Zimmer Biomet Holdings Inc (ZBH) 2008 Q2 法說會逐字稿

Good morning.

I am Paul Blair, Vice President of Investor Relations for Zimmer.

I would like to welcome you to the Zimmer second quarter 2008 earnings conference call.

Joining me today to host this call are David Dvorak, President and Chief Executive Officer; Jim Crines, Executive Vice President Finance and Chief Financial Officer; and Dr.

Cheryl Blanchard, Senior Vice President Research and Development and Chief Scientific Officer, who is joining us today to assist in responding to your questions with regard to Durom.

This morning we will review our performance for the second quarter, provide you with an update on certain key issues to include those which involve our Durom product, present an update to our outlook for 2008, and conclude our discussion with a question-and-answer session.

Before we get started I would like to point out that 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, forecasts and projections about the orthopedic industry, management's beliefs, and assumptions made by management.

These statements are not guarantees of future performance and involve risks, uncertainties and assumptions 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 statements, 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 other financial and statistical information for the periods to be presented on this conference call, was included in the press release announcing our earnings, which may be accessed from the Zimmer website at www.Zimmer.com, under the section entitled Investor Relations.

A rebroadcast of this call will be available from approximately two hours following the conclusion of today's call through the end of the day on August 6, 2008.

And calls can be accessed from the Investor Relations section of the Zimmer website

At this time I would like to introduce David Dvorak, President and Chief Executive Officer of Zimmer.

Good morning everyone.

As we begin, I want to first thank you all for making the scheduling adjustment to join us this morning.

I hope that you can appreciate the priority we recognized in announcing the results of our Durom Cup investigation, and in initiating the steps required to communicate to surgeons.

Our first concern is patient safety and we could not delay our Durom announcement.

Of course our voluntary action with respect to the Durom Cup will have financial consequences, therefore accelerating the timing of our earnings release was necessary.

We wanted to make that information available to you and the investment community and answer questions as soon as we could.

So that brings us together here today, one day earlier than we originally planned.

This morning, as Paul stated, in addition to reviewing our overall results for the quarter, we will provide you with additional detail on the Durom matter, update guidance for the year, and report on the progress we're making in furtherance of the strategic priorities we previously outlined.

Throughout these discussions I hope you'll recognize a pattern in the way we face difficult issues.

We have made decisions that we believe will best prepare Zimmer to compete effectively in the expanding markets of the future.

Where we need to make improvements, we want the changes to be long-lasting and sustainable.

We're absolutely committed to positioning Zimmer to thrive for years to come.

With that as context, I would like to review our second quarter results.

Consolidated sales for the quarter of $1,080 million were up 11.2% over the prior year's second quarter, and 5.5% in constant currency.

We generated 5% growth in adjusted earnings per share.

Our sales results, acknowledging an additional billing day in the quarter, were led by strong underlying growth in knee unit sales, with excellent balance across all of our geographic knee segments.

Asia-Pacific led all territories with 14% constant currency growth in knees, despite a challenging price environment, especially in Japan.

Hip sales growth was consistent with our first quarter.

Some of our other business franchises, however, experienced a deceleration in sales growth, and we will talk more about that.

The weakening US dollar favorably impacted our topline growth.

This favorable impact on our topline is essentially neutralized on the bottom line due to our hedging program.

During the quarter we generated operating cash flow of $281 million, and we used $496 million to repurchase 6.9 million shares.

Jim will discuss specific details of our financial results and stock repurchase program activity in a few minutes.

As we communicated last night, we have completed an extensive investigation into the performance of the Durom Cup here in the United States, following reports of cup loosenings and revisions of acetabular component in some patients who have undergone total hip replacement.

While many US surgeons have had success with the Durom Cup since its launch, a subset have experienced elevated revision rates.

This observation clearly contrasts ongoing positive clinical experience in Europe, where the product has been available since 2003.

We launched a rigorous investigation, which included a thorough review of manufacturing processes, design specifications, production documentation and clinical experience in the US and Europe.

Based on the results of that investigation we will temporarily suspend marketing and distribution of the Durom Cup in the US.

We will update labeling to provide more detailed surgical technique instructions to surgeons and prepare to implement a comprehensive surgical technique training program for the US.

We have reviewed our investigation and conclusions with the US Food and Drug Administration, and are actively communicating with surgeons now through multiple channels to explain this field action and identity and address their related needs.

We're also communicating with customers around the world to clarify that the Durom Cup will continue to be marketed and distributed outside the United States without interruption.

Our primary objective in taking prompt action based on the results of our Durom investigation is to ensure better clinical outcomes for patients.

We believe that the likelihood of currently implanted patients requiring revisions is low.

But we want to make sure that we are clear with our US surgeons that they should stop implanting the Durom Cup until we issue the updated labeling that provides more detailed guidance on surgical technique, and until they receive training.

We also, of course, want to make sure we support surgeons in every way we can as we implement these actions.

With this goal in mind, we will provide clinical management guidelines to assist surgeons in the ongoing evaluation of patients currently implanted with the Durom Cup.

Within the next several weeks we will issue a further communication to US surgeons that provides them with updated labeling, including more detailed surgical technique instructions.

We also are working with experts in Europe and the United States to develop a robust surgical skills training curriculum.

Following initiation of the new training program, the Durom Cup will be made available to US surgeons again as they complete training.

We're confident that these measures are the prudent and responsible course of action.

And we are committed to conducting them in a manner that demonstrates our deep commitment to patients and our customers.

I would now like to spend a few minutes providing an update on the investments that we're making at Zimmer that will help drive operational and earnings leveraged and growth in the future.

We made good progress during the quarter on our quality systems upgrades.

With respect to our orthopedic surgical products operation in Dover, Ohio, our remediation plans continue as scheduled.

And we expect to have most, if not all, of OSP products back in production by the end of this year, many in the next two or three months.

We also made good progress with our global IT system project during the quarter, which will allow us to apply technological efficiencies across our entire business infrastructure.

During the quarter we continued to work on a new Zimmer facility in Shannon, Ireland, and had begun hiring and training the management team that will operate this facility in early 2009.

We also announced the planned addition of 50,000 square feet of foundry operations in Warsaw, Indiana that is expected to increase our annual output by 1.3 million castings.

Further, we announced plans to add approximately 100,000 square feet of manufacturing space to our Winterthur, Switzerland facility.

We feel it is imperative to make these investments today in order to serve the anticipated increase in global demand for our products in the coming years.

For the past couple of quarters we have explained the processes of coming to and working through the impacts of our resolution agreements with the US government, and how we expect those agreements and related initiatives will shape the future growth of our industry.

We're taking the time and making the investments now to put this challenge behind us and ensure that we have a sustainable global business model for collaboration with surgeons that will not be disrupted in the future.

During the quarter Jim, Cheryl and I, as well as many other members of our senior management team, personally met with over 100 surgeons.

We explained the chronology of events of the past year or so, where we are today, and how we believe our surgeon relationships will carry forward.

While this process certainly has not been easy, and we have addressed many tough and fair questions, I will tell you that it is great to be reengaged with our surgeon community.

The surgeons we have met with are principally concerned about the quality of care for patients.

They generally support our efforts to employ greater discipline around Company/surgeon collaboration, and are enthusiastic about the resumption of these activities.

While we have more to do, we're making great progress towards what we believe will be much more efficient and effective relationships in the future.

We at Zimmer understand and appreciate the importance of these collaborative relationships and the benefit that they have provided thousands, if not millions, of patients worldwide.

We resumed US hip and knee surgeon training courses during the quarter.

