currency exchange rate fluctuations.

We do utilize our hedging strategies to manage the short-term financial risks associated with these fluctuations, and this in turn provides the opportunity to incorporate these changes into our annual planning process.

Reported gross profit margin for the quarter was 75.8 percent.

U.S.

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

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

This stepup has been expensed as a non-cash charge to the P&L and to the inventory to which it is associated with is sold.

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

The total Centerpulse's inventory stepup recorded as of October 2 when the acquisition was completed was $95 million, and the Implex inventory stepup recorded in April of this year was $7 million.

In the third quarter, $5 million of the Centerpulse and $2 million of the Implex inventory stepups were expensed to cost of goods sold and had a negative impact on gross profit margin of 100 basis points.

This $7 million pretax expense, $4 million net of tax, equates to an EPS reduction of 1.5 cents in the third quarter.

Excluding the effect of inventory stepup expenses, the adjusted gross profit margin for the third quarter was 76.8 percent, which we believe is the highest among our direct competitors.

It also represents a record high gross profit margin for Zimmer.

The growth and mix of new products continue to contribute positively to our gross profit margins.

New products represented 19 percent of our total sales in the quarter.

Also because the growth of our Americas business with its higher gross profit margins is faster than our European business, we're seeing a favorable contribution from geographic mix.

Continuing improvements in manufacturing operations also contributed substantially to our gross profit margin improvement.

The remaining $2 million of Centerpulse-related inventory stepup will be recorded to the P&L as non-cash expenses in the fourth quarter and going forward will have no additional effect on reported gross profit margins in 2005 and beyond.

The remaining $5 million of Implex inventory stepup will be expensed over the next three quarters.

On a year-to-date basis reported gross profit margin was 72.9 percent.

In the first nine months, $56 million of the inventory stepup was expensed and had a negative impact on gross profit margin of 260 basis points.

This $56 million pretax expense or $36 million net of tax equates to an EPS reduction of 14 cents in the first nine months.

Excluding the effect of inventory stepup expenses, the adjusted gross profit margin for the first nine months was 75.5 percent.

Reported operating expenses for the third quarter were 48.4 percent of sales.

Included in reported operating expenses for the quarter were acquisition and an integration expenses totaling $12 million pretax, or $8 million net of tax, or 3 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 46.8 percent.

In total adjusted operating expenses were $8 million below the second quarter, but were 130 basis points higher as a percentage of sales due to the seasonality effect of lower sales in the summer months of the third quarter.

On a year-to-date basis, reported operating expenses were 49 percent of sales.

Included in reported operating expenses for the first nine months were acquisition and integration expenses totaling $67 million pretax, or $43 million net of tax, and 18 cents in earnings per share.

Excluding the impact on the acquisition and integration expenses, the adjusted operating expenses as a percentage of sales were 45.9 percent.

Reported operating profit margin was 27.4 percent for the quarter, and excluding the impact of the inventory stepup and integration expense and acquisition expenses, adjusted operating profit margin was 30 percent or 40 basis points greater than the second quarter.

Year-to-date reported operating profit margins were 23.9 percent, while adjusted operating profit margins were 29.6 percent.

With our continued strong operating and free cash flow, we paid down total debt by $189 million in the third quarter to a total of $680 million and reduced interest expense for the quarter to $7.7 million, down $600,000 from the $8.3 million expense in the second quarter.

Since our acquisition of Centerpulse 12 months ago we have paid down $800 million in debt, which represents about 50 percent of the Centerpulse acquisition-related debt from October of last year, and 100 percent of the cash required to acquire Implex in April of this year.

Since the acquisition, we have spent $245 million on integration and acquisition costs. $147 million of those costs have been expensed at the P&L with $12 million being expensed in the third quarter and $67 million expensed during the first nine months of this year.

We expect to expense $22 million in the fourth quarter and $42 million during 2005 as the majority of the remaining integration activities are completed.

Zimmer's effective tax rate for the first nine months was 31.1 percent on reported pretax earnings and 32.0 percent on adjusted pretax earnings, excluding the effect of inventory stepup and acquisition and integration expenses.

To bring our adjusted effective tax rate down to 32 percent on a year-to-date basis at the end of the third quarter, the third quarter stand-alone rate on adjusted pretax earnings was 30.9 percent.

I mentioned earlier that we began to implement our global tax strategy in the third quarter, and we have now begun to see the benefits of our new international structure reflected in our effective tax rate.

Implementation will continue to be rolled out over the balance of this year and into 2005 and 2006.

ATD 28 requires that the expected full-year effective tax rate be recorded on a year-to-date basis.

With only the work done to date, we have been able to lower our full-year estimated effective tax rate to 32 percent.

Additional work throughout the balance of 2004 should give us the ability to lower the rate further to approximately 31 to 32 percent for the full year of 2004.

This also positions us well to lower the effective tax rate even further in 2005 and beyond.

Reported earnings per share for the third quarter was 52 cents.

Excluding inventory stepup and acquisition and integration expenses, third-quarter adjusted EPS was 56 cents, which is 3 cents over the top end of our previous guidance, 3 cents over First Call consensus estimates and 30 percent over the prior year of 43 cents.

Included in the quarter was approximately 1 cent of dilution from the Implex acquisition.

The earnings per share effect of recording a 30.9 percent effective tax rate in the third quarter compared to the year-to-date rate of 32 percent was approximately $2.2 million or almost 1 penny a share.

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

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

Our combined days sales outstanding for the quarter were 63 days, two days below the second quarter, and this improvement in DSO is due to factoring receivables in some parts of Italy where collections tend to be a very lengthy process.

Days inventory on hand were 277 days, excluding the effect of inventory stepup.

This is four days higher than the 273 days reported at the end of the third quarter 2003.

This increase is due in part to the seasonality of the slower summer sales months, which in turn slows the velocity of our inventory turns in the third quarter of every year, and also in part to the buildup of inventory necessary to launch new products throughout the balance of 2004 and into 2005.

We do expect days on hand of inventory to decrease back to approximately 250 days by the end of this year.

Operating cash flow was a record $206 million for the quarter and $604 million for the first nine months.

