The following discussion and analysis should be read in conjunction with the consolidated financial statements and the corresponding notes included elsewhere in this Form 10-K.

OVERVIEW

We are a global leader in the design, development, manufacture and marketing of orthopaedic and dental reconstructive implants, spinal implants, trauma products and related surgical products (sometimes referred to in this report as "OSP"). We also provide other healthcare related services. Orthopaedic reconstructive implants restore joint function lost due to disease or trauma in joints such as knees, hips, shoulders and elbows. Dental reconstructive implants restore function and aesthetics in patients who have lost teeth due to trauma or disease. Spinal implants are utilized by orthopaedic surgeons and neurosurgeons in the treatment of degenerative diseases, deformities and trauma in all regions of the spine. Trauma products are devices used primarily to reattach or stabilize damaged bone and tissue to support the body's natural healing process. OSP include supplies and instruments designed to aid in orthopaedic surgical procedures and post-operation rehabilitation. We have operations in more than 25 countries and market products in more than 100 countries. We manage operations through three reportable geographic segments - the Americas, Europe and Asia Pacific.

Certain percentages presented in this discussion and analysis are calculated from the underlying whole-dollar amounts and therefore may not recalculate from the rounded numbers used for disclosure purposes. Certain amounts in the 2007 and 2006 consolidated financial statements have been reclassified to conform to the 2008 presentation.

Beginning in 2008, our Hips product category sales no longer include bone cement and accessory sales, which have been reclassified to our OSP and Other product category. Amounts in the years ended December 31, 2007 and 2006 related to sales of bone cement and accessory products have been reclassified to conform to the 2008 presentation.

We believe the following developments or trends are important in understanding our financial condition, results of operations and cash flows for the year ended December 31, 2008.

Demand (Volume and Mix) Trends

Increased volume and changes in the mix of product sales contributed 3 percentage points of 2008 sales growth, which is 6 percentage points below the rate of growth from 2007 compared to 2006. We estimate that the orthopaedic procedure volume market growth rate on a global basis will be in the mid single digits in the coming years driven by an aging global population, obesity and more active lifestyles, among other factors. In addition, the continued shift in demand to premium products, such as Longevity, Durasul and Prolong Highly Crosslinked Polyethylenes, Trabecular Metal Technology products, high-flex knees, knee revision products and porous hip stems, continue to positively affect sales growth. Our 2008 increase of 3 percentage points decreased from 2007 and was lower than market growth due to the factors discussed below.

Pricing Trends

Selling prices were flat during 2008, which is similar to 2007 when compared to 2006. Asia Pacific selling prices decreased 3 percentage points for the year ended December 31, 2008, compared to a 1 percent decrease in 2007 when compared to 2006. Japan and Australia reported 4 percent and 3 percent decreases, respectively, in average selling prices as a result of scheduled reductions in reimbursement prices. Japan and Australia combined represent approximately 10 percent of our sales. Selling prices in the Americas were flat during 2008, compared to a 1 percent increase in 2007. In Europe, selling prices for 2008 were flat, compared to a 1 percent decrease in 2007. With the effect of governmental healthcare cost containment efforts and pressure from group purchasing organizations, we expect global selling prices to remain flat in 2009.

Foreign Currency Exchange Rates

For 2008, foreign currency exchange rates had a positive 3 percent effect on global sales growth. If foreign currency exchange rates remain consistent with the year end rates, we estimate that a stronger dollar versus foreign currency exchange rates will have a negative effect in 2009 of approximately 4 percent on sales. We address currency risk through regular operating and financing activities, and, under appropriate circumstances and subject to proper authorization, through the use of forward contracts and options solely for managing foreign currency volatility and risk. Changes to foreign currency exchange rates affect sales growth, but due to offsetting gains/losses on hedge contracts and options, which are recorded in cost of products sold, the effect on net earnings in the near term is expected to be minimal.

Abbott Spine Acquisition

In October 2008, we acquired Abbott Spine, previously a subsidiary of Abbott Laboratories, for approximately $360 million. The purchase price was funded by a combination of cash on hand and borrowings under existing credit facilities. This investment adds a number of innovative products and helps build toward critical mass in the Spine product category. The acquisition also enhances our research and development capabilities in the Spine product category and strengthens our sales coverage. We recorded $48.7 million of acquisition and integration costs in 2008 as a result of this transaction, including $38.5 million of in-process research and development expense. For more information regarding the acquisition of Abbott Spine, see Note 4 to the consolidated financial statements included elsewhere in this Form 10-K.

