Zimmer Biomet Holdings Inc (ZBH) 2002 Q3 法說會逐字稿

Good morning, my name is Laura and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Zimmer holdings third-quarter earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer period.

If you would like to ask a question during this time, simply press star, then the number 1, on your telephone keypad.

If you would like to withdraw your question, press the pound key.

Zimmer would like to note that the statements made in this conference call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Risk factors and cautionary statements concerning important considerations that could cause actual results to differ materially from those in the forward-looking statements are described in the company's filings with the Securities and Exchange Commission and in the press release issued yesterday.

The company makes no commitment to update any forward-looking statement based on new information, future events, or otherwise.

Thank you.

I would now like to introduce Mr. Ray Elliot.

Mr. Elliot, you may begin your conference.

Great.

Thank you, Laura.

Good morning everyone, and welcome to Zimmer's third-quarter 2002 conference call.

We're pleased to be hosting this call to discuss another solid quarter and our fifth report as an independent public company.

Today's call will be scheduled for one hour and will allow time for detailed disclosure and questions.

Joining me on today's call are Sam Leno, our Senior Vice President and Chief Financial Officer, and Jim Crines, our Vice President and Corporate Controller.

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

If not, you can obtain a copy from our website at www.zimmer.com.

Alternatively, please feel free to contact Sam and we'll have a copy faxed to you as well as add you to our e-mail distribution for future releases.

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

Unless otherwise noted, we'll be discussing our reported results for the third quarter of 2002 compared to prior year's pro forma results.

Let me begin with the fundamentals of our consolidated P&L and balance sheet performance for the quarter and year-to-date.

Consolidated sales for the third quarter were 338 million, an increase of 18% over prior year and about $12 million higher than consensus street expectations.

Worldwide sales in constant currency increased 16% for the quarter.

This continued solid performance was led by volume mix growth of 12% in the quarter, while worldwide price improvement remained firm as with previous months at 4%.

As a point of interest for Zimmer, the Americas price increases were once again at 5% and matched the previous four quarters.

Our Americas business continued its excellent growth again at 17%, and Europe has dramatically increased growth to 38% in the quarter.

We experienced a continued improvement in Asia-Pacific sales growth to 10%.

We believe and are comfortable that all of our geographic segments are driving market share increases in local currency.

On a year-to-date basis, sales increased to 1.002 billion, 16% over prior year.

Our Americas business and Europe again led the way with growth of 18% and 26%, respectively.

We will discuss Zimmer's performance versus served market growth in the category and geographic sections.

The year-to-date return of ZMH on the New York Stock Exchange is currently up 37%, and during the quarter we crossed the 8 billion market cap barrier.

Diluted earnings per share for the third quarter were 33 cents, an increase of 32% over prior year, and 3 cents over consensus estimates.

Year-to-date EPS is 95 cents, an increase of 34% over prior year.

Cost of goods sold increased 19%, versus a 18% increase in sales based on favorable product mix, price, and our continuing successful efforts to reduce manufacturing costs, while offset by dramatic growth in our Europe business at slightly lower margins and forward contracts.

Gross profit margins versus prior year decreased by 30 basis points to 74.8.

This gross profit margin of 74.8 was sequentially a decrease of 50 basis points from second-quarter 2002, but equal to our year-to-date average.

It's important to note that had our Europe growth been at our year-to-date Europe average, our margins would have continued to be at record 75% levels.

More importantly, our reported results provided a million dollars more in real gross profit dollars than the hypothetical scenario I just described.

We believe that around 75% year-to-date, our gross margins are still the best in the industry.

SG&A expenses were well managed at 39.6%, a 180 basis point improvement over third-quarter 2001, and for your reference, a whopping 480 basis point improvement collectively over the two years from 2000.

For the quarter, SG&A expenses increased only 13%, despite an 18% sales increase, and actually grew at a slightly lower rate than the year-to-date SG&A average.

Our strong results in SG&A reflected a sequential improvement of 30 basis points from the second quarter 2002.

