Overview

We are a global leader in the design, development, manufacture and marketing of orthopaedic reconstructive implants, dental implants, spinal implants, trauma products and related surgical products (sometimes referred to in this report as "OSP"). We also provide other healthcare related services. Reconstructive orthopaedic implants restore joint function lost due to disease or trauma in joints such as knees, hips, shoulders and elbows. Dental implants restore function and aesthetics in patients that 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 includes supplies and instruments designed to aid in predominantly 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 Management's 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 2008 consolidated financial statements have been reclassified to conform to the 2009 presentation. Beginning in 2009, we no longer include our Dental product category sales within our Reconstructive products category. Prior year amounts related to Dental product category sales have been reclassified to conform to the current year presentation.

We believe the following developments or trends are important in understanding our financial condition, results of operations and cash flows for the three month period ended March 31, 2009 and our expected results for the remainder of 2009.

Demand (Volume and Mix) Trends

Decreased volume and changes in the mix of products resulted in a 1 percent decline in sales during the three month period ended March 31, 2009, compared to 6 percent of sales growth in the same 2008 period. The sales growth rate declined from the 2008 period due to lower volume as a result of a weaker global economy and the ongoing effects of the disruptive factors experienced during 2008 as discussed below.

We believe the market for orthopaedic procedure volume temporarily decelerated from mid to low single digits growth rates on a global basis due to the weakened global economy. We believe long-term market growth rates will be driven by an aging global population, obesity, proven clinical benefits, new material technologies, advances in surgical techniques and more active lifestyles, among other factors. In addition, the ongoing shift in demand to premium products, such as Longevity®, Durasul® and Prolong® Highly Crosslinked Polyethylenes, Trabecular MetalTM Technology products, high-flex knees, knee revision products, porous hip stems and the introduction of gender-based devices continues to positively affect sales growth.

Pricing Trends

Global selling prices were flat for the three month period ended March 31, 2009, which is similar to the same 2008 period. Selling prices in the Americas were flat during the three month period ended March 31, 2009, compared to a 1 percent increase in the same 2008 period. In Europe, selling prices for the three month period ended March 31, 2009 were flat, which is similar to the same 2008 period. Asia Pacific selling prices decreased 3 percent for the three month period ended March 31, 2009, compared to a 1 percent decrease in the same 2008 period. Japan and Australia reported 5 percent and 3 percent decreases in average selling prices, respectively, as a result of scheduled reductions in reimbursement prices. We anniversary out of these price reductions in April 2009 for Japan and July 2009 for Australia. Japan and Australia combined currently represent approximately 10 percent of our sales. With the effect of governmental healthcare cost containment efforts and pressure from local hospitals and health systems, we expect global selling prices will remain flat to slightly negative in 2009.

Foreign Currency Exchange Rates

For the three month period ended March 31, 2009, foreign currency exchange rates resulted in a 5 percent decline in sales. We estimate that an overall stronger U.S. Dollar versus foreign currency exchange rates will have a negative effect of approximately 4 percent on sales for the year ending December 31, 2009. 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 foreign currency 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, which are recorded in cost of products sold, the effect on net earnings in the near term is expected to be minimal.

Disruptive Events

We believe that we have suffered customer losses as a result of disruptive factors experienced during 2008, 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. Starting in the fourth quarter of 2008, we estimated that on a cumulative basis these customer losses reduced our global knee market share by approximately 1.5 percent and hip market share by approximately 2.0 percent. We estimate that we experienced additional share losses of 0.1 percent in knee market share and 0.2 percent in hip market share, in the first quarter of 2009. 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, we continue to expand our global medical education programs and as we launch new products in sufficient quantities to recover some of the product related losses. We expect our sales growth to be at a rate slower than the market in the near term due to these disruptive factors.

Global Economic Conditions

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 many medical product categories from swings in the broader economy because the need for these procedures does not diminish, even if the timing is affected. In particular, we expect our dental revenues to experience pressure due to the weak economic environment as many of those procedures are not reimbursed by third-party payors.