And will continue to provide this critical surgeon support, not only at the Zimmer Institute in Warsaw, but at various regional training centers throughout the world.

This is another example of where we're taking the time and making the investments to create lasting and sustainable change.

Our training activities will ramp out throughout the remainder of 2008.

And we will enter 2009 with a state-of-the-art training capability and an aggressive scheduled for supporting our new product introductions.

We have taken on the challenge of executing several important strategic initiatives concurrently.

And it has been a monumental endeavor.

I would like to take this opportunity to personally thank the many employees, distributors and sales representatives who have displayed their commitment and dedication to Zimmer through their tireless efforts in this process.

I will now turn to our updated guidance for the full year 2008.

Jim will provide more details momentarily.

Due to the developments in the second quarter, including Durom, we are revising our expectations for 2008 fully full year sales growth to 4.5% to 5% constant currency.

We're also lowering our adjusted earnings guidance for the full year to be between $4.05 and $4.10 per fully diluted share.

We naturally are disappointed to be making these adjustments.

However, with regard to earnings guidance, alternative responses would have compromised momentum on strategic, operational and infrastructure initiatives.

We believe our response to these challenges will make it possible to deliver fully on the future promise of our business.

As we look to the future, it is with a focus on the potential of our business to drive not only our growth, but to help Zimmer achieve an enduring leadership position in healthcare.

We're developing our business to help move our Company more deeply into high potential areas where our strategic assets can make a difference in musculoskeletal health, in ways that address some of the most important needs of the aging populations and challenged healthcare systems.

The market opportunity for our business is sizable.

Our 2009 strategic and operating plans will focus on leveraging our infrastructure and technology platforms across our various business franchises to grow share.

We also look forward to restoring positive earnings leverage in 2009 with the expectation of achieving at least low double-digit adjusted earnings per share growth.

Jim will now provide further details on the quarter and our guidance.

I will review our performance in the quarter in more detail and then provide some additional information related to our guidance.

Sales of $1,080 million for the quarter represent an increase of 11.2% reported and 5.5% constant currency.

These results, among other things, reflect the benefit of one additional selling day in the quarter compared to same period in the prior year, strong underlying unit growth in knees in all three of our operating segments, and lower OSP, Durom and dental product sales.

A weaker US dollar persisted during the quarter, and as compared with the prior year, added 6% or $56 million in revenue in the quarter.

As expected, consolidated pricing was essentially flat for the quarter.

In the Americas, as well as the case in the first quarter, price contributed 0.6 of a point to growth.

In Europe price was 0.2 of a point negative versus 0.5 point negative during the first quarter.

With Germany and Italy reporting low single digit reductions in average selling prices, while other markets in Europe were flat or slightly positive.

Asia-Pacific results include negative price of 3.3%, driven by negative 5.2% in Japan.

Turning to our revenue growth by major product category.

Worldwide Reconstructive Sales increased 13.8% reported, 7.6% constant currency.

Knee sales in the quarter improved 9.9% constant currency, and were up from 6.7% in the first quarter of 2008.

With billing day differences neutralized in our first-half results, knee sales growth averaged out at 8.3% constant currency over the six month period ended June 30.

Knee pricing on a global basis was down 0.6 of a point in the quarter.

Flex knees accounted for 51% of our knee unit sales on a global basis in the second quarter, accounting for more than half of our Knee sales units for the first time.

We're still early into the launch of our Gender Solutions Natural-Knee Flex, well as our NexGen Mobile Bearing knee.

Unit sales of these two systems accounted for less than 10% of our knee units on a global basis in the quarter and continue to represent an important opportunity going forward.

In addition, our new Gender Solutions Patello-Femoral Joint System is now broadly available.

And we're also launching a modular trabecular metal tibial tray for our NexGen Knee System.

In other knee systems, Zimmer Uni, LCCK and RHK, as well as our Prolong Highly Crosslinked Polyethylene grew in double-digits.

During the quarter our knee portfolio showed particular strength across geographies.

In the second quarter Knee sales in constant currency increased 9.1% in the Americas, 10% in Europe, and a strong 13.7% in Asia-Pacific, respectively.

Hip Sales increased 4.4% in the quarter, reflecting a volume and mix increase of 5.5%, offset by a decrease in average selling prices of 1.1%.

In the US Durom Cup sales volume was off 26% from our first quarter in response to reports of loosenings and revisions.

Durom Cup sales units outside the US grew by over 10% in the second quarter compared to same period prior year.

These results, absent Durom-related losses, reflect steady growth across our primary hip portfolio, including porous primary stems and our Trilogy and TM Acetabular Cups.

Our TM primary stem, and M/L Taper Stem with Kinectiv Technology experienced steady growth, offset in part by lower sales of our VerSys Fiber Metal MidCoat, Beaded 6" FullCoat, and other cemented stems.

On a geographic basis and in constant currency, hip sales increased 3.2% in the Americas, 6.7% in Europe, and 2.5% in Asia-Pacific, which includes negative pricing of 4.8%.

Extremity sales for the quarter in constant currency increased 14.3% on a challenging comp of 32.6% in the second quarter of 2007.

Extremity sales increased 16.8% in the Americas, 9.2% in Europe, and 4.5% in Asia-Pacific.

We experienced solid growth in both shoulder and elbow sales.

Dental sales increased 6.1% for the quarter on a prior your comp of 19.4%.

Dental sales decreased 7.1% in the Americas.

Our domestic business faced some tough challenges in the quarter, in large part as a result of temporary disruption caused by transition to our enhanced business model.

Zimmer Dental collaborates with institutions and practicing clinicians to conduct training on the use Zimmer Dental implants.

As we have been working to structure Zimmer Dental's training activities in accordance with our enhanced enterprise-wide professional training and education platform, certain training activities have been delayed.

Our current priority with Dental is to reconcile Zimmer's broader compliance framework with conventional marketing practices in that sector.

And we're moving rapidly to resume a robust training program that is central to that division's success.

And while this disruption is temporary, this issue together with the weak US economy is expected to adversely affect Zimmer Dental sales performance in the near term.

In Europe Dental sales increased 17.7%, including the effect of the distributor acquisition in Italy during the second quarter of 2007.

Dental sales increased 35% in Asia-Pacific on a small base.

Trauma sales in the quarter were up over the prior year 3.2% constant currency.

Our plate and screw lines, as well as bone graft substitutes, led trauma growth.

We continue to proceed with the development of an upgraded nail line, which is expected to be in limited release in 2009.

On a constant currency basis, trauma sales in the quarter increased 1.4% in the Americas, decreased 1.8% in Asia-Pacific, and increased 13.7% in Europe.

At 8.7% over prior year second quarter, spine sales were impacted by certain delays in new product training in the US, similar to those experienced at Zimmer Dental.

However, sales were strong throughout the rest of the world in the quarter.

Spine in the Americas was up 5.5%, Europe increased 15%, and Asia-Pacific was up 67.5% on a small base.

Finally, orthopedic surgical products and other sales declined 17.6% constant currency in the quarter, as a result of the suspension in sales of certain patient care products, partially offset by bone cement and accessory sales which grew over prior year.

The OSP and other category was down 15.6% in the Americas, declined 26.8% in Europe, and was down 17.3% in Asia-Pacific compared with the prior year period.

As David indicated, our remediation plans to address the manufacturing suspension at our Dover facility continue on schedule.

Now I will focus on the rest of the income statement.

Our adjusted gross profit margin at 75.8% for the quarter is down 190 basis points from the prior year second quarter.

Foreign currency hedge losses accounted for the majority of the decline in gross margin, with idle plant costs and excess and obsolete inventory charges making up the balance.