Major contributors to our strong cash flow in the quarter were better-than-expected earnings, driven by improved margins, as well as excellent working capital results.

Capital expenditures for the quarter were $61 million, consisting of $32 million for instruments and $29 million for all other property, plant and equipment fixed asset additions.

Free cash flow, which is operating cash flow less capital expenditures, was $145 million for the quarter and $438 million for the first nine months.

As a result of the Centerpulse and Implex acquisitions and the related $633 million of amortizable intangibles recorded at the transaction dates, amortization expense for the third quarter was $11 million, while depreciation expense was $36 million for the quarter.

Due to the strength of our operating performance in the third quarter, we announced in our press release last night that we are updating our sales and earnings guidance for the fourth quarter of 2004, and we are providing guidance for the full-year 2005 for the first time.

Fourth-quarter sales are expected to be within the range of $775 million to $780 million, representing growth of approximately 10 to 11 percent over the fourth quarter of 2003 pro forma.

This represents a $10 million reduction from the top end of the Company's previous guidance for the fourth quarter, which included a range of $775 million to $790 million.

When developing our fourth-quarter sales guidance in preparation for our earnings call at the end of last quarter, we used an incorrect fourth-quarter assumption when determining the potential effect of foreign currency.

As a result, when describing the factors that contributed to our $775 to $790 million expected range of sales for the fourth quarter, we attributed $9 million too much to constant currency growth and $9 million too little to the effects of foreign currently.

As you analyze our new fourth-quarter guidance, there are three factors to look at.

The conversion of additional dealer relationships in parts of Scandinavia and Southeast Asia to our direct sales model had originally been forecasted for the third quarter were still being negotiated at the end of the quarter.

Consequently approximately $5 million in sales returns associated with these potential distributor changes contributed favorably to the Company's third-quarter sales performance compared to guidance and are expected to shift into the fourth quarter.

Also as Ray mentioned earlier, spine and trauma, which represent our two smallest product categories, are growing slower than their respective markets.

Our fourth-quarter range of $775 million to $780 million in sales represents approximately 10 to 11 percent growth over prior year and is in line with our original postacquisition sales growth expectations for the first one to two years after the acquisition communicated in October of 2003.

Our sales in the fourth quarter of this year will reflect the full effect of the sales dissynergies that will have occurred this year originally estimated to be approximately $40 million annually.

Last year's fourth quarter had virtually zero sales dissynergies which creates a very difficult comp.

Including our updated fourth-quarter sales guidance, full-year 2004 sales are expected to be in the range of $2,955,000,000 to $2,960,000,000, representing an increase over combined pro forma sales for 2003 of 14 percent, 3.5 percent of which is contributed by foreign currency.

We will have delivered a 10.5 percent full-year constant currency sales growth for 2004 while overcoming more than $40 million of sales dissynergies and approximately $15 million of sales returns from executing our strategy to convert several of our countries from a distributor model to a direct sales model.

We will have also overcome a flat fixer-upper spine business and an acquired Centerpulse orthopedic implant business that was growing at a slower rate than the market.

For the full-year 2005, the Company estimates sales in the range of $3,325,000,000 to $3,345,000,000, which represents an increase of approximately 13 percent over 2004.

As I mentioned earlier, if foreign exchange rates hold constant from current levels throughout 2005, the contribution of foreign currency movement on 2005 sales growth should be negligible.

As a result of the improved gross profit and operating profit margin that we saw in the third quarter, as well as our confidence in our ability to continue to drive our integration plan ahead of schedule, we are increasing our earnings per share estimates for the fourth quarter to a range of 62 to 64 cents on an adjusted basis, excluding the effects of inventory stepup expenses and excluding acquisition and integration costs.

This will represent an EPS increase over prior year of approximately 25 percent for the fourth quarter, an EPS increase of 30 percent for the full-year 2004, and continues to demonstrate our ability to gain positive leverage from every sales dollar of growth.

The Company also estimates 2005 adjusted diluted earnings per share in a range of $2.80 to $2.85.

This will represent an increase in excess of 20 percent over prior year.

Today's 2005 guidance reaffirms the Company's original expectations communicated in October of 2003 for the combination of Zimmer and Centerpulse to deliver in excess of 10 percent sales growth in 2005, a 20 to 25 percent adjusted diluted earnings per share growth in 2005, and the potential to exceed the 25 percent adjusted diluted earnings per share growth in 2006.

As a reminder, our earnings per share guidance for 2005, as well as 2006, does not include the impact of any potential changes in U.S.

GAAP related to the accounting for equity-based compensation.

When the date for this U.S.

GAAP accounting standard is made effective, we will adjust our guidance accordingly.

In summary, the third quarter was an outstanding quarter.

We overachieved our sales and earnings expectations for the quarter while producing record operating cash flow.

We achieved a record gross profit margin of 76.8 percent, a 30 percent operating profit margin and a 20 percent net income margin as a combined company.

We announced our intention to have a ceramic-on-ceramic hip product offering in the market during the second half of next year to further complement our market-leading product depth in recon.

We continue to lead the market by advancing our MIS activities, and we've increased our earnings guidance for the fourth quarter of this year.

We have communicated our combined continued confidence in our served markets, as well as our expected performance within those markets by issuing strong sales and earnings per share growth expectations for 2005.

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

And now we would be happy to take your questions.

Lynn, we will turn the call back to you.

(OPERATOR INSTRUCTIONS).

Katherine Martinelli.

Merrill Lynch.

Thank you.

Just a couple of questions if I may.

Firstly on the gross margin, Sam, I know you made some comments with respect to gross margin, but I am still really grappling with the magnitude of the improvement in a sequentially lowest revenue quarter, recognizing that I'm assuming the manufacturing synergies tied to Centerpulse are not really kicking in yet since my sense is those are tied to the timing of OEM contracts.

So could you just may be flesh that out a little bit more to give us a sense of what is really driving gross margin?

Yes. (inaudible) manufacturing synergies because you're right those will come later, it is a combination of a variety of things.

We did mention the Americas business, which has stronger gross profit margins growing at a faster rate than Europe.

That's very helpful.