ZIMMER HOLDINGS, INC. 2008 FORM 10-K ANNUAL REPORT

Compliance-Related Matters

In September 2007, we and other major U.S. orthopaedic manufacturers reached a settlement with the U.S. government to resolve claims related to an investigation into financial relationships between the industry and consulting orthopaedic surgeons. We paid the government $169.5 million and entered into a Deferred Prosecution Agreement (DPA) under which we will remain subject to oversight by a federally-appointed monitor through March 27, 2009.

We also entered into a Corporate Integrity Agreement (CIA) with the Office of the Inspector General of the U.S. Department of Health and Human Services, which has a term of 5 years. For more information regarding the settlement, see Note 16 to the consolidated financial statements included elsewhere in this Form 10-K.

We did not record any tax benefit related to the $169.5 million payment in 2007. During 2008, we reached an agreement with the U.S. Internal Revenue Service confirming the deductibility of a portion of the payment and recorded a current tax benefit of $31.7 million, resulting in a decrease to the current period effective tax rate. For more information regarding the tax treatment of the settlement expense, see Note 12 to the consolidated financial statements included elsewhere in this Form 10-K.

We have developed and substantially implemented enhanced global compliance initiatives which address areas such as product development, marketing, surgeon training and educational and charitable funding. The principles of this program meet or exceed the requirements of the DPA and CIA, as those principles are being applied in most respects to all product segments and reach all worldwide operations. Costs related to the DPA, CIA and the enhanced compliance initiatives in 2008 were approximately $60 million, including the fees incurred for the federally-appointed monitor.

Durom Acetabular Component

In July 2008, we temporarily suspended marketing and distribution of the Durom Acetabular Component (Durom Cup) in the U.S. to permit us to update product labeling to provide more detailed surgical technique instructions and implement an enhanced surgical training program in the U.S. We resumed marketing and distribution of the Durom Cup in the U.S. in August 2008.

During 2008, we received claims from a number of Durom Cup patients seeking reimbursement for costs and payments for alleged pain and suffering and we expect to receive additional similar claims. We recorded a provision for certain claims of $69.0 million in 2008, which represents management's estimate of liability to patients undergoing revision surgeries related to the Durom Cup. The estimate is limited to revisions associated with surgeries occurring before July 2008 and within two years of the original surgery date. Any claims received outside of these defined parameters will be managed in the normal course and reflected in our standard product liability accruals.

We believe we lost hip product sales during 2008, in large part as a consequence of the events involving the Durom Cup. In addition, we expect that our entry into the U.S. hip resurfacing market has been hindered or delayed as the Durom Cup had previously been integral to our plans for entry into that market.

Orthopaedic Surgical Products (OSP) Actions

In the first half of 2008, we initiated voluntary product recalls of certain OSP patient care products manufactured at our Dover, Ohio facility that we determined did not meet internal quality standards and we temporarily suspended production and sales of certain OSP products manufactured at the Dover facility. We estimate that these actions adversely impacted 2008 OSP revenues by approximately $70 million and 2008 diluted earnings per share by $0.18 including related inventory charges, idle plant costs and other non-recurring charges. We expect to have a significant portion of these products back in production in the first quarter of 2009, with most other products coming back into production in the second quarter of 2009.

Impact of Disruptive Events on Market Share

As a result of the disruptive factors discussed above, including our temporary suspension of U.S. marketing and distribution of the Durom Cup, our voluntary recall and suspension of production of certain OSP patient care products, and the implementation of our enhanced global compliance initiatives, we have suffered customer losses during 2008. We estimate that these customer losses reduced our knee and hip market share by 1.5 to 2.0 percent as measured from fourth quarter results. We expect our sales growth to be at a rate slower than the market in the near term due to these disruptive factors.

2009 Outlook

We expect conditions in the broader economy will result in a temporary slowdown in elective hospital procedures. Although many of our products are used in elective procedures, we believe our core knee and hip franchises remain more insulated than most from swings in the broader economy because the need for these procedures does not diminish, even if the timing is affected.