R&D expenses decreased 6.3% to $50 million for the quarter compared to last year.

And as was the case in the first quarter, reflected lower spending on consulting services.

At 4.6% of sales R&D spending was below our historical range of 5% to 6%.

Collaborative development activities have resumed during the quarter, and we expect R&D spending for the full year to be at the lower end of our previously stated 5% to 6% range.

Selling, general and administrative expenses increased to $446 million, up 19.2% over prior year.

And include monitor fees as well as consulting and legal fees associated with the implementation of the enhanced compliance model, including a global comprehensive review of surgical collaborations and related agreements, and assistance with implementing at a local level the enhanced standards and processes to ensure collaborations will continue in accordance with our policies.

At 41.3% of sales, SG&A expenses are 270 basis points above prior year, and within the quarter include the significant increase in third-party consulting and legal fees.

Such fees account for approximately 175 basis points of the increase from the same quarter of the prior year.

Acquisition, integration and other amounted to $12.5 million in the quarter comprised of costs pertaining to current and prior period acquisitions, including facility consolidation costs, legal fees and retention and termination payments.

Adjusted operating profit in the quarter decreased 1.3% to $322.4 million.

At 29.9% our adjusted operating profit to sales ratio decreased by 380 basis points from prior year as a result of the lower gross margin and the significant but temporary step up in SG&A costs.

Interest and other income for the quarter amounted to $6.8 million, including a onetime gain of $8.7 million from the sale of certain other assets.

Adjusted net earnings increased 1% compared to prior year at $236.9 million.

And adjusted diluted earnings per share rose 5.1% to $1.03 on 229.5 million average outstanding diluted shares.

These adjusted earnings per share are inclusive of approximately $0.08 of share-based compensation.

At $0.99 reported diluted earnings per share increased 2.1% on prior year second quarter reported EPS of $0.97.

At 28% adjusted for the quarter, our effective tax rate is slightly below our expectations in the prior year second quarter due to favorable geographic mix of earnings and profits.

During the quarter we repurchased 6.9 million shares at a total purchase price of $496 million or an average price per share of $71.55.

We used cash of $276 million and $220 million in borrowings to acquire the shares.

6.7 million shares were purchased under the $1 billion stock repurchase program which was scheduled to expire on December 31, 2008.

That program has now been fully executed.

During the first quarter we announced that a separate $1.25 billion repurchase program had been authorized by the Board of Directors, expiring at the end of 2009.

We utilized $19 million to acquire the balance of the 6.9 million shares during the quarter under this new program.

The Company had approximately 225 million shares of common stock outstanding as of June 30, 2008, down from 231.5 million as of March 31, 2008.

We continue to believe that share repurchases are an effective and efficient use of available free cash flow.

Operating cash flow for the quarter amounted to $280.6 million, a decrease of 7% compared to prior year second quarter, as a result of higher estimated tax payments and higher investments in working capital.

Inventory days on hand finished the quarter at 275 days, a decrease of 9 days from prior year second quarter, reflecting higher cost of goods in the quarter.

Our trade accounts receivable days sales outstanding finished the quarter at 59 days, an increase of 1 day over the prior year second quarter.

Depreciation and amortization expense for the quarter increased to $67.4 million.

Capital expenditures for the quarter totaled $130.1 million, including $62 million for instruments and $68.1 million for property, plant and equipment, with $29 million related to infrastructure initiatives.

Finally, free cash flow was $150.5 million for the quarter.

Now I would like to provide an update on guidance for 2008.

We expect to deliver topline sales growth in 2008 of 8.5% to 9% compared to the original 10% to 11% range.

And adjusted earnings per share in the range of $4.05 to $4.10.

Our sales guidance anticipates approximately 4 points of growth to come from foreign currency, and therefore assumes a constant currency growth rate of 4.5% to 5%.

The adjustment to our sales guidance includes a projected loss of $20 million to $30 million in hip products sales, pertaining principally to Durom Cup in the US, weakness in US Dental revenues, and slower than anticipated uptake on certain new products, partly due to delays in offering training programs in support of the new products introductions.

As I indicated in my comments regarding Zimmer Dental, this global effort we have undertaken to transition to enhanced standards for collaboration has caused disruption in product training, not only for Zimmer Dental, but other business units as well.

Revised adjusted earnings guidance gives effect to the reduction in sales from prior guidance, as well as an increase in operating expenses associated with the global implementation of the Company's enhanced compliance program.

As part of the enterprise-wide effort to implement our enhanced program, we have engaged outside resources to, among other things, complete comprehensive reviews of all domestic and international collaborative arrangements with healthcare professionals, not otherwise covered by US hip and knee resolution agreements.

Once these reviews are completed this year, we do not anticipate having a need to retain these outside resources in ongoing compliance activities.

Adjusting for these additional operating expenses in 2008 in relation to a reduced topline, we are now anticipating SG&A expense for the full year to average at or around 41% of sales.

With the anticipated completion of these and other activities over the next several months, we will have the opportunity to both reduced these fees and expenses and reinvest in the collaboration, training and development efforts, which to this point in time have been delayed or otherwise disrupted.

With regard to share repurchases, we previously disclosed our intent to draw up to $500 million dollars in our credit facility to fund share repurchases under approved repurchase programs.

During the quarter we borrowed $220 million to fund repurchases.

At the end of the first quarter we indicated that our diluted weighted average shares for 2008 were expected to be 230 million.

We now expect full year 2008 diluted weighted average shares to be between 228 million and 229 million.

In addition, interest and other income is expected to be between $25 million and $30 million for the full year before tax, inclusive of the interest expense on borrowings and anticipated onetime gains on the sale of other assets.

We anticipate a tax rate slightly above 28%, consistent with our year-to-date rate for 2008.

And to arrive at our GAAP earnings per share for the full year, you should assume subtracting acquisition, integration and other expense of approximately $27 million or an estimated $0.08 per share.

As always, our guidance and assumptions exclude the effect of potential future acquisitions or other unforeseen material business events or litigation matters.

Turning to cash flow.

We anticipate capital expenditures in the range of $450 million to $500 million, reflecting the capital components of many of our 2008 infrastructure and operating initiatives.

David, I will turn the call back over to you.

We continue to make meaningful progress in preparing Zimmer to expand its leadership position in the markets we serve.

While we have encountered some challenges that arose during the first half of the year, our responses have been focused on long-term results and sustainable improvements.

We're committed to building on Zimmer's 80 year history of success.

And we're excited about the ability of the 8,000 plus dedicated men and women of Zimmer to keep us moving boldly into the future.

Now I would like to open the call to your questions.

(OPERATOR INSTRUCTIONS).

Tao Levy, Deutsche Bank.

I was wondering maybe if you could spend a few minutes going through -- you did mention as we move into 2009 some of the headwinds you are facing in '08 start to disappear.

I was wondering if you could quantify the three main areas and the impact that you're seeing this year, and what percentage of that could disappear in '09?

I would love it if you could hit Durom, OSP and the compliance monitors.

This is Jim.

First of all, with respect to -- I guess will start with OSP.

As David indicated and I indicated in my comments, we're on schedule with our remediation efforts.

Expect to be back in production of those patient care products between now and the end of the year.

And have the opportunity to go back into the market as those products come back online.

Going into 2009 we would look to get back as much of that $70 million to $80 million as we lost as we possibly can.

We wouldn't expect to get all back.

But we will certainly be back in the market with those products and pursuing opportunities to regain share in that segment.

Concerning the fees and expenses, we're looking now at a total in 2008 of $50 million to $60 million in fees associated with the global rollout of our enhanced compliance program.