We continue to benefit from the unit growth that we are seeing in driving favorable manufacturing variances just from normal operations and that is helpful.

And Ray articulated a number of the successes we have had by driving continued penetration of products that drive higher margins, so we get the benefit of mix as well.

So all that together has given us just tremendous leverage for gross profit.

If I can add one thing and one thing only, the Puerto Rican products that we have in place have also been on the very high side of the sales growth.

And, of course, the efficiencies and margins we run in Puerto Rico are significant as well.

So it's made a huge difference when you combine it altogether with mix, plus a lot of the historical things as Sam commented on that we have been working on in the plant.

We are not seeing the new synergy items because those are a longer tail to the moose as you correctly mention.

But a lot of the things that we started two years ago we are starting to see the benefit of, even though at the time we did not plan them as part of a Centerpulse deal.

For example, you know because whatever we drive in terms of reduced costs today does not find its way to the P&L until about nine months from now but because we have 200 and roughly 50 days of inventory.

So some of what we are seeing today are the benefits of the cost reduction programs that we put in place last year finally finding their way to the P&L.

That's very helpful.

Now in terms of the Centerpulse business recognizing the Legacy Centerpulse growth in the low mid single digits being impacted by as you guys mentioned the lack of R&D in new products when it was a stand-alone company, when are you guys assuming that you start to see sequential growth in that old Centerpulse franchise because it seems to hit your revenue targets for next year?

You would have to start to see momentum rebound, practically on the reconstructive side for the Legacy Centerpulse.

Is that a correct way to be thinking about that business for next year?

I think it is.

I thing when we did the original work, and we've stood by that and it looks to be true, that we really felt the combined businesses would run.

We would try and stay at 10 percent or just in the double-digits through the first roughly two years, so that would be October of '05.

We have not seen as much to synergies as we expected.

They actually came in about 40 million instead of 50.

We don't expect them to go up from this point.

They will obviously start to come down.

We have not seen the positive impacts really much yet in the way of crosstraining.

We have seen it on some products that are obvious.

We are seeing some more growth in NexGen.

OSP products are a little easier to learn perhaps and sell, and Centerpulse did not have those products.

Some of the obvious things.

I still think that we are looking at the first couple of years at about 10 percent in total.

A swing factor in that could be how quickly can we get -- dental is performing very well.

We are really really pleased with dental.

How quickly can we get some spine sales that are off, flat, cages stabilized and back up, because that would really help us from two aspects?

A) Obviously it would drive higher blended sales growth even though it's a smaller division.

But spine margins tend to be really higher than recon in general and, therefore, would help contribute to margins as well.

But I still think we are second half '05.

Great.

One last question then on the MIS side.

Ray, you mentioned that you were gearing up to launch -- and I apologize I missed the timing -- a smaller incision and/or lateral hip.

Would that technique with those instruments allow for you to avoid cutting the muscle because it seems as if you could do a smaller incision that did not cut the muscle, you would get all the benefits of a 2-Incision, but it would be a lot less technically challenging.

Is that correct, and what was the timing again for the instrument launch?

Yes, you are well versed.

The key is not to have a -- as we have said now for six years, the key is not to have a single incision that simply does what the old incision did on the inside of the body.

The key is to have a single incision that has the same patient benefits if possible even as the 2-Incision.

That will be tough to get to, but I think we can get there.

The timing for it is ended early next year, and we expect to have and be able to show some pretty significant patient quality of life benefits with what we expect to be an easier procedure.

As you know very well, the patient outcomes from the 2-Incision are just absolutely exceptional.

The economic benefits are exceptional.

But it is complex to do and it is tough to teach, so we are trying to obviously find a way to get all the benefits with an easier process.

Dhulsini De Zoysa.

SG Cowen.

I was wondering if you would comment on what you're seeing in Europe, specifically where you would take the organic growth rate?

Where crosstraining stands in that market?

When you might expect to realize the impact of crosstraining?

And then maybe just DSOs, if you could, U.S. versus overseas?

Okay, I will turn to the first part of that.

The organic growth rates, if we take -- it depends how you want them -- if you take -- mix and volume I guess together is probably the easiest way to do it because price is kind of all over the place.

If we take mix and volume together, it is probably in the 5 to 6 percent price is going to be somewhere between plus 1 and minus 1 because it depends on -- for Zimmer, it's about minus 1, but it's going to vary by competitor because it depends on where your strength is in relative countries.

And we see that on a go forward basis.

Again, as we get updated information, I like to put it in the conference calls, but there is nothing new on Germany and France.

That was already calculated in the 2 to 3 percent that we've been talking about for some time.

Crosstraining is about 60 percent complete, which would lag at about 10 or 15 percent behind the U.S..

The benefits of it are minimal at this point, other than on obvious products that particularly the Centerpulse salesforce did not have access to.

Such things as we are the world leader in tourniquets.

They clearly did not have access to that, and in some cases we did not have the competitive position there.

The key on the flipside is getting MX (ph) and the Alloclassic and the CLS paternal stamps, the more traditional Centerpulse stems and knees, converted to MIS which is in the first half of '05 and, of course, accelerate our training and penetration on that basis.

One of the things I did not go into great detail on just because of time, so I will only do it fast now, Europe.

For us to turn around Europe, it is we can offset some of the price decline, if not all of it, by pricing improvements on a by-hospital basis where Centerpulse or Zimmer had the strength and obviously we are selling at different prices.

MIS is obviously important as you already mentioned.

Completing the crosstraining is important.

The outcome is from the distributor restructuring to direct that we have talked about.

Growing new trend.

Increasing spine and dental mix.

The distribution consolidation.

We run a very different business than Centerpulse did, and we tend to work out of big shops that work 24/7.

So our distribution profile will be different over there.

So there is a pretty long list of things to do, but we're very happy with Europe.

It does not perhaps look so on paper sometimes with the numbers, but given the magnitude of the challenge there in the first year of the deal, we are very genuinely very pleased with what is going on.

Sam, do you want to comment on the --?

On the DSO front, the U.S.

DSO -- I should say the Americas DSO -- is running about 40 days, and as you recall in the U.S., prior to the acquisition of Centerpulse, we ran in the low 30s -- 32, 33 days, sometimes as low as 31.