We expect to experience further customer losses in 2009 affecting our knee and hip market share as a result of the ongoing effects of the disruptive factors discussed above. Our assumption is that share loss should stabilize by year-end 2009, as we anniversary out of the majority of the 2008 customer and product-related losses, and as we launch new products in sufficient quantities to recover some of the product-related losses.

Among our other product categories, we expect extremities and trauma sales growth to be in line with market growth rates. We expect dental revenues to reflect the weak economic environment and to underperform relative to market growth rates given company-specific operational challenges. Finally, we expect spine revenues to increase as a result of the Abbott Spine acquisition and reflect sales dis-synergies associated with the ongoing integration of the two businesses.

ZIMMER HOLDINGS, INC. 2008 FORM 10-K ANNUAL REPORT

In 2009, our operating expenses will be impacted by a number of factors, which in the aggregate are expected to result in a modest net decrease in total expense compared to 2008. We expect to realize significant savings from third-party fees related to compliance with the DPA and the implementation of our enhanced compliance initiatives, Durom-related certain claims and acquisition, integration and other expenses. For 2009, however, we intend to partially offset those savings with increased spending in areas that suffered disruption in 2008, including product development and medical education. We also continue to step-up our level of spending on quality systems to achieve our continuous improvement objectives in the areas of design and process control as well as ongoing product surveillance.

RESULTS OF OPERATIONS

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

  Net Sales by Operating Segment




The following table presents net sales by operating segment and the components
of the percentage changes (dollars in millions):


                       Year Ended December 31,                   Volume/                   Foreign
                          2008            2007       % Inc           Mix       Price      Exchange


   Americas       $    2,353.9       $ 2,277.0           3 %           3 %         - %           - %
   Europe              1,179.1         1,081.0           9             4           -             5
   Asia Pacific          588.1           539.5           9             5          (3 )           7


   Total          $    4,121.1       $ 3,897.5           6             3           -             3

"Foreign Exchange" as used in the tables in this report represents the effect of changes in foreign exchange rates on sales growth.

  Net Sales by Product Category




The following table presents net sales by product category and the components of
the percentage changes (dollars in millions):


                                                   Year Ended December 31,                              Volume/                      Foreign
                                                         2008            2007        % Inc (Dec)            Mix        Price        Exchange


Reconstructive
Knees                                            $    1,763.0       $ 1,634.6                  8 %            7 %         (1 )%            2 %
Hips                                                  1,279.5         1,221.4                  5              2           (1 )             4
Extremities                                             121.0           104.0                 16             14            1               1
Dental                                                  227.5           221.0                  3              -            1               2


Total                                                 3,391.0         3,181.0                  7              5           (1 )             3


Trauma                                                  221.4           205.8                  8              4            1               3
Spine                                                   230.6           197.0                 17             14            2               1
OSP and other                                           278.1           313.7                (11 )          (14 )          -               3


Total                                            $    4,121.1       $ 3,897.5                  6              3            -               3

The NexGen Complete Knee Solution product line, including Gender Solutions Knee Femoral Implants, the NexGen LPS-Flex Knee, the NexGen CR-Flex Knee and the NexGen LCCK Revision Knee, led knee sales. In addition, the Zimmer Unicompartmental High-Flex Knee and the Gender Solutions Natural-Knee Flex System exhibited strong growth.

The continued conversion to porous stems, including the Zimmer M/L Taper Stem, the Zimmer M/L Taper Stem with Kinectiv Technology, the CLS Spotorno Stem from the CLS Hip System, and the Alloclassic Zweymüller Hip Stem, led hip stem sales, but was partially offset by weaker sales of cemented stems. Trabecular Metal Acetabular Cups and Longevity and Durasul Highly Crosslinked Polyethylene Liners also had strong growth. The temporary suspension of marketing and distribution of the Durom Cup in the U.S. negatively impacted hip sales growth. Additionally, with the lack of a hip resurfacing product within our U.S. hip portfolio, we expect to face a continuing challenge in hip sales growth with the adoption of hip resurfacing in the U.S. market.

As a result of the disruptive factors discussed above, we suffered customer losses during 2008. We estimate that these customer losses reduced our knee and hip market share by 1.5 to 2.0 percent as measured from fourth quarter results. We expect to experience further customer losses in 2009 as a result of the ongoing effects of these disruptive factors.