As I indicated in my comments, we will have the opportunity as we develop our plans for 2009 to either reinvest, as we look to put the work that is being done this year behind us to either reinvest that $50 million to $60 million in training and development activities, or deliver savings to the bottom line.

I think to some degree we certainly understand what the target is going into the operating plan, as David referenced the fact that we're targeting at least low double-digit growth in earnings in 2009.

And again, as we work through the plan for 2009 that'll dictate how much of that gets reinvested, as opposed to get delivered to the bottom line.

Finally, on Durom, certainly as we go into 2009 we're going to have our full training courses up and running.

And we will have passed the point where we would be able to allow surgeons to use that product again within the United States market.

I think that in this quarter that activity will be ramping up.

We will start with reissuing the surgical technique instructions, and then taking people through the training courses that are being developed currently.

As we get into the fourth quarter, I would expect those courses to be fully up and running.

And so we would have greater visibility as to what that revenue stream in the metal on metal area is going to look like as we march into 2009.

And probably be able to provide you with a more meaningful update on the next quarter call.

Also, I think it is going to be important to note, even though it wasn't one of the three items that you mentioned, that our training courses are going to be up and running in full by the time we exit 2008.

And that is going to help our revenue streams in some of these other business units.

We obviously made hips and knees the priority, got those courses back up and running on the surgical skill side during the second quarter, beginning in May.

We have about I think 40 courses already scheduled on the surgical skill side between now and the end of the year in that area.

But these activities are going to ramp up in the other business units, most importantly on the Dental side, but as well as spine.

So we will see the benefits of the reinitiation of those activities too as we go into 2009.

Bruce Nudell, UBS.

I have two questions actually.

The first just pertains to Durom itself.

In your background you mentioned 1.1% failure rate for people who knew what they were doing and around 6% for groups that really weren't following the protocol exactly.

What is the aggregate -- what is the anticipated aggregate revision rate, early revision rate with the product, given the disparities in training?

And how much reputational damage could do that cause, given the 13,000 implants that have taken place to date?

I'm going to let Cheryl respond to that question.

I think the best way to answer that question is, first of all, to understand that what our analysis tells us to date is that the likelihood of currently implanted patients requiring revision is going to be low.

I will tell you that in our detailed analysis of the clinical aspects of those investigations, you did see in the backgrounder piece that in the group that had success with the device that they had about a 1.1% revision rate, while the other groups were at 5.7%.

It is very difficult for us to project out where we think those numbers are going to go eventually.

What I can tell you is that we were able to discern the there were some specific elements of surgical technique and cup placement that are the items that really make the difference in terms of those clinical outcomes.

I think it is difficult to comment on the last part of your question, which is reputational damage.

I think that will frankly be determined by the actions that we have taken today and our level of being proactive as we move forward, trying to work with surgeons to help them get through this difficult situation with their patients.

We absolutely recognize that for those patients that are involved that there will be some items that we will need to help them with, and we're going to be proactive about that.

Let me add that the initial responses that we have received from the surgeons have been understanding of the decision and appreciative of the way that we're conducting ourselves to put them in the best position to take care of their patients.

So I think the early results are that people see this as being the prudent thing to do under the circumstances.

And that always is going to be the best thing for the Company's reputation.

I guess my follow-up question would be pertaining to -- the big fear that investors have about the stock is that the new DOJ rules, coupled with the -- exacerbated by Durom let's say, are likely to result in a more fluid marketplace and share loss.

In the quarter it looks as though knees US, ex US, and ex US hips were in line with the market.

It sounds like most of what happened in US hips was Durom.

Could you comment just with regards to scale of the anticipated shortfall this year in revenues, which looks like $60 million plus or so, $30 million of which are Durom?

How much of that is anticipating share loss?

And do you really feel that that is a major risk at this point in time in your key hip and knee business?

This is Jim.

As you pointed out, we have not seen -- and I would agree with the way you characterized performance in the quarter -- we have not seen share loss, absent what we may be losing with respect to large (inaudible) metal on metal offering within the hip segment.

And we are obviously not participating in the resurfacing in the US.

But outside of that, we're not seeing share loss in our core franchise.

I will run through for you in a bit more detail the adjustment to our expectations, relative to what they were coming into the year, and the update that we provided on the first quarter call.

It is an adjustment, as you pointed out, of $60 million to $80 million in total, including the $20 million to $30 million in hips, related principally to Durom, but acknowledging as well the slower uptake on new products in the hip franchise.

For us that would include the Kinectiv Technology, the Fitmore stem, a bone conserving stem that we're just in the process of launching, and even the EPOCH stem that we're looking to get cleared for commercial sale in the US within the back half of the year.

About a $10 million adjustment to our expectations on knees, representing really some loss opportunity for above market growth.

And that associated with again new products, in this case our Mobile Bearing Knee, the Gender Solutions NK Flex, and our Patello-Femoral joint.

And extremities about a $5 million adjustment.

And there again related to some disruption in training associated with our new TM Inverse/Reverse Shoulder System.

In Dental about a $15 million adjustment to our expectations.

Clearly this business, and you can see it in the results reported for the quarter in the US has been perhaps most affected by this transition to this enhanced compliance program.

We are working through that with that Dental organization.

In trauma about a $5 million to $10 million adjustment in our expectations.

Trauma admittedly is not so much associated with new products.

We have acknowledged there that we continue to see competitive pressure on our Nail System.

And we will really not be able to effectively address that until we come out with a new nail, which I indicated we expect to have in limited release in 2009.

Then finally spine, about a $5 million to $10 million adjustment.

That related to the disruption we have been talking about in surgical skills training, and associated in this case with Dynesys, Atavi and TiTLE 2 principally.

But, Bruce, let me come back to your core theme there.

And I think it is a really important one for us.

We have made decisions that we weren't going to incrementalize this change with respect to the surgeon collaborative relationships.

And so as we previously announced, we went beyond the four corners of the DPA and the CI that we entered into last September.

And the point of that from the Company's strategy and with respect to our future, is that we want to make sure that we are able to collaborate with surgeons in all the essential ways that are most important from the patient's prospective, especially.

And that includes collaborating to develop the next generation of great products that address unmet clinical needs.

It also includes having the very best training and education programs out there.

Those are areas that we're very focused on.

We don't want to see disruption to these business units going forward, and so we're biting the bullet now to make that change.

And it will be a permanent change.

But we believe that we are going to be operating in a market that everyone else is going to ultimately come to operate in, whether they do that voluntarily or involuntarily.

So it is disrupted in the short term, but we firmly believe that is the right long-term strategy for the business.

And we really are confident that that is going to prove out.

Jim, just to clarify, are the new product issues in hips, knees, extremities, and dental, and I guess spine, are those principally related to training, other than Durom?

It is, particularly when you look at what it takes in the case of some of these new products that are just -- that surgeons are unfamiliar with, and would look to be able to get into to either cadaver-based surgical skills training program or live surgery before they would be willing to use the device.

You can think of that too in the context of something like Kinectiv Technology or inverse/reverse shoulders, and even Dynesys within the spine field, those are products that surgeons aren't going to be comfortable adopting until they had that training.

And frankly we wouldn't want them to.

That is the point that Jim has referenced in his prepared remarks about the uptake on those new products.

And it was also noted in our earnings release that went out last night.

Raj Denhoy, Thomas Weisel Partners.

I was curious if I could just clarify, did you mention it was $25 million to $35 million this year in other income?

I did.

I think you said there was some sale of products or assets in that.

Can you maybe give us a little more detail on that?

I'm not going to go into specific details on that.