First Quarter Results of Operations

Net Sales by Operating Segment

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


                       Three Months
                           Ended
                         March 31,                           Volume/                    Foreign
                    2009         2008         % (Dec)          Mix          Price      Exchange

    Americas       $ 594.6     $   607.1            (2 )%          (1 )%         - %          (1 )%
    Europe           265.1         305.5           (13 )            1            -           (14 )
    Asia Pacific     132.9         146.6            (9 )           (4 )         (3 )          (2 )

                   $ 992.6     $ 1,059.2            (6 )           (1 )          -            (5 )

"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):


                      Three Months
                          Ended
                        March 31,                               Volume/                    Foreign
                   2009         2008         % Inc (Dec)          Mix         Price       Exchange

 Reconstructive
 Knees            $ 429.0     $   453.5                (5 )%           1 %        (1 )%          (5 )%
 Hips               299.6         330.2                (9 )           (2 )        (2 )           (5 )
 Extremities         33.0          31.8                 4              8           -             (4 )

 Total              761.6         815.5                (7 )            -          (1 )           (6 )

 Dental              47.4          55.8               (15 )          (12 )         1             (4 )
 Trauma              56.9          55.7                 2              5           -             (3 )
 Spine               64.6          54.0                20             21           3             (4 )
 OSP and other       62.1          78.2               (21 )          (20 )         1             (2 )

 Total            $ 992.6     $ 1,059.2                (6 )           (1 )         -             (5 )

The NexGen® Complete Knee Solution product line, including Gender Solutionstm 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 Gender Solutions Natural-Knee Flex System made a strong contribution.

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 made strong contributions. The temporary suspension of marketing and distribution of the Durom Cup in the U.S. announced in the second half of 2008 negatively impacted hip sales growth. Additionally, with the lack of a hip resurfacing product within our U.S. hip portfolio, we face a continuing challenge in hip sales growth with the adoption of hip resurfacing in the U.S. market.

The Bigliani/Flatow® Complete Shoulder Solution and the Zimmer Trabecular Metal Reverse Shoulder System led extremities sales. Dental sales were led by orthobiologicals and prosthetic implants, including the Tapered Screw-Vent® Implant System. Zimmer Periarticular Locking Plates and the I.T.S.T. tm Intertrochanteric/Subtrochanteric Fixation System led trauma sales. In the fourth quarter of 2008, we acquired Abbott Spine. As a result of the acquisition, spine sales have increased but reflect sales dis-synergies associated with the integration of the business. 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®1 Bone Cement.

1 Trademark of Heraeus Kulzer GmbH

Americas Net Sales

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


                                     Three Months
                                         Ended
                                       March 31,
                                   2009        2008        % Inc (Dec)

                 Reconstructive
                 Knees            $ 276.1     $ 280.1                (1 )%
                 Hips               141.6       148.6                (5 )
                 Extremities         25.6        23.3                10

                 Total              443.3       452.0                (2 )

                 Dental              26.1        29.9               (13 )
                 Trauma              32.4        33.4                (3 )
                 Spine               51.5        42.4                22
                 OSP and other       41.3        49.4               (16 )

                 Total            $ 594.6     $ 607.1                (2 )

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.

Porous stems, including the Zimmer M/L Taper Stem and the Zimmer M/L Taper Stem with Kinectiv Technology, led hip stem sales, but were 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. has continued to negatively impact hip sales and the adoption of hip resurfacing in the U.S. market will continue to adversely affect our hip sales growth.

As a result of the ongoing effects of the disruptive factors discussed above, we have suffered customer losses. These customer losses negatively impacted sales growth, primarily in the knee and hip product categories.

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. Spine sales increased as a result of the Abbott Spine acquisition completed in the fourth quarter of 2008. 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):


                                     Three Months
                                         Ended
                                       March 31,
                                   2009        2008        % Inc (Dec)

                 Reconstructive
                 Knees            $ 105.0     $ 120.1               (13 )%
                 Hips               107.9       128.2               (16 )
                 Extremities          5.7         6.7               (16 )

                 Total              218.6       255.0               (14 )

                 Dental              16.7        19.0               (12 )
                 Trauma              10.6        10.5                 2
                 Spine               10.5         9.7                 8
                 OSP and other        8.7        11.3               (23 )

                 Total            $ 265.1     $ 305.5               (13 )

Changes in foreign exchange rates negatively affected knee and hip sales by 15 percent and 13 percent, respectively. 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.