The Bigliani/Flatow Complete Shoulder Solution and the Zimmer Trabecular Metal Reverse Shoulder System led extremities sales. Orthobiologicals and prosthetic implants, including strong growth of the Tapered Screw-Vent Implant System, led dental sales. Zimmer Periarticular Locking Plates and the I.T.S.T.
Intertrochanteric/Subtrochanteric Fixation System led trauma sales. The Dynesys Dynamic Stabilization

ZIMMER HOLDINGS, INC. 2008 FORM 10-K ANNUAL REPORT

System and the Trinica Select Anterior Cervical Plate System led spine sales, which also reflect an increase as a result of the Abbott Spine acquisition. OSP sales were negatively affected by the patient care product recalls and related voluntary suspension of production of certain products, but these negative factors were partially offset by strong growth in PALACOS Bone Cement.

The following table presents estimated* 2008 global market size and market share information (dollars in billions):

                              Global                          Zimmer        Zimmer
                              Market       Global Market      Market        Market
                                Size          % Growth**       Share      Position


            Reconstructive
            Knees            $   6.4                   8 %        27 %           1
            Hips                 5.7                   6          22             1
            Extremities          0.8                  13          14             3
            Dental               3.2                   7           7             4


            Total            $  16.1                   7          21             1


            Trauma           $   4.1                  10           5             5
            Spine***         $   6.8                  10           3             5

* Estimates based on competitor annual filings, Wall Street equity research and Company estimates

** Excludes the effect of changes in foreign exchange rates on sales growth

*** Spine includes related orthobiologics

  Americas Net Sales




The following table presents Americas net sales (dollars in millions):


                                   Year Ended December 31,
                                      2008            2007       % Inc (Dec)


             Reconstructive
             Knees            $    1,089.8       $ 1,029.8                 6 %
             Hips                    576.1           568.3                 1
             Extremities              88.1            73.9                19
             Dental                  114.9           118.9                (3 )


             Total                 1,868.9         1,790.9                 4


             Trauma                  125.8           122.9                 2
             Spine                   181.3           160.3                13
             OSP and other           177.9           202.9               (12 )


             Total            $    2,353.9       $ 2,277.0                 3

The NexGen Complete Knee Solution product line, including the Gender Solutions Knee Femoral Implants, NexGen LPS-Flex Knee, the NexGen LCCK Revision Knee and the NexGen CR-Flex Knee, led knee sales. The Gender Solutions Natural-Knee Flex System also made a strong contribution.

Growth in porous stems, including growth of the Zimmer M/L Taper Stem and the Zimmer M/L Taper Stem with Kinectiv Technology, led hip stem sales, but was partially offset by weaker sales of cemented stems. Trabecular Metal Acetabular Cups and Longevity Highly Crosslinked Polyethylene Liners also made a strong contribution. As noted above, the temporary suspension of marketing and distribution of the Durom Cup in the U.S. will continue to negatively impact hip sales and we also expect that the adoption of hip resurfacing in the U.S. market will continue to adversely affect our hip sales growth.

As a result of the disruptive factors discussed above, we suffered customer losses during 2008. These customer losses negatively impacted sales growth, primarily in the knee and hip product segments. We expect to experience further customer losses in 2009 as a result of the ongoing effects of these disruptive factors.

The Bigliani/Flatow Shoulder Solution and the Zimmer Trabecular Metal Reverse Shoulder System led extremities sales. Negative sales growth for our dental business reflects disruptions caused by the implementation of our enhanced compliance initiatives and overall weakness in the U.S. economy. Zimmer Periarticular Plates and the I.T.S.T. Intertrochanteric/Subtrochanteric Fixation System led trauma sales. The Dynesys Dynamic Stabilization System and the Trinica Select Anterior Cervical Plate System led spine sales, which also reflect an increase as a result of the Abbott Spine acquisition. OSP sales were negatively affected by the patient care product recalls and related voluntary suspension of production of certain products, but these negative factors were partially offset by strong growth in PALACOS Bone Cement.