That is why I give guidance on that line item, and have pointed out that includes both interest expense on our borrowings, including the $220 million draw down on our credit facility, as well as both the gain we reported in the second quarter that I referenced, the $8.7 million gain on sale of certain other assets, as well as additional anticipated onetime gains related to further sales of other assets we would look to accomplish in the back half of the year.

But no detail on what does assets are, if there are anything meaningful?

No.

If I could just ask a couple of clarification questions while on the surgeon training program.

Are you requiring that surgeons attend a hands-on training course before they can resume implantation of Durom in the US?

Some form of training will be required.

That is right.

Those courses should resume -- as you mentioned it will come online towards the end of the year.

So until that time there should be no expectation for any sales of that product at all in the US?

We expect to have those courses up and running over the course of the next several weeks.

So we would expect revenues to come back online in advance of the end of the year.

But obviously, we will have to see how things go on the uptake of those products as they are reintroduced after the training.

And we will provide you with a more full update as we enter into the third quarter call.

Just one broad one.

I think you have mentioned several times you're sort of holding the Company to a higher standard I think than maybe it had been previously and other companies are holding themselves to, you know, with the voluntary recall and USP product, the voluntary withdrawal of Durom, your reworking of the surgeon relationships.

You mentioned that you expect this over time to be something that provides you with an advantage.

Maybe I'm putting words in your mouth, but over time that this'll work in your favor.

I'm curious how you imagine that to play out?

Is it that other companies over time will have to come up to where you are, whether they will be perceived in the marketplace that you are a company that people want to do business with?

Really just how does that advantage actually where to your favor over time?

Obviously, trust is absolutely essential within this business.

And whether it comes up in the context of these collaborative relationships in the public's view, in the enforcement agencies' view of how those relationships are structured and managed, that is critical.

I think that the same theme applies in the context of making responsible decisions with respect to the products that we introduce, and the benefits of those products provide to patients, and how we take care of the relationships that we have with surgeons.

So our reputation and the trust that people place in us is going to be key to the future success of the Company.

And so we treat that matter very, very carefully and with a lot of protective steps in place to ensure that the trust is in no respect impaired.

I think on the collaborative relationship side, over the course of the next 5, 8, 10 years what you're going to see is that companies within medical devices that believe that collaborative relationships with physicians are key to their future are going to have to implement systems that are not all that dissimilar to the quality systems that have been implemented in these medical device companies over the last many years to protect the ability to be able to collaborate with surgeons on a go forward basis.

The enforcement agencies are going to expect those programs to be in place.

And I suspect that they're going to allocate their enforcement resources in a way where obviously it is going to be risk-based analysis, and they will come in and evaluate the compliance programs.

And it will be very disruptive to the Company that doesn't have the right program in place.

I think that as the surgeon community becomes better informed as to those risks, they're going to want to collaborate with the companies that have those protective systems in place.

I think it is going to work down to our benefit in that regard as well.

Michael Jungling, Merrill Lynch.

I've got three questions.

Firstly, on the royalty payment that you have delayed.

Are you in breach of contract with physicians, and have doctors taken legal action against you from selling products that have got their technology in it?

Secondly on Durom, the $20 million to $30 million worth of sales, can you indicate how much that is in terms of annual sales?

I think it is pretty much the entire amount.

Thirdly on Dental, if you exclude bone augmentation products, what was the Dental implant growth rate?

And how much competition did you see in Dental from generic competition or low-cost providers?

Thank you.

I will pick up with the royalty question to begin with.

Let me tell you that we have done a lot of work and are making a lot of progress to bring those payments back online.

It is the case that we are in arrears with those payments.

We have communicated very actively with the involved third-parties.

We have a lot of resources committed to this, including some of those third-party resources that Jim referenced earlier in the call.

At this point in time I do not see that our licensing rights are at significant risk.

But we obviously have obligations that we need to make good on within the context of those contracts.

And I think that the progress that we are making will allow us to arrive at an appropriate resolution and be able to make those payments.

Those communications have really expanded over the last quarter, as have our progress steps in that regard.

And I think that we're doing the right things, and would look to make significant progress between now and the end of year with respect to making those payments.

This is Jim.

With regard to Durom, as we indicated in earlier comments, it represents about 5% to 10% of our hip revenues in the US.

It happens to be the case as well outside the US.

If you look at how, and we look at how that product was growing coming into the year, coming out of the first quarter before reports of loosenings and revisions, we were trending clearly to the high end of that range.

And the $20 million to $30 million, again principally associated with Durom, does get you to two-thirds to the full amount.

But as I indicated, with regard to the hip franchise there's also the impact that some disruption that training is having on the new products that we reintroduced in the hip portfolio, namely the M/L taper with Kinectiv and the Fitmore and the EPOCH devices, that we're focused on in the second half of year as well.

Let me tick up on your on your Dental question as well.

I think that you rattled off several factors that could be impacting the business.

At this stage, prior to the other companies reporting out on their second quarter performance, it is a little bit difficult for us do disaggregate those factors.

I will tell you as we have already mentioned that our training efforts on the physician trading education, clinician training and education side were impaired.

We obviously had to prioritize our largest larger business units.

But we are making good progress in that regard now.

So we do think that that had a negative impact on our business.

I think that there probably has been a continuation of the threat of some of the other providers, say the low-cost providers and low value providers within that marketplace.

But I don't think that that has accelerated and justifies our poor performance within the US marketplace.

Anecdotally, it is true that we have received some reports from the field that in certain large procedures, where there are multiple implants, that in instances people are moving from using four implants to two implants and then connecting the gaps with bridgework or more traditional dentistry.

So that could be impacting it as well.

But I think that we will need to carefully review the other companies' performances and we will all learn more in the coming weeks on what is happening within the US marketplace.

There is no doubt that that marketplace is a bit more sensitive to the general economy because of the private pay basis for that business within the US market.

So that has had an impact on the business as well.

Like I said, we will gain greater visibility as the other companies report and be able to disaggregate those factors and think more intelligently about our actions going forward.

A quick follow-up question for you, Dave.

I'm still confused why you have suspended the sale of Durom.

Because if you look at all the registries around the world, the actual failure rate is roughly in line with best practice, or in line with competing products.

And you'll always have one or two or three people who will have higher failure rates because they haven't followed the procedure.

Why recall it when all you would need to do is perhaps train two, three, four, five physicians that are having issues, and not make it a problem of 500 physicians who are getting very, very good results?

Again, we did not recall the product.

The action that we're taking here is to step back, make sure that we can properly revise and add greater clarity to the surgical technique and the instructions for use on that product.

And then make sure that everyone is trained.

We think that if it is the responsible thing to do.

One could deem it to be a conservative action, but when it comes to patient safety we're going to make decisions on the conservative side of the continuum.

Mike Weinstein, JP Morgan.

Let me just pick up on a couple of the items that have been discussed so far.

On Durom, I guess probably two questions.

One, how much do you think you'll spend on surgeon training with the -- based with the relaunch of the product in the United States?

And is it necessarily worth the expense and the distraction on your other products to relaunch this product in the US?

Then how many surgeons do you think you will need to train in order to get the product fully back out there?

I think to respond to those questions -- this is David -- the spending is not going to be anything that is really out of the normal course for us.

We incur a great deal of expense every year on surgeon training and education.

It is a very important aspect of our business.

I wouldn't look for anything that is significant and conspicuous to come out of the expenses that we incur in that regard.

It will just be part of our overall effort on that side of our business.

As far as the number of surgeons, there are several hundred within the US.

I think that our records would indicate that there have been some 900 surgeons or approaching 1,000 surgeons.

And so we would want to train several hundred surgeons.

