2003 FORM 10-K ZIMMER HOLDINGS, INC. AND SUBSIDIARIES ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations  OVERVIEW The following discussion should be read in conjunction with the consolidated financial statements and the corresponding notes included elsewhere in this Form 10-K. This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements. The Company is a global leader in the design, development, manufacture and marketing of reconstructive orthopaedic implants, including joint and dental, spinal implants, and trauma products and related orthopaedic surgical products. 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 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. The Company’s related orthopaedic surgical products include supplies and instruments designed to aid in orthopaedic surgical procedures. With operations in more than 24 countries and products marketed in more than 80 countries, operations are managed through three reportable geographic segments – the Americas, Europe and Asia Pacific. Events Affecting Operating Performance in 2003. Centerpulse results of operations have been included in the Company’s results subsequent to the completion of that acquisition on October 2, 2003, and their respective assets and liabilities have been recorded at their estimated fair values in the Company’s consolidated statement of financial position as of October 2, 2003, with the excess purchase price being allocated to goodwill. The pending acquisition of Implex gives the Company enhanced flexibility in the development of products using  Trabecular Metal  Technology, which the Company believes has significant potential in orthopaedic reconstructive and spinal product applications. The Company continues to make significant progress in the development and introduction of  MIS  Procedures and Technologies. This includes the continued rollout of the Zimmer  MIS  2 -Incision  Hip Replacement Procedure, and the development of the  MIS Quad-Sparing  Total Knee Procedure that the Company introduced at the 2004 American Academy of Orthopaedic Surgeons meeting in San Francisco. The Company believes such innovative approaches will significantly impact the orthopaedics industry. Since its opening in March 2003, the Zimmer Institute in Warsaw, Indiana has seen extensive use for  MIS education, new product development meetings and sales training programs. During the year, the Company continued to expand the Zimmer Institute’s global affiliations. With the acquisition of Centerpulse, the Company begins an exciting new chapter in its history. The successful integration of the Centerpulse business, which began in the fourth quarter, is the Company’s critical objective for the near term. More than 100 full time personnel from Zimmer, Centerpulse and independent professional service organizations are managing more than 275 major integration projects for over 80 legal entities in 80 different countries. The integration process, under the direction of the Company’s senior management team, continues to advance. The Company has made substantial progress in developing global combined product strategies, in integrating the Company’s U.S. sales and European business organizations, and in melding essential activities as diverse as global accounting principles and E-mail systems. During the year, the Company recorded $79.6 million (pre-tax) of acquisition and integration costs for contract terminations, professional fees, employee severance, retention pay, employee relocation costs and other expenses. In 2004, the Company expects to incur another $128.0 million for similar costs and expenses as integration progresses. The Company’s operating results in the fourth quarter, the first quarter for which it reported combined results, indicated that the acquisition of Centerpulse was accretive to our shareholders, excluding acquisition and integration expenses, in-process R&D write-off and inventory step-up. The Company’s combined gross margin, in the fourth quarter, including an inventory step-up charge of $42.7 million, was 68.1 percent directly related to geographic and product mix, price and strong manufacturing performance. The Company believes that its reported gross margin for the fourth quarter, which reflects the combination with Centerpulse and the consequently higher European revenue content, remains strong. Other important financial metrics include the Company’s level of spending on research and development and its selling, general and administrative expenses as a percentage of sales. The Company expects over the next couple of years to continue to invest in research and development at almost 6 percent of sales, as investments in spine, biologics and new technology increase. In management’s view, the Company’s selling, general and administrative expenses are well managed, closing out the fourth quarter at 40.9 percent of revenue. Despite the strong operating performance in the fourth quarter, the Company expects to realize approximately $50 million in sales dis-synergies in 2004. The Company believes it is possible, given the complexity of the Centerpulse combination, that its reconstructive revenue growth in Europe, for example, may lag the European reconstructive market as the Company works through integration challenges in key markets such as France, Italy and Germany. Economic and Industry Wide Factors Relevant to the Company.  On a worldwide basis, price improvement has remained firm at 3-4 percent in the last two years. The Company realized better than expected growth in average 20