  Europe Net Sales




The following table presents Europe net sales (dollars in millions):

                                   Year Ended December 31,
                                      2008            2007       % Inc (Dec)


             Reconstructive
             Knees            $      452.6       $   407.8                11 %
             Hips                    493.9           459.9                 7
             Extremities              25.8            23.2                11
             Dental                   82.2            71.3                15


             Total                 1,054.5           962.2                10


             Trauma                   47.4            41.1                16
             Spine                    40.1            31.2                29
             OSP and other            37.1            46.5               (20 )


             Total            $    1,179.1       $ 1,081.0                 9

Changes in foreign exchange rates positively affected both knee and hip sales by 5 percent. The NexGen Complete Knee Solution product line, including the NexGen LPS-Flex Knee, the NexGen LCCK Revision Knee and the NexGen CR-Flex Knee, led knee sales in our Europe region.

Growth in porous stems, including the CLS Spotorno Stem, led hip stem sales. Longevity and Durasul Highly Crosslinked Polyethylene Liners, Trabecular Metal Acetabular Cups and the Allofit® Hip Acetabular System also contributed to hip sales.

As a result of the disruptive factors discussed above, we suffered customer losses during 2008. These customer losses negatively impacted sales growth, primarily in the knee and hip product segments. We expect to experience further customer losses in 2009 as a result of the ongoing effects of these disruptive factors.

The Anatomical Shoulder System and the Coonrad/Morrey Total Elbow led extremities sales. The Tapered Screw-Vent Implant System led dental sales. The Cable-Ready® Cable Grip System and the NCB Plating System led

ZIMMER HOLDINGS, INC. 2008 FORM 10-K ANNUAL REPORT

trauma sales, which were offset by weaker sales of our intramedullary fixation systems. The Dynesys Dynamic Stabilization System and the Optimatm5 ZS Spinal Fixation System led spine sales. OSP sales were negatively affected by the patient care product recalls and related voluntary suspension of production of certain products.

  Asia Pacific Net Sales




The following table presents Asia Pacific net sales (dollars in millions):


                                     Year Ended December 31,
                                     2008               2007       % Inc (Dec)


            Reconstructive
            Knees            $      220.6       $      197.0                12 %
            Hips                    209.5              193.2                 8
            Extremities               7.1                6.9                 3
            Dental                   30.4               30.8                (1 )


            Total                   467.6              427.9                 9


            Trauma                   48.2               41.8                15
            Spine                     9.2                5.5                65
            OSP and other            63.1               64.3                (2 )


            Total            $      588.1       $      539.5                 9

Changes in foreign exchange rates positively affected knee sales by 6 percent and hip sales by 8 percent. Reported decreases in average selling prices negatively affected both knee and hip sales by 4 percent. The NexGen Complete Knee Solution product line, the NexGen CR-Flex Knee and the NexGen LPS-Flex Knee led knee sales. The Gender Solutions Knee Femoral Implant also made strong contributions to knee sales for the period.

The continued conversion to porous stems, including the Fiber Metal Taper Stem from the VerSys Hip System, the Alloclassic Zweymüller Hip System and the CLS Spotorno Stem, led hip stem sales. Sales of Longevity and Durasul Highly Crosslinked Polyethylene Liners, the Trilogy Acetabular System and Trabecular Metal Acetabular Cups also increased.

As a result of the disruptive factors discussed above, we suffered customer losses during 2008. These customer losses negatively impacted sales growth, primarily in the knee and hip product segments. We expect to experience further customer losses in 2009 as a result of the ongoing effects of these disruptive factors.

The Bigliani/Flatow Shoulder Solution and the Coonrad/Morrey Total Elbow led extremities sales. The Tapered Screw-Vent Implant System led dental sales. Trauma sales were led by the I.T.S.T. Intertrochanteric/Subtrochanteric Fixation System. The Dynesys Dynamic Stabilization System led spine sales. OSP sales were negatively affected by the patient care product recalls and related voluntary suspension of production of certain products.

  Gross Profit




Gross profit as a percentage of net sales was 75.8 percent in 2008, compared to
77.5 percent in 2007. The following table reconciles the gross margin for 2007
to 2008:


                Year ended December 31, 2007 gross margin     77.5 %
                Foreign exchange impact, net                  (0.8 )
                Excess and obsolete inventory                 (0.6 )
                Inventory step-up                             (0.2 )
                Other                                         (0.1 )


                Year ended December 31, 2008 gross margin     75.8 %

. . .