So we believe going forward there continues to be some improvement opportunity on the U.S. front.

Internationally they obviously run higher.

What I will say that Europe is higher than Asia-Pacific typically by about 20 days or so, typically in those countries that pay slower in the south of Europe and especially in countries like Italy.

But on balance we look at the 63 days of receivables still having a little room for improvement, primarily driven not so much by international but driven by U.S. potential.

If I may follow-up.

The profitability delta between U.S. and Europe is certainly dramatic.

When would you expect or where could that go -- Europe I mean -- and when?

Is that sort of a 2006 improvement?

Yes, I think if you look back at Zimmer, once we got the old Legacy Zimmer straightened around in Europe or where we wanted it, it was running about 20 percent.

We have been able to leverage that up to 30 percent just on the sheer size and opportunities presented to us with the acquisition of Centerpulse.

That would leave you with about a 20-point gap -- in rough terms a 20 point gap between the U.S. and Europe and about a 10 to 15 point gap between Asia and Europe.

I don't think Europe in my mind will ever reach profitability levels, at least in the foreseeable future that you have in the U.S..

I think it has the potential in our case given our mix and how we like to run our business from a distribution profile and our mix of products and so on to get closer to the 40 percent than the 30 percent.

So there is still quite a bit of room there, but I think the pricing differentials and some of the inherent multiple country issues you have in Europe would probably make it pretty difficult to ever get into the 50 percent, at least again in the foreseeable future.

Mark Landy.

Susquehanna Financial Group.

Ray, you mentioned that you have got pretty good technology concessions and compliance rates with the contracts you negotiated thus far.

Historically compliance has been the Achilles heel of these contracts.

How do you go about improving compliance?

Maybe an observation is, is information technology making it easier given that you can get utilization reports on a daily basis now?

The IT systems veteran hospital -- I will answer the last part first -- are getting considerably better.

In fact, I just went to a Medtek meeting that was on that subject in Indianapolis, and it is just amazing some of the IT technology and how we can link that.

The reason I went to it, and I am particularly interested, is because I want to be able to link economic value-added marketing stories that will take the hospitals to databases that they can actually use in the hospital and validate themselves that they are getting the benefits, so that was the reasoning.

And I think the answer to that is yes.

In terms of the price and what we're seeing in carveouts and compliance, we have tended in the last I think probably year and half or two years as we have done a number of negotiations to get much higher carveout rates than we think we're seeing in the competition.

Our carveout rates are those things that we tend to get out and get, for lack of a better term, closer to list price.

It tended to be anywhere from 12 to 18 percent of the total listing of SKUs.

That is unusual because the usual carveouts will tend to be 5 or 6 percent, maybe 10 at the absolute most.

So obviously the balance and mix of pricing shifts more favorable.

In terms of compliance, the only difference I've seen -- first of all, we cannot get compliance.

The hospitals work with the surgeons to do that.

But two things I have seen is that there seems to be more accommodation on the surgeon's part if in fact they can get access to the unique things they want.

So in other words they maybe more willing to comply with some of the hospitals requests and go to two vendors instead of four if they are sure they can get their hands on X. Maybe that is trabecular metal in our case or somebody else's products and somebody else's case.

But I think the reduction in the number of vendors which we have clearly seen from averages of four and five down to what now is in many cases two, and the high access and easy access to carve out products, I think has improved and will continue to improve the relationships.

I'm not crazy about the long-term concept of solely relying upon the so-called surgeon manufacturer strength of relationship.

It is strong, but we are going to have to learn how to bring the hospital under the tent in that relationship, and I believe for Zimmer that's going to come from economic value-added propositions related to MIS in other areas that we can prove benefits to the hospital.

Just maybe if we look at the contract should you have negotiated thus far, 2005 over 2004, could you give us some insight into price volume and mix?

I will give you a real general answer, Mark, because by legal documents we're not allowed to disclose that.

It's a confidentiality agreement.

But I will give you a very broad answer.

If you look at -- first of all, almost all these agreements are either two or three-year agreements.

So we are in pretty good shape, not just for '05 but for '06, and in some cases out into '07.

It covers thousands of hospitals, and we're not seeing price opportunities that are any less than we have had in the last year or two relevant to those deals.

Okay.

And then from a mix perspective, say that is actually even more favorable given the greater carveout that you have gotten?

It is more favorable, but we have had to balance that with probably a little less on the other side.

So the net of the two comes out to where we have been in the -- where we have been in the past.

What I am particularly pleased about, first of all, is the ability to maintain those kind of pricing and net negotiations, and obviously there's benefits in there for the hospitals and surgeons as well.

Offsetting that, though, that I really like actually more than that, is the fact that we get rid of two or three vendors in the hospital and we get it down to its Zimmer plus somebody else in what accounts to hundreds and in some cases I guess a couple of thousand hospitals.

That is a hunting license with two people that I really like.

And then lastly on the cash flow, it's getting exceedingly or increasingly exceedingly (inaudible).

Do you accelerate the debt payments, or do you build the cash forward to do further acquisitions?

Well, it depends if the acquisitions come long I guess is the answer.

Obviously we don't talk about that.

We clearly need to make and will make some technology acquisitions in spine.

Our basic philosophy that we have had going back since we did the spin has not changed.

If we build some cash, it's not through big intention.

Our primary focus is rapid debt paydown, use of the money for smaller acquisitions.

I mean obviously in the spine area it's more inclined to be something between 50 and 200 million.

We're not stock buyback people as long as the key multiples remain at decently high levels.

We don't see stock buyback as being effective for our shareholders, and we are not anti-dividend.

But at this point, we want to make sure we pay off the debt and use the money effectively for technology acquisitions.

So I think our fundamental operating philosophies that we have put in place with the spin I see no reason to change them at this point.

So we should see some continued acceleration of a debt downpayment in 2005?

As long as the cash flows pay at this level and assuming we continue with a plan of small acquisitions, especially if they are cash-based acquisitions as opposed to stock, you know you will see us use our money for those two things and those two things only at this point.

Milton Hsu.

Bear Stearns.