Porous stems, including the CLS Spotorno Stem and Alloclassic Zweymüller 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 ongoing effect of the disruptive factors discussed above, we have suffered customer losses. These customer losses negatively impacted sales growth, primarily in the knee and hip product categories.

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 trauma sales, which were offset by weaker sales of our intramedullary fixation systems. Spine sales increased as a result of the Abbott Spine acquisition completed in the fourth quarter of 2008. 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):


                                     Three Months
                                         Ended
                                       March 31,
                                   2009        2008        % Inc (Dec)

                 Reconstructive
                 Knees            $  47.9     $  53.3               (10 )%
                 Hips                50.1        53.4                (6 )
                 Extremities          1.7         1.8                (3 )

                 Total               99.7       108.5                (8 )

                 Dental               4.6         6.9               (33 )
                 Trauma              13.9        11.8                17
                 Spine                2.6         1.9                34
                 OSP and other       12.1        17.5               (31 )

                 Total            $ 132.9     $ 146.6                (9 )

Changes in foreign exchange rates negatively affected knee sales by 7 percent and positively affected hip sales by 1 percent. Reported decreases in average selling prices negatively affected knee sales by 6 percent 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 and the Alloclassic Zweymüller Hip System, led hip stem sales. Sales of Longevity and Durasul Highly Crosslinked Polyethylene Liners, the Trilogy Acetabular System and Trabecular Metal Acetabular Cups also contributed to hip sales.

As a result of the ongoing effects of the disruptive factors discussed above, we have suffered customer losses. These customer losses negatively impacted sales growth, primarily in the knee and hip product categories.

The Bigliani/Flatow Shoulder Solution and the Coonrad/Morrey Total Elbow led extremities sales. Negative sales growth for our dental business reflects an overall weakness in the global economy. The Tapered Screw-Vent Implant System led dental sales. Trauma sales were led by the I.T.S.T.
Intertrochanteric/Subtrochanteric Fixation System. Spine sales increased as a result of the Abbott Spine acquisition completed in the fourth quarter of 2008. 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 76.8 percent in the three month period ended March 31, 2009, compared to 76.0 percent in the same 2008 period. The primary contributor to the increase in gross profit margin was foreign currency hedge gains recognized in 2009 compared to hedge losses recognized in the 2008 period. Under our hedging program, for derivatives which qualify as hedges of future cash flows, the effective portion of changes in fair value is temporarily recorded in other comprehensive income, and then recognized in cost of products sold when the hedged item affects earnings. These hedge gains were partially offset by an increase in excess inventory and obsolescence charges due to increased inventory levels and certain product-specific matters as well as increased inventory step-up as a result of the Abbott Spine acquisition.

Operating Expenses

Research and Development, or R&D, as a percentage of net sales was 5.2 percent for the three month period ended March 31, 2009, compared to 4.5 percent in the same 2008 period. R&D expense increased to $51.8 million

for the three month period ended March 31, 2009, from $47.8 million in the same 2008 period, reflecting increased spending on certain development, clinical and external research activities compared to the delay in activities experienced in 2008 connected with our operational compliance with the DPA and CIA and implementation of our enhanced compliance program. We expect R&D spending in 2009 to return to our historical average of 5-6 percent of sales.

Selling, general and administrative, or SG&A, as a percentage of net sales was 42.7 percent for the three month period ended March 31, 2009, compared to 39.4 percent in the same 2008 period. SG&A expense increased to $423.7 million for the three month period ended March 31, 2009, from $417.8 million in the same 2008 period. Fees associated with the various litigation matters discussed in Note 12 to the consolidated financial statements contributed to an increase in SG&A costs as well as costs related to operating initiatives such as improving quality systems at our Dover, Ohio facility and the expansion of global medical education programs. The acquisition of Abbott Spine increased SG&A costs for items such as selling expenses, increased instrument depreciation and amortization of the acquired intangible assets. Additionally, SG&A as a percent of sales is negatively impacted by the significant decrease in revenues caused by changes in foreign currency rates. A majority of our SG&A spend is incurred in the U.S., primarily from our corporate headquarters and similar functions at our various businesses such as Dental, Trauma, Spine and OSP. Therefore, SG&A expense does not respond to changes in foreign currency rates proportionally to our revenue which has caused SG&A as a percent of sales to increase.