And this will be an ongoing effort, not just in the coming quarter or two, but thereafter.

We do think that the product offers great patient benefits, as evidenced by the clinical success that had been obtained by many US surgeons and the tens of thousands of patients that have had great results with this product overseas.

We believe that the metallurgy is superior to the competitive products that are out there.

So it clearly is worth the investment.

But we're going to do this in a very responsible way, both to the surgeon customers and to the patients that receive these implants.

Just as a point of clarification, the implants will be made available to the surgeons as they receive training.

So there won't be a threshold that we train a certain number and then the implants become available.

They will become available to individual surgeons as they receive their training.

So they have to go through the training first in order to start doing implant again?

They do.

David, one of my concerns here is that I see all that has happened in the -- particularly in the last nine months between yourselves and surgeons and the way the relationship is evolving.

This is true for Zimmer, but it is probably broadly true for the industry as well.

But part of what you're talking about here is that the disruption on training and some of the other disruptions that are having an impact on the uptake of new technologies.

Part of my question is really, why isn't this -- part of what we are seeing is that in that post DPA world that with changing relationships, less ability to influence surgeons, maybe less interest in surgeons on new technologies, fewer surgeons on your product development teams, why isn't going forward -- the uptake of new technology is going to be slower than what we saw in the past?

I don't think that the uptake of new technologies will be slower.

I will tell you that I think that what we're going through right now is transitional in its nature.

And you're seeing this with not only our Company but the competitors out in the field, either to a greater or lesser extent.

But I do think that what will be the case is that because of the strains placed upon the governmental systems and third-party payors to provide health care with a growing population of folks that need this care, that the necessity of proving out the clinical benefits to new products, if you're going to expect to get mix benefit or price benefit more generally, is going to be more rigorous.

So I think that what you're seeing on the uptake right now is probably a temporary transition as people work through the compliance with these resolution agreements.

But I think that the long-term dynamic is going to dictate that you do have to prove out in a more rigorous way with empirical evidence that if you want to get a premium on a product it has to prove out to provide greater patient benefits.

You see this in the discussions that are taking place within the US on the reimbursement side and notions of comparative effectiveness.

In some form, for sure, you're going to see those types of principles be embedded in that decision-making.

And so what we want to be as an organization is a very innovative organization that addresses unmet clinical needs and have appropriate clinical data to be able to prove that out.

And that is just what we're doing in allocating our R&D efforts.

So we believe that we're going to be able to continue to compete very effectively, introduce innovative products going forward.

One final question for Jim.

On the other income line you are selling off some investments and some assets to help contribute support 2008 earnings.

Should I assume that in 2009 that other income line comes back to more normalized level?

Until such time as we prepare an operating plan for 2009, I would like to stay away from providing any specific guidance on 2009.

But we have -- and what we have disclosed -- being careful to make it very clear that is what is running through that is one-time in nature.

Ben Andrew, William Blair.

I just wanted to follow up with a couple of quick things.

Is there any plan to accumulate clinical data related to Durom in the United States?

You talked about the need for clinical evidence, maybe with a registry or a broader study?

What I can tell you is with respect to the ongoing experience and the experience that we will move forward with post training, that we will be continuing to very closely monitor the clinical experience with this device.

Then just more broadly, speaking back to the training issue, clearly the disruptions and delays in being able to train and work with surgeons more closely is directly -- basically every business.

Where is the confidence coming from that you're going to be able to see a quick restoration of the scope of relationship you had with surgeons historically, as you have been delaying that and disrupting those relationships as you get those pieces back in place?

What timeframe should that be happening on?

I think that we're going to make significant progress in the coming weeks and months.

And I would expect that we will have fully transitioned and be up and running at a full clip before we exit this year.

I will tell you that was respect to the relationships that we have with the surgeons, there is a high desire among them to get back at these activities.

As I mentioned, we have had in person meetings with over 100 surgeons, just in the second quarter.

The common theme among all of them is that they want to ensure that patients' interest are protected.

And they are very passionate about these activities.

They are very passionate about the collaborative relationships and the benefits that they think are derived for their patients through those relationships.

So I don't anticipate that we're going to have any trouble at all at getting first-rate people signed backup to help us teach these courses and participate.

Joanne Wuensch, BMO Capital Markets.

There are two questions.

The first has to do with your communication with the FDA regarding the Durom, and if you think that they will take some sort of action towards this.

The second question has to do with hip resurfacing.

It is my understanding that the Durom hip cup is used as part of your resurfacing program.

Does this delay introduction of that?

Thank you.

I will take both of those questions.

First of all, with respect to the communications with the FDA, we have shared our review and conclusions with the agency, and we will continue to update them.

In terms of future interactions, it would be difficult for me to predict.

They will be necessary and appropriate, certainly.

In terms of our ongoing US IDE study on the resurfacing system, in response to the actions that we're taking today with respect to the Durom Acetabular Component, which is the acetabular component in that system, we are suspending enrollment until further notice.

Matt Miksic, Piper Jaffray.

I had one clarification here.

I just want to make sure I understood you.

And then I have a couple of questions if that is okay.

The clarification was on this comment you made on SG&A.

I think you talked about 175 basis points of increase due to legal and compliance expense, was that right, Jim?

That's right.

Is that in 175 bips of growth or is that as a percentage of sales?

Maybe I will make it easier for you.

It is about close to $20 million in expenses in the quarter.

I guess that is the number I was coming up, and that just sounded a little higher than I was thinking of in terms of a runrate.

Is that -- did I do [stuff] right?

I think that is fair.

Because I talk also about $50 million to $60 million for the year, so clearly the second quarter was the high watermark.

Just clarification on you talked about this first-half growth.

I didn't hear whether you had attributed some sort of percentage growth number to the selling days and the Easter effect for the quarter.

I think what you ought to do is look at the growth rates for the first six months, because those billing day differences get neutralized as between the two quarters.

That 8% number, or whatever it was that you gave us, that is the normalized runrate sort of first-half?

That's right.

Sort of looking at -- there has been a lot of questions about this, but I guess I just want to understand how we should think about it playing out over the next -- granted this is going to go into next year, but I hope you can help us think about it.

It sounds like this rollout of the enhanced compliance program as you would go into other divisions and layer in the same kind of rigor that you're putting into orthopedics, that is slowing things down.

You have more training.

Do you have a implementation timeline for that?

I would love to hear when you think you'll be done.

But is the right way to think about this at the end of that, assuming that you don't lose a lot of share, that you are going to be able to reaccelerate some of the growth in those businesses, just as you -- as that becomes part of the more normal operations, or you get people trained up or get through this implementation process?

Absolutely.

We are very optimistic based upon the feedback that we have received from surgeons that this is a transitional period.

They are enthusiastic about the fact that we're back out and communicating with them in a very proactive way.

There are a lot of elements of this, obviously, and we are prioritizing our execution plans in accordance with the import of that business unit.

And so there are aspects that first and foremost are essential on the communication front, to get the training and education programs up and running across all these business units.

With respect to the US hips and knees, obviously the payments are another area of prioritization for us.

We're making good progress on that front.

I think that you can see that most of the other competitors have slowed down their payments over the course of the nine-month term of these resolution agreements as well.

But I anticipate us making very significant progress in the third quarter.

And working with an eye towards marching into next year, and certainly by the end of the first quarter of next year, to have all that stuff behind us.

I would expect just in a macro sense to have the training and education events all up and running.

And that process to be very smoothed out before we exit this year.

And that the remaining US hip and knee payment stuff may pend or pend over until the first quarter of next year, but largely be resolved by the first quarter of next year as well.