Ray, just touching on something you just mentioned a second ago with the number of vendors per hospital declining, we have heard the same thing from our hospital contacts.

Do you think going forward that should change what is going to drive market share shifts?

Maybe market share shifts are even a little bit harder to come by?

And number two, is this going to be a more technology-driven market than a service driven market?

Well, I would have answered no to that first question for most of my life, but I think if they can really make some of the compliance work, and I think they will the way it is structured, I think you may see some modest shift in market share related to these big deals.

Because of the size of the market and the number of hospitals, I don't know that it's going to be a material shift, but I think you actually will see some, particularly when it gets down to one or two vendors.

I don't think you can pick technology over service for obvious reasons.

I think what is going to be more obvious to people is the fact that we can make more changes in patients' lives with some of the unique technologies coming into play now so that just raw service on similar products will not be enough.

We're going to have to demonstrate technology.

As you can tell from a lot of the investor presentations that we do and the comments I just made in the call, I also believe at least for Zimmer that economic value-added and linking new technology to a price, that while it may be higher, it has a demonstratable patient benefit, as well as an economic benefit to the health care system.

I think is going to be the linkage you have to put together.

Raw technology at three times the price of the existing product, I don't think is going to cut it.

Okay and just a second question.

Turning to Europe as the dissynergies go away a little bit next year, can you give a little more detail on what will drive an inflection point in Centerpulse's growth?

I know the cross-selling is part of it, but in order to see maybe high single digit growth constant currency in Centerpulse, do we necessarily need to see leverage of MIS, Trabecular metal, and conversion to Highly Crosslinked Polyethylene in that market?

I think you do need to see, not necessarily the long list of everything, but in order to get that size of business up into that single digit where we would like it, I think three or four things have to happen.

You do have to complete the training.

You do have to get market share gains in the easier things.

What I mean by that is some of the OSP products as an example create initial opportunities there.

We have to get benefits from all the country changes and the subsections of countries that we're doing on the distributor restructurings.

I mean we clearly we are not doing that to breakeven.

We have to get incremental sales and profitability benefit.

Conversion of their products, their meaning Centerpulse products to MIS, formats and the application of computer-assisted I think will create inflection points.

And I think price as much as we tend to think of price as being kind of a negative conversation in Europe now, it is from a governmental reimbursement point of view at least in Germany and France, but we have a lot of price opportunities that we're doing some pretty sophisticated analysis on right now with an outside firm to take a look at where there is opportunities to put programs together, hospitals and benefit from price, which obviously accelerates sales.

Those are at least some of them.

I think Trabecular metal, spine growth, Crosslinked Polyethylene penetration because it is low there, are things that we're working on right now and people will begin to slowly do.

But I don't think there's a single inflection point.

It's a very large business, and there's a long long list of obviously target accomplishments we have to get done.

Okay.

Thank you.

Glenn Reicin.

Morgan Stanley.

You gave us a lot of granularity on specific products.

I would love to know if we can put some of those products into buckets, and if you can give us your view of growth for, let's say, a knees revisions, speculator medical growth, mobile bearing knees, UNIs, and for hips maybe Highly Crosslinked Polyethylene porous code stems and metal-on-metal?

Would you like me to do that in alphabetical order by any chance?

No, we are not going to give that kind of guidance.

First of all, we are just finishing our operating plans at a product country level in the next week and half, so I probably could not do that (multiple speakers)

I'm talking about Q3 growth in those areas buckets?

I thought you said next year growth.

Now we would not give that level of -- that is too much information for all that are listening.

I would not give that level of granularity because then you would expect it on every call.

What about mobile bearing and metal-on-metal?

(multiple speakers).

Metal-on-metal, I don't have the numbers right in front of me.

Metal-on-metal is up.

I don't remember what the percent increase is.

Mobile bearing, we're real small player for the most part in Europe with the old Zimmer MBK, and the MX (ph) is just coming out from Centerpulse, and obviously we don't sell mobile bearing in the U.S..

So mobile bearing, while it is up probably low double digits if I remember correctly, it's a real small sales base.

Okay.

None of these other buckets revisions are UNIs or anything like that?

Well, you can derive from the fact that the penetration rates are growing at a faster rate than the market that obviously we're clearly growing in positive territory.

I would not get line item specific on that level of granularity.

I think it is too much.

Okay.

A couple of other follow-ups then.

On the pro forma gross margins, did Implex play a role at all in the quarter, say, on a sequential basis?

No, not really.

The Implex margins we essentially had a good bit of it with our distribution relationship from Implex, and the manufacturing margins that are associated with Implex, we don't get access to until we finish the inventory stepup.

And then finally, you mentioned a little bit about contracting.

I think Mark asked that earlier.

There was a decision that came out regarding the Mercy Hospital case.

Can you talk a little bit about the industry implications of that case and what you expect from that?

Well, it is about to become a live case I guess, so I will not get too far into it.

One of the things we have to be careful of in these kind of things, and they become stories because we are in a touchy marketplace right now, but these are allegations out of nowhere.

There was no discovery done.

We have already commented in some detail externally to those folks that some of the commentary, for instance, cash and cash equivalents, I mean those kind of things are just nonsense.

So I'm not quite sure what the underlying motivation is of the gentlemen who is filing that, but these are just absolute total allegations.

This thing was thrown out of court in a matter of a few days in the initial proceedings, and we intend to go back and try and have that reversed.

We absolutely will defend our position.

We work hard to build relationships in there, but we resent the fact that people make those kind of comments, and we will be very scrappy about defending our reputation.

But some of the stuff in there is just nonsense allegations.

I was just wondering from an industry perspective in terms of putting the (inaudible) on the manufacturers to disclose discounts to Medicare, I thought that was sort of the central issue on the case.

Well, it does not fall in under a lot.

Now a lot of those cases that you're talking about really don't involve the manufacturer, in fact, nearly as much as it involves the hospital.

What they do as you know and as with many legal cases, they list a whole bunch of people as defendants because they want to be able to discover the maximum amount of information.

The implication that you are on there as a defendant tied to the fact that you may ultimately be connected is really not a complete connect.