Year-to-date, SG&A expenses are 40.2%, a 100 basis point improvement to prior year.

We continue to be very pleased with the leverage gained from sales.

Each incremental sales dollar in the quarter cost only 33 cents of incremental SG&A spending.

This translates into, with our current gross profit, almost 50 cents in operating profit for each incremental dollar of sales above our prior-year base.

We continue to successfully operate our working dollars model, driving down costs of good sold, cost of capital, and G&A expenses while investing in sales and pipeline development.

We continue to execute our strategy to invest in R&D at the top of our class, with a three-year consistent target of approximately 6% to sales, and this quarter at 6.1.

Our R&D investments increased by 3.4 million in absolute terms for the third quarter 2002 versus 2001, and reached $20.6 million.

Year-to-date, the R&D ratio to sales is 5.9%.

We are pleased to report that operating profit grew in the quarter by 23% over prior year.

These operating profit results represent an increase of 140 basis points versus prior year, and our year-to-date operating margins are slightly under 29%.

Net earnings in the period increased by 36%, assisted by declining interest expense to 3 million and a significant reduction in tax rate from 36.1% to 31.5%, providing a very quick return on the one-time tax restructuring costs mentioned in our second-quarter call.

Sam will provide a more detailed discussion of our tax results, the third-quarter rate, and our near-term future expectations.

Year-to-date net earnings have increased 34%.

As previously mentioned, diluted EPS increased 32% to 33 cents based on 197 million average diluted [inaudible] outstanding.

Year-to-date EPS is 95 cents.

I'd like to provide some very brief introductory cash flow and balance sheet highlights.

Free cash flow for the quarter and year-to-date were both on target at 47 million and 113 million, respectively.

In the quarter, inventory has been increased by 16 million to a level of 253 million and in days from 254 to 268.

As we've indicated on our three previous conference calls, it's our intention to operate the business with approximately 250 to 260 days of inventory for the foreseeable future, while our pipeline is turning out almost 40 projects.

We continue to note that on a normalized basis, Zimmer can and has successfully operated its inventories with high service levels between 200 and 220 days.

This represents, with our product line, a 75 to 100-day advantage over our major competitors.

The somewhat higher day value in the third quarter simply reflects a seasonally lower cost of goods sold denominator at the same time that we are building and completing the pipeline.

Our goal for year-end continues to be approximately 250 days.

Consistent with prior quarters, our fill rate accuracy is more than 98%, and our global forecast accuracy on thousands of SKUs is 91%.

These asset management metrics, along with others, drive efficient inventory performance.

We are pleased to report that our net debt has declined by $222 million from 450 million at our spin-off in August of 2001, to 228 million at the end of the third quarter in 2002.

In approximately 14 months as a public company, we have cut our debt in half and we continue to target being debt-free by the end of 2003, excluding any acquisitions.

Our industry-leading receivables collections continues to provide for ready access to cash flow base and defines some of the top balance sheet metrics in the medical device industry.

In the third quarter, we reduced our U.S. receivables to a record 32 days.

Let's review sales in a little more detail.

Reconstructive sales for Zimmer are hips, knees, shoulders and elbows implanted in patients during the period.

For the third quarter, worldwide reconstructive sales increased 258 million representing a reported increase of 21% over prior year and 19% constant currency.

Year-to-date sales are 772 million, an increase of 19% reported, and 19% constant currency.

Many analysts believe -- and we would concur -- that on a reported basis, the worldwide reconstructive market grew approximately 8% in calendar 2000, 10% in 2001, and what looks to be for 2002 around 15% in the quarter and approximately 13% year-to-date.

If this is the case, then Zimmer has continued a consistent pattern of growing at a rate of 40% faster than the market.

Based on year-to-date results of 772 million, Zimmer reconstructive sales are straight-lining at more than $1 billion for 2002.Let's take a look at each global product and geographic segment more closely.

First products, in the knee category, on a worldwide basis in the quarter, knee sales increased 22% to 142 million versus prior year, and 20% constant currency.