Acquisition, integration and other expenses for the three month period ended March 31, 2009 were $7.0 million, compared to $7.3 million in the same 2008 period. These expenses pertain to prior period acquisitions, including facility consolidation costs, legal fees and retention and termination payments.

Operating Profit, Income Taxes and Net Earnings

Operating profit for the three month period ended March 31, 2009 decreased 16 percent to $279.8 million, from $331.6 million in the same 2008 period. The decrease in operating profit is due primarily to lower revenues as well as increased spending on R&D and SG&A.

Interest and other expense for the three month period ended March 31, 2009 increased to $3.7 million, compared to income of $1.0 million in the same 2008 period. The increase in interest expense is the result of increased long-term debt used to partially fund the Abbott Spine acquisition and share repurchases.

The effective tax rate on earnings before income taxes decreased to 26.8 percent for the three month period ended March 31, 2009, from 28.0 percent in the same 2008 period. This decrease is due primarily to the recognition of certain adjustments which took effect in the quarter as well as increased profits in lower tax jurisdictions.

Net earnings decreased 16 percent to $202.2 million for the three month period ended March 31, 2009, compared to $239.3 million in the same 2008 period. Basic earnings per share decreased 12 percent to $0.91, from $1.03 in the same 2008 period. Diluted earnings per share decreased 11 percent to $0.91, from $1.02 in the same 2008 period. The disproportional change in earnings per share as compared with net earnings is attributed to the effect of 2009 and 2008 share repurchases.

Liquidity and Capital Resources

Cash flows provided by operating activities were $184.6 million for the three month period ended March 31, 2009, compared to $242.7 million in the same 2008 period. The principal source of cash was net earnings of $202.2 million. Non-cash items included in net earnings accounted for another $100.9 million of operating cash. All other items of operating cash flows reflect a use of $118.5 million of cash, primarily related to pension funding and working capital investments. Additionally, we continue to resolve outstanding payments to healthcare professionals and institutions resulting in cash outflows of approximately $30 million in the three month period ended March 31, 2009. The resolution of these outstanding payments, along with a change in the timing of employee bonus payments compared to the 2008 period, contributed to a decrease in accrued expenses for the three month period ended March 31, 2009.

At March 31, 2009, we had 61 days of sales outstanding in trade accounts receivable, an increase of 2 days compared to both December 31, 2008 and the same 2008 period. At March 31, 2009, we had 373 days of inventory

on hand, an increase of 29 days compared to December 31, 2008, reflecting a planned increase in field-based inventory deployments in the U.S., a build-out of our inventory pipeline for certain new products we are preparing to launch in 2009 and increased near term inventory levels as manufacturing volumes are reduced to respond to previously discussed loss of market share.

Cash flows used in investing activities were $84.4 million for the three month period ended March 31, 2009, compared to $110.9 million used in investing in the same 2008 period. Additions to instruments decreased during the three month period ended March 31, 2009 compared to the 2008 period as year-over-year spending on instruments is expected to decrease compared to the significant investments made in 2008. Spending on other property, plant and equipment decreased to $30.9 million during the three month period ended March 31, 2009 compared to $53.4 million in the same 2008 period. On a full year basis, we expect a modest decrease in spending on property, plant and equipment compared to 2008 levels, as certain planned infrastructure initiatives from 2008 are completed. Acquired intellectual property rights of $7.6 million relate to lump-sum payments made to certain healthcare professionals and institutions in place of future royalty payments that otherwise would have been due under the terms of an existing contractual arrangement. We anticipate making additional payments to acquire intellectual property rights during 2009.

Cash flows used in financing activities were $95.9 million for the three month period ended March 31, 2009, compared to $125.9 million used in financing activities in the same 2008 period. Our borrowings from our credit facilities increased approximately $210 million during the three month period ended March 31, 2009 to repurchase shares of our common stock. Our current share repurchase program can be financed in part with third party debt, subject to limits set by our Board of Directors. For the three months ended March 31, 2009, we purchased 8.6 million common shares for a total of $301.4 million, including commissions, under our stock repurchase program authorized by our Board of . . .