You are on there because people want information, and obviously we will supply information appropriately.

I don't see it -- I don't see it as earth shattering.

I've looked at it.

Frankly, it looks like a lot of nonsense to me, and I will tell you we will defend that very very quickly.

Mike Weinstein.

J.P. Morgan.

It is Taylor Harris here.

A couple of questions just to start with on your knee business.

Prolong in the knees, can you update us on the CR unit penetration there?

And then are you still on track for PS by the end of the year?

I can.

It is about 50 percent or so penetration on CR.

That's a little misleading, of course, because we have the CR-Flex coming out, and it is going to be more important there.

When you translate that into combined Zimmer/Centerpulse CR plus PS, I believe Prolong has a penetration of about 12 percent at this point in time compared to almost 60 percent if you look over on the hip side as an example.

PS is on schedule for very late '04 or very very early in '05.

It is a kind of a plus or minus 30-day thing.

Just to refresh us, what is the approximate price premium you get there with Prolong, and is it going to be the same with the PS version?

Well, refresh would imply that I have already given that out at some previous point, which we have not.

Okay.

Then in the high-flex knee business, it sounds like it's running at about 8.5 percent or so a year overall sales.

Where do you think that is versus the market, and how much higher do you think it can go?

Well, there is almost no other high-flexion on the market in the sense of a full system.

There is some high-flexion modifications to articulating services, which would imply somewhat better flexion.

But the absolute modification to all the component pieces of the knee designed from scratch into a system don't exist to a large extent.

So we have the vast majority of that.

I fully expect that some of the new systems coming out will put high-flexion in for two reasons.

A) We have been very successful with it, and obviously I would think people would want a part of that.

Secondly, it very clearly provides some patient benefits that are useful.

The key for us is to take our high-flexion as we know it today after five years of experience, put some of the key component technologies into it that we know work very well, and then apply it to MIS and quad-sparing.

That allows us to stay hopefully a step or two in front of everybody else.

It is Mike.

How are you doing?

I want to step back for a second and just look at the guidance for next year and give you a chance to -- you give so much detail on this call to maybe put in contact your thoughts about topline growth next year.

Right now you guys are pegging growth that would be about 12.5 maybe 13 percent.

Off of right now your organic growth is running at about 10.5 percent the last two quarters.

And if I listen to everything you've talked about in the call and think about what drives some of that acceleration that you're expecting on the topline, I guess I would probably list it, and help me out here if I am getting this right, no more sales dissynergies is your comparisons sort of in the second quarter in Japan; better growth in trauma; new product launches; an improvement gradually in growth in the spine business.

Is that a fair picture?

What else am I missing there?

That is a good list.

I'm not sure I could add much to that.

I think to the earlier question that was asked on Europe, some of the things that would cause an inflection point in Europe, I think you can put in there at some point later in the year.

And of course the other thing that we talk to is new products.

We have got a horde of new products.

I listed off a quick 20 just to give people a feel because we had not done that for a while.

So I thing think obviously a very detailed new product listing.

The one other area you did not list was about 15 (inaudible).

It is small, but it is not small, and that is about $15 million worth of distributor returns that we don't have.

So by the time you add all of that up, you know we obviously feel good about that forecast.

That is in a business that we forever have said from deal start that we would only do about 10 percent in the first two years.

So if we can do 12.5 or 13 and execute well on that and leverage the earnings, we are in good shape I think.

(technical difficulty)-- I had said that I guess in addition to your distributor commentary would be I guess better cross-selling on the two companies' products.

We have not included -- other than -- let's say we have not included a lot of cross-selling.

We've included cross-selling on MIS because obviously that is a key for us.

We have not included for the '05 year huge amounts of cross-selling because I continue to believe there is a lag time between training and the execution of that sort of didactic technology into the operating room, and until proven differently I will continue to believe that.

But I think the list you provided, plus a few things we added there, ought to give us good confidence.

The other thing that came up obviously is the buying group contracts for us are huge.

They literally are thousands of hospitals, and having the security of knowing those are negotiated, we've knocked it down to two vendors.

They go out two or three years and the pricing looks attractive, frankly, is meaningful, too.

Not so much on the upside, but protection against the downside I guess if you will.

Bill Plovanic.

First Albany Capital.

Thank you.

Good morning.

Just two questions.

First, can you remind me, what was the percentage that the European training has been completed to date?

We rated about 10 points, up in the 55, 60 percent.

It is kind of hard because it is done by country, by product, and it is done by division.

So I am being speculative here, but I think the correct numbers is in around a 60 percentage, and that would put it 10 to 15 percent or so below the U.S..

Okay, and then with gross margins better-than-expected in the quarter, it looks as though you may have started investing more in R&D in the marketing lines.

I think you had mentioned we could expect that to come down a bit in the future.

What would you really see as your terminal operating margin as you look out maybe three to five years?

How profitable can you get the business?

More profitable?

We don't want to give long-term guidance obviously.

I mean we have several points percentage points or ratio points of potential growth improvement.

I have read some pretty good analysis that says we can get out -- it gets tough when you get over 34, 35 percent on the operating line as an example.

On the leverage, you get better drop than that.

You can get towards 25.

But we have not done any work other than normal strategy plans that gives you a level of detail to get out that far.

But there is clearly percentage points of ratio improvement that we can still get.

We're not satisfy at 30/20.

We would tell you that clearly.

Also, while we have spent a few more dollars in absolute terms for R&D, the percentage spiked largely because of the lower sales quota that comes to us in Q3.

You'll see that percentage drop back down again when we get to Q4.

Yes, what was the absolute dollar increase?

It was about $3 million.

About 2.5 million.

So there is some incremental spending.

The other thing that is varied and you have mentioned it -- it is varied in there that you don't see, is the accelerated -- it's depreciated now because it is on an asset basis, but very clearly we're putting out MIS instruments at a far faster rate than anybody else.

And that has an effect at any given point on your quarterly P&L.

Joanne Wuensch.

Harris Nesbitt.

Thank you very much.

Turning to your upcoming ceramic-on-ceramic product launch, could you give us an idea of how you're going to approach this market?

On the one hand, you have talked about it being a niche market.