With respect to the other businesses and the global compliance, is it first or second quarter of next year that you feel like you get that behind you as well?

I think no later than that.

I am more optimistic that on that front we will probably have most of that behind us before this year is out.

The other thing about this is, as you mentioned what other companies are doing, I think I understand.

You have talked about what you're trying to do in terms of settling up with the surgeons that you have these royalty-based relationships with.

And then redrafting new agreements to go forward.

Are you concerned at all that that sort of cutting these folks lose to some degree as free agents at the end of the year once that agreement is signed?

Whereas I look at other manufacturers, not to be too -- sound too sort of mercenary here, but the folks with relationships with other manufacturers clearly have a reason to maintain and concentrate on that relationship because they do have these ongoing payments.

Obviously, there is no nexus in our minds between the product choice that the surgeon makes and who we're engaging to provide services, whether it is on the training and education side, or providing intellectual property and input into the design of our products.

But our initiatives in that regard matter just to make sure that these existing contracts are treated in an appropriate way.

And that we're going back through and doing whatever work we need to to make sure that the payments that go out are consistent with our current compliance program and our fair market value principles.

So I don't want to describe that as sort of a settle up process.

I will tell you that our initiative in that regard is very rigorous and comprehensive.

But the objective there is to make sure that everyone that we have collaborated with is treated in a fair way, and they are provided with full and fair value as supported by third-party valuations, if necessary, of those contracts.

That is the initiative that is underway in that context.

I think that is fair.

The last question here was on some of the new products.

The training sounds like it is part of the impact.

Just to put this in perspective, if we think about Natural-Knee and Mobile Bearing, even when training gets going again those are maybe a segment of your knee business.

Is any of the sluggishness around some of these new products driven by concern over the cost of the technology or the complexity of the technology?

I guess I'm thinking of the Gender hip with Kinectiv Technology.

Is that something that you're confident is going to pick back up again?

Or is that -- to your point earlier about making a connection between new products, the premium of the product and the clinical outcomes, is that something that you feel like you have a strong case there, or has there been pushback on the price on that product?

I think that it just is -- it is in the early stages.

So we have seen enough disruption in the training efforts there to where we have lost some time to be sure.

But we still believe in that technology and the receptivity that we have received to what that technology represents and the patient benefits is still very positive.

So we're optimistic about any of these launches that we have underway right now.

We just think that we lost a bit of time.

That's fair.

Thanks again for taking the questions.

David Roman, Morgan Stanley.

I just want to spend a couple of seconds on the guidance.

You went through all the details on the lowering of sales estimates.

Given that in every case you're saying that that is related to training and the implementation of your own compliance standards, what surprised you during the quarter compared to Q1 that caused such a dramatic change?

I would say that I don't know that anyone anticipated the amount of work that was going to go into complying with the resolution agreements at the outset.

So it is difficult to forecast out because that is not a normal business cycle that you're going through or process that you're working through.

We probably lost some time on the front end that we didn't fully project out or appreciate going into the -- even the first quarter, let alone the second quarter.

So some of it was just that dynamic.

If you look at Mobile Bearing, for example, and the number of physicians you have been able to train compared to, let's say, a more rapid product launch, can you give us a sense as to how that compares six months out?

I think that the difference is pretty dramatic is the way I would characterize it, as opposed to what you would normally do at the point of launching those types of products.

New technology along the lines of Kinectiv would fall in that same category.

But Kinectiv and Mobile Bearing knees, a lot of training and education is necessary prior to a physician picking up that product and feeling comfortable with it.

Any disruption in that regard is going to be seen directly in the commercialization side.

Then on the margin front, gross margins are down -- a little light relative to I think where people were looking for.

Can you give us a sense as to where you think that will shake out for the full year?

I can try to do that.

If you look -- maybe the best way to focus on that is to look at the change this quarter relative to second quarter prior year, the reduction of 190 basis points.

About 160 basis points of that is related to the foreign currency hedge losses, and the balance to both idle plant expense that we are experiencing at the Dover facility, as well as inventory obsolescence charges.

I think if you look at where we landed for the quarter, there or maybe slightly better is where we would expect to -- when we consider that and the other charges that have run through there in the first quarter related to that OSP issue is where we would expect to be for the year.

Are you dialing in anything for higher raw material costs?

Have you seen anything on that front?

We have, and that is reflected.

Just to give you some indication of what that looks like, we had -- as well we have been visibility to that coming into the year.

We had that reflected in the guidance coming into the year.

But to the extent we have seen further increases, we're now looking at what is roughly about $10 million to $15 million of purchase price variances, some of which will get carried over into next year.

The last question, just to follow up on SG&A.

You said that -- the 270 basis point year-over-year increase, 175 basis points related to compliance.

What is the rest of that?

The rest of that would be the step up we talked about coming into the year related to the operating and infrastructure initiatives.

It is an opportunity for our US distributor organization to earn higher compensation on trauma productlines.

The pushing out more instruments into the US distributor organization, the costs associated with that.

So they are in a better position to deal with the demands that are being made with surgery schedules getting pushed towards the front of the week.

It is those other initiatives that are contributing to that increase.

You think those efforts will be complete in 2008?

They are, but as we have said before, those are things that carryover as well into future periods to some degree.

Doug Schenkel, Cowen and Company.

I believe you mentioned that Q2 R&D spend was lower than expected in part because of royalty renegotiations.

And you guided us to expect R&D on the low end of the guidance range.

Can you talk about how ongoing changes in your R&D practices may be affecting development timelines, and how that compares to your assumptions coming into the year?

This is Cheryl.

I can take that.

First of all, just a point of clarification.

There have not been in a royalty renegotiations.

It has really been a decrease in spend just related to straight fee-for-service consulting activities.

So just a point of clarification on that note.

In terms of how it has impacted development timelines, there certainly has been an impact.

I think it is fairly well understood that during the initial phases of the monitor period that we were not holding development meetings.

So there certainly will be some delay overall.

I will tell you that the projects that were in their later phases are continuing to move along.

And we are continuing to drive towards those timelines currently.

That is helpful.

Maybe a follow-up to the R&D question then.

Is it fair to assume that the decision to suspend retrain, and essentially prelaunch Durom in the US, rather than to just discontinue the product, might have been different if you had a follow on metal on metal products planned for launch in the US, either in 2009 or 2010?

Again, we believe in the technology and in the clinical benefits of that product.

The issue is not with respect to the product, but rather to the surgical technique and the specificity of that technique in the training that accompanies it.

That is the basis for the decision.

Maybe a more direct follow-up.

Could you give us any color on when you think you might have a follow on metal on metal products in the US?

That obviously is a very important part of our pipeline.

I will tell you that it will continue to be a priority, and has been a priority, not just metal on metal, but the cup side of our hip business in general going into 2009.

We would anticipate making progress and working towards launching one or more cup products within that time period.

One more question.

You talked about the need to see other earnings reports from some of your competitors before arriving at any firm conclusions on market dynamics.

But I think at this point it is fair to conclude that recon volumes were decent at Biomed, DePuy and Stryker during the quarter.

Given you said your moderation in your second half outlook goes really across your different businesses, can you help us understand why we shouldn't conclude that some of these enhanced compliance approaches that you are implementing, either aren't going to drive you specifically to lose share, if others aren't following the same approaches?

Or that in general if others are taking similar approaches that volumes in general will pull back a little bit?

We responded to the understanding of what is happening in the markets in the context of Michael's question on the Dental market.

I think that we do have great visibility and a clear understanding of the core recon business and what has happened in the second quarter market-wise.

So that was Dental specific, just to start off with.

I don't believe that this enhanced compliance model is going to negatively impact our future business.