On the other hand, you are obviously entering it.

Do you plan on competing on price?

Do you plan on positioning the product as here is ones that you have a full buffet of products that physicians don't have to turn patients away?

Can you just give us some feel on that?

Yes.

That is a good question.

It is more of the latter.

I don't want to just take it and call it just a service item because I think that would be a little unfair.

It is a good product.

I still believe it is 6 to 7 percent.

We have no intentions of doing major DTC programs.

In fact, it is a rare occurrence for me to say I'm willing to be second behind Stryker.

I will probably never say that again in my life.

But I am more than willing to ride their coat tails on the DTC campaigns because those patients when they go to a Zimmer surgeon are going to get a Zimmer ceramic.

So I have no intention of doing anything very dramatic on it, other than make sure that we hit our minimums, do a good PMA filing, and get it into the hands of our sales reps, and maybe a little bit of modest advertising just to make sure people know we have it.

If you're not going to do a DTC campaign on ceramic-on-ceramic, are you thinking of one in another area?

We will stay with the kind of DTC work we do now, which I call low-cost DTC, which is encouraging and helping TV programs and magazine articles and people who do those with a good background information, good DVD material and good write-ups from us.

We're just shifting into a national ad campaign which includes TV on the quad-sparing, which is going to run in 12 cities.

We're just starting that.

But it's what I would call Zimmer-style DTC.

It's very low-cost.

It's way you don't see any implications of it in our operating expenses because it's based on context and relationships we have with a number of TV stations, magazines and so on that will allow us to get those stories done in sort of a non-advertising way, but it allows it to get it our to patient community and the surgeon community.

Our strategy on that at least for the foreseeable future will be unchanged.

We have been very successful on that low-cost DTC basis.

One final question.

When you train these physicians on your MIS technique to bring them into Warsaw to go through the fabulous training program you have there, what kind of follow-up do you need to do with them, and how do you measure sort of stickiness?

Are they going out and using the devices and implementing them?

I mean how do you follow-up to make sure that this program is staying?

We do.

We have a statistical -- to follow-up with them -- let me answer that first -- the follow-up with them varies from I got it, I don't need your help at all, to would you arrange a proctor to come out and work with me on my first few cases, to installing them into our follow-up programs or whatever.

In other words, the range of activity level with surgeons once they leave here and and any of the institutes is from very little to quite a bit and everything in between.

The mechanism we have for tracking and follow-up is a precise information technology mechanism where the data is feed into us, and we know precisely by numbers of surgeries how many are done and what type they are.

We don't have sufficient data yet on the quad-sparing.

We have good data for North America on the hip side.

We have pretty good data starting to begin to come in in Europe.

It's not quite there yet and it is more complicated by country.

And we are not there yet on Asia, but we have relatively small penetration.

But we have pretty precise data and pretty much know what is going on a weekly basis.

Robert Faulkner.

Prudential Equity Group.

I wonder if you could perhaps detail some of the impact of purchasing distributors.

If memory serves this can boost the top line growth a little bit in the gross margin, but then you pay the SG&A directly.

I wonder if you can maybe quantify the impact a little bit going forward on doing that in Europe, or isita negligible at this point?

Well, you know you are offsetting a number of things.

Obviously we are taking under GAAP we are taking a sales return which you have seen the effects of, and we have a couple more to do.

That's about $15 million.

If you assume the average distributor earns -- and it varies.

But there is a lot of deals that are around 20 percent and then he pays the sales rep.

There's not a lot of necessarily huge earnings growth for us here.

There's a little bit of sales pickup obviously because you're picking up his margin, but that is offset by the return you did prior to that.

Most of the reasons we do these deals are in areas where we feel either the distributor is not where we want to be and we cannot find one we do like or where we feel that a direct process for the long-term is more effective.

The absolute sort of millions of dollars here are not significant, except on the quarter that you're shifting it causes us some GAAP issues which you have seen.

The real dollars of gain and profitability in sales are probably -- not probably -- they are insignificant relative to the total size of the Company.

Thanks.

Two little follow-ups.

One, about eight years ago we started getting a lot of younger patients being implanted with hips and knees.

I'm wondering if you're anticipating kind of a bump in revision procedures over the next few years?

And then secondly, artificial spinal discs are expected to be launched this or next quarter.

I wonder what kind of impact do you think that might have on your buying line business?

Okay, on the first one, I think there are a couple of things affecting our revisions.

Yes, there were younger patients.

Yes, we will see some of those, partly because of the timing of their age, and therefore, they need another revision.

The other thing we noticed and we've really seen over the last 10 years that everybody has increased activity levels from everybody, and therefore, the probability of increased revisions continues to grow.

And then on the back-end of the curve, obviously people are living longer, and therefore, no matter how good the technologies and how many years it has been there, those people still do get revised.

We don't leave them in a position where the technology is not operating properly.

If you look today probably across all the competitors, but I know specifically with Zimmer, there is a 50 percent faster growth rate in revision surgeries than there is primaries.

A) And that is partly volume.

B) Revision surgeries are more expensive, and therefore, the unit of sale, if you will, for surgery is pretty effective for us.

So that's all good news from a commercial point of view on that revision side.

On artificial discs, I don't think I see anything that changes our opinion.

Cages are down now and have declined over the last three years with Centerpulse buying down to a point no where I just made the comment that we are kind of running around $9 million a quarter.

So if you put that in perspective relevant to the size of our business on a quarterly basis, it's about 1 percent of our sales or a little over 1 percent I guess of our sales on a quarterly basis.

I don't know at what point they level off.

I will tell you one thing we're going to stay in the cage business long enough to find out if discs work really well.

We are not getting out of the cage business, but we will certainly have some more negative effects.

On the flipside, I think discs will do well early from a commercial point of view.

I have few doubts of that.

The question is, will they do well in first generation form for how long and what can we do with other alternatives that get at the disease earlier, like dynamic stabilization with Dynesys?

I like the idea personally of getting at the disease earlier in the destructive stage, instead of simply having a gold standard offset to fusion.

So I think discs are going to do well.

I still believe we have the right strategy for the long-haul, and even if we don't, I'm not spending $200 or $300 million to get into a disc because there's no return on it for our shareholders.

So we better like the strategy we've got because I don't see a disc strategy that makes sense for us in the first generation.

Second generation, I think is a different story.

So the cage exposures in your view is the sum total of your exposure to discs?

Yes, I don't think there's anything else in our product line.

Dynamic stabilization as an earlier alternative is on the upsweep, and I don't believe if anything we will benefit from all the attention that is placed on artificial disc strategy and fusion and spine in general.

So frankly I think it will do us a lot of good.

Raj Denhoy.

Piper Jaffray.

Thank you for taking my call.

I realize we are over the two hour mark.

I wanted to ask a couple of quick ones.

On the MIS economics that you mentioned from Harvard, in the past you have mentioned a couple of payers that had at least told you the idea of increasing the payment to doctors for performing MIS procedures.

Has there been any more move on that?

There is lots of movement on it.

It's all a question what you want to put in the conference call.

There's about five or six new activities in that area -- mostly regional, local regional with individual surgeons or hospital buying groups or local insurance groups that are part of larger organizations.

We've got a huge one going on right now with NICE, so-called NICE in the UK, where as usual with most governments they classify 2-Incision as an experimental procedure initially until we supply data.

So we just put together a huge government filing package for all of the UK relative to this.

We may not win the first battle.

I'm not suggesting they are going to come out with a reimbursement in a few weeks.

That's highly unlikely.

But those kind of activities are going on all the time in multiple states and multiple countries.

I probably should put it back in the conference call and just summarize the last five or six months.

I have not done that for a while.

Great and then just one quick one on Dynesys.

I'm not sure you gave an update on the timing on that.

It does sound like you are doing quite well in Europe.

You were mentioning it with products here in the states at some point, but is there an update on when we might see that here?

Early part of 2005 as long as we can get by.

We've got some paper filing and IP work to do to clean up, but the expectation at this point has been for the first quarter.

The clinical -- we have approval as you know.

The issue was that the number of patients completed in the filing was below what we would like to do.

Plus there are some additional things we wanted to look at, and Centerpulse obviously was under a cash flow crunch prior to the acquisition efforts.

So some of that had been cut back.

So we needed at least until year-end or early '05 to complete the patient work and a few other things we're doing.

But if all that stays on track where it is now, it will be in the first quarter.

If I'm not mistaken, isn't that approval though as in abject fusion, not necessarily as in motion preservation? (multiple speakers).

Is that work going to be -- will we see something on that front at some point?

It goes on -- you're absolutely right, and that's the right way to classify it.

That work will be like everything else, it hass fairly long, two-year follow-ups and what not.

We will not be in a position to the best of my knowledge to take advantage of that in the near-term.

It will be as you describe and probably in the first quarter.

Jason Wittes.

Leerink Swann.

Thank you.

Two quick ones given the time.

First off, what tax rate should we be assuming for '05, or is that yet to be determined?

And secondly, on metal-on-metal hips, your Metasul, what's sizes are you offering now for the cups, and do you anticipate expanding them next year given that part of the acceptance of those products has been the larger hip size?

The tax rate, let me address that, and Ray will answer your second question.

Tax rate, we said in prior calls that we expect wherever we finish out this year we should be able to look to next year and the year after to continue to drive about another half-point or so out of the tax rate in each of the next few years.

A half-point per year over the next couple of years?

Yes.

Right.

Metasul is standard 28s with 32s to come and larger sizes we hope.

We've got 32s for sure in place in Europe.

I'm not sure about beyond that size.

And (multiple speakers)

In the U.S. anytime soon?

32s center, no time soon for beyond that, and of course, 28 and 32 apply as large ball strategies in Asia because of the smaller patient size.

So we are okay over there.

We are believers in the so-called big mall strategy as anti-dislocation process.

I think that is good clinical work has been done on that.

The issue is simply getting the paperwork through the government.

But at this point, it's going to be 28s and 32s, and we do need larger sizes on that in order to be really effective.

But I guess you're saying in '05 at least probably not beyond.

And also it sounds like the U.S. you're not going to have a 32 at least in the near-term?

The 32 I don't know if it's doable in '05 or not.

I will have to check.

I will follow up for you on the regulatory side.

I'm not sure if it's doable on the '05, and I don't want to mislead you on it, but I will follow up.

Ted Huber.

Wachovia.

I wanted to go back to the guidance for a second.

It sounds as if this 13 percent you're targeting in '05 on the top line could be a bit back-end weighted given the product cycles and crosstraining and what not?

Is that in case -- is that the fact, and if so, what is the magnitude of the difference between early '05 versus late '05 top line?

Well, we have not done.

As I said, we are going to meetings in the next two weeks.

We have not done the monthly or quarterly breakdowns yet.

I think the back-ending that is of most significance is until the new products on trauma and spine come out, I don't see trauma and spine being strong strong in the first half.

But they are also our two smallest divisions.

The only other -- the new products flow comes out all the way through the end of '04 through early '05, through the AALS.

So I don't think the new product aspect is significant at all.

The sales dissynergies if you followed the quarterly proceedings have kind of tracked at sort of 10 or 12 million per quarter.

So they are actually quite evenly spread over the year and the Japan price anniversary comes into place in April.

So if you put all those factors together, I would not say back-end -- I would not say back-end loaded particularly other than the few -- other than obviously on the spine trauma comments that I made.

That is helpful.

Then as a follow-up, Ray, as I recall, about this time last year you had signed up a lot of your U.S. distributors to one-year kind of guarantees if you will to get them through all the change that comes through this merger.

Do you see much risk that we could see any distributor turnover in the quarter or two ahead now that those agreements are probably rolling off?

Zero.

All right.

That is it.

Thanks.

At this time, there are no further questions.

Mr. Elliott, are there any closing remarks?

No.

In our undying effort to get it below two hours, we have failed again, and we just went 2 hours and 10 minutes, which is worse than we usually do.

So I think it's a good time to call it a day.

Thanks, everybody.

We are around for the next day or so.

If you need us, give us a call.

Thank you.

This concludes today's conference call.

You may now disconnect.

Thank you.