I think that it is the right thing to do.

Is a longer-term strategy.

I think that the likely impact is in the short term.

But I think what you're going to see is continued scrutiny of these relationships.

And we're making the decisions now that will allow us to continue to collaborate with surgeons in all the essential ways.

And so I think we're making the hard decisions out in front.

And for anyone who decides that they are going to be dragged through this transition process by an outside entity as opposed to internally driving a cultural change, and a rigorous program in this context, what they're likely to see is future disruption to their ability to collaborate with surgeons.

That is what we're going to avoid with the process that we're going through now.

Kristen Stewart, Credit Suisse .

I have a couple.

I guess in the quarter it looks like from your cash flows you sold -- obviously you talked about selling the business, and you also bought something.

Can you give us any color since those are obviously closed deals on what those were?

I'm not going to give on the sale of the other assets specific detail.

I think there's a fair amount of information out in the public domain that people are able to get a fair idea of what contributed to that gain in the quarter.

Then with respect to the very small acquisition that we did in the quarter, that was an acquisition of our independent recon distributor based in Finland.

Just going back, I know this has been asked several times, but your other income including the gain on the sale of the assets, I guess I'm just curious on your philosophy with adjusted net earnings.

Since it looks like you are excluding all of the costs associated with acquisitions, but now including gain for divestitures, should we really be looking at it as $1.03 less what looks like $0.03 in the quarter as more of an ongoing sort of runrate basis?

I would say our philosophy with respect to how we report our financial results is to be very clear and transparent.

And I think we have accomplished that.

That gain that you can see is in the interest and other income line.

It is below operating profit, as it should be.

And we have been very clear about how much and the impact that it is having on earnings.

What did you say the guidance was for the full year on that line?

$25 million to $30 million.

That is all gains or is that including the (inaudible)?

No, that is a net number, so that includes both interest, expense on our borrowings as well as anticipated one-time gains.

Just going back, I guess, to your going into the field and looking at the experience with Durom.

I'm just curious, were you using any higher incidence -- I know that this product has been used off label in hip resurfacing.

Are you seeing any higher incidence of revisions when it is used in that condition versus any sort of use in a more traditional hip arthroplasty procedure?

And what may be the implications for resurfacing?

I know you said you are suspending enrollment, but how do you look at that going forward?

I think the last update you gave would be at best 2011.

How do you feel positioned to compete against your competitors that will likely have a system, especially in light of some of your commentary last fall on how concerned you were with hip resurfacing?

Let me take first of all, your question on its potential use in off label applications.

I will tell you that in our very in-depth investigation where we reviewed individually 1,300 cases that we did not see one example of where the Durom Cup was used in any other instance other in a large diameter head application and a total hip arthroplasty.

So I find myself not in a position to comment on its use in off label applications because I have not seeing it.

I'm not saying that it is not out there.

Certainly surgeons have the opportunity to direct their own use for the best care of their patients.

But I will tell you that we have not seen it.

In terms of your question related to the IDE study, because that cup is the acetabular component in that resurfacing study, and because we have taken the action that we have, we find it only appropriate to suspend enrollment on that study until further notice.

And then in terms of our ability to compete in that productline going forward, I'm going to turn that one over to Jim.

As you are rightly pointing out, we're clearly going to be focused on competing in the [90 to 92], depending on where hip resurfacing levels out in the US market, whether it is say to 10%.

With everything else that we have in our portfolio, including Trabecular Metal which is unique and proprietary, the new products, the M/L taper with Kinectiv Technology, David referenced some work that we have underway in development to bring out what will be a new acetabular component system.

With the suspension I would suspect, although this is something that still obviously has to be evaluated, there will be some delay beyond that 2011 period that we earlier referenced.

Cheryl, just going back to your comments on reviewing, I think you said 1,300 patients.

Is that correct?

In the United States, yes.

Is that just 10% of all US procedures?

And I guess are you very comfortable but that is a good kind of sample to project on what the total experience would be?

That does represent about 10% of the cases that are currently available in the United States.

I will tell you that the tact that we took was to go to among the highest volume sites in the United States, because there was a certain sense of urgency related to our ability to come to conclusion on the issues that were raised by our knowledge of loosenings and revisions that were occurring.

Do we think that it is a statistically significant representative sample that allows us to draw the conclusions that we did and take the action that we did?

The answer is absolutely yes.

Operator, in the interest of everyone's time let's take two more questions.

Bob Hawkins, Bank of America.

I've got just two questions.

First question is on the stability of the sales organization.

Can you comment on the stability of the sales organization?

And specifically have you lost any distributors?

And then when it comes down to individual reps, what is a normal rate of turnover that you might see in a quarter, and what is the current rate of turnover that you saw in this quarter?

Thank you.

It is David.

We won't go into turnover, but I will tell you we have had extraordinary stability among the US distributor sales force.

Furthermore, I think that our distributor group has really answered the call and addressed the challenges that we have gone through in a an admirable way.

They are clearly very onboard with what we're doing as an organization.

We think that we have the best distribution channel in the industry.

Their reaction and how they have conducted themselves through this period evidences that.

I have absolute confidence in our ability to execute with that group, and we're proud to be affiliated with them.

So you haven't lost any?

We have lost no distributors.

You are basically comfortable saying you've got no abnormal level of turnover with the sales organization?

That's right.

I will tell you that the single exception to that has been we have had some turnover on the Dental side within the US.

But I have seen nothing abnormal at all outside of that.

The second question is would you rule out M&A as an option to bolster your metal-to-metal offerings, and by extension hip resurfacing?

We would never rule out any external opportunities.

Obviously, we're constantly evaluating external opportunities.

And those are getting evaluated in the context of our internal development plans at all times.

If there was technology that we thought was unique or that could accelerate addressing any aspect of our offering that we thought was going to provide significant clinical benefits to patients, we would be interested in that.

Are those deals less likely now, given the incremental expenses that you are incurring in '08 and the early part of the '09, or not necessarily?

No, they aren't less likely.

Jeff Johnson, Robert Baird.

Just a few clarifications here at the end.

One, do you need any regulatory signoff on the labeling changes for Durom?

And if so, could that be the rate limiting step here as opposed to the training courses?

Number two then, just a clarification on the P&L treatment of the royalty agreements that are in arrears at this point.

Have you been running these presumed payments at all through the P&L, or have they been left out of the P&L the last two quarters?

Then the third question/clarification, Jim, obviously some sensitivity around talking about the asset sales.

But is it fair to assume the stock sales in the quarter that did add to this to the non-recurring gain would be the same sales going forward, and there would be no other type of non-strategic asset sales?

It would just be the similar one we saw here in this quarter.

This is Cheryl.

I'm happy to take your first question regarding regulatory sign off.

There will certainly be appropriate communication with the SG&A on that aspect of the field action.

And we will submit to them the labeling change, which is the regulatory action that is occurring as a result of this.

I will tell you that I do not believe that will be a rate limiting step.

I think that will happen in the normal course of our business.

And that that will not be anything that will be causing us to slow down anything on the training and education side at all.

This is Jim to respond to the question about royalty expense.

We have continued to reflect that in the income statement.

And we have talked as well about the fact that it has contributed as well, to the extent that we're not making those payments, to what is getting reported in terms of free cash flow.

It is in the order of $23 million -- $20 million to $25 million on a quarterly basis.

Then finally on the asset sales, I'm not going to answer that directly, other than to say with whatever asset sales we undertake in the balance of the year, we will do that an organized and orderly fashion to ensure that we get good value for any assets that we sell.

This concludes today's conference call.

Thank you for your participation.

You may now disconnect.