On a year-to-date basis, knee sales have increased 21% to 426 million and 21% constant currency.

These are continuous and significant market share gains in all geographies.

For example, in the third quarter, the U.S., Germany, France, Spain, Norway, Sweden, Finland, Russia, central and eastern Europe, and Korea all delivered knee growth in excess of 20% to prior year.

The successful introduction of Prolong, the specially designed highly cross-linked polyethylene for NexGen Cruciate Retaining Knee articulating surfaces continues, and it's really delivering great results.

After only two months on the market, Prolong is already selling at more than 20% over our own internal plans.We expect to have the PS version available later in 2003.

In addition to early Prolong success in the quarter, we also launched Trajectory Metal mono-block tibias and our new RHK rotating hinge knee which jumped to $10 million annually literally overnight from only six weeks on the market.

During August, we nationally broadcasted the first-ever live global MIS uni surgery by web cast with Drs.

Aaron Rosenberg and Rich Berger from Rush Presbyterian in Chicago.

The broadcast was viewed by more than 500 surgeons from 10 countries around the world.

We know it's a very crowded uni market out there, but still our MIS M/G Uni's have grown on a worldwide basis another 53% in the third quarter, 65% in Japan, and increased year-to-date by 75%.

All these results were measured against the toughest comps and a large existing Zimmer Uni base.

We recognize that some competitors now carry multiple brands but the Zimmer M/G Uni product line with anticipated 2002 sales of $30 million remains the single most popular brand in the world.

Our NexGen LPS Flex Knee, the Zimmer lifestyle design product intended to potentially safely accommodate 155 degrees of flexion, has continued its winning ways in the quarter.

On a worldwide basis, LPS Flex units grew by another 52% in the third quarter.

As with our MIS Uni knee, our new LPS Flex direct consumer campaign has already attracted extensive participation, with more than a thousand prospective patients seeking a Zimmer surgeon in their area.

At current growth rates for 2002, we should easily continue to approach 17 to 18,000 units.

Notably this quarter, we completed the addition of LPS Flex to BrainLAB's next issue of their software revisions for robotic surgery and as important, we completed the 180th recorded surgery ever MBK, Mobile Bearing Knee, investigational device evaluation, just in case down-classification never happens in the U.S.

Let's take a closer look at hips.

On a worldwide basis in the third quarter, hip sales increased 19% to 108 million, and grew 17% in constant currency.

Year-to-date hips have increased by 15% to 321 million and have grown 16% constant currency.

Porous stem sales continued their more than two-year long growth run and increased by 29% in the third quarter.

We'll discuss the continued role of cemented to porous mix in more detail under the hot topics section.

Porous revision stems, along with revision cups and liners, continue to be an area of strong focus for Zimmer, and our sales showed a dramatic increase of 49% in the third quarter.

Zimmer primary acetabular shells grew 21% in the third quarter.

Trabecular Metal mono-block cups, augments, and shells have quickly become a new $10 million plus product line, and despite extremely tough comps and relatively high penetration, premium-priced Longevity highly crosslinked polyethylene liners increased by 38% in the third quarter.

We believe this acceptance is growing with both the introduction of large head articulations and the continuing stream of scientific analysis, specifically as it relates to Zimmer's Longevity brand.

But more about crosslink poly in the hot topics section.

Similar to robotics for knees previously mentioned, Zimmer this summer added almost the entire VerSys hip system - both porous and cemented - to the upcoming revision of BrainLAB's robotic surgery software.

Of course, there is much good news on the MIS hip front, but I'll cover that update later.

In upper extremity joints, Zimmer's Bigliani/Flatow shoulder has continued to take significant market share in the world with 25% growth in the third quarter, 29% year-to-date.

We will enhance the shoulder product line with the addition of both highly crosslinked polyethylene and trabecular metal.

On a worldwide basis trauma sales improved, as expected, with an increase of 8% and 7% constant currency.

Trauma sales increased sequentially over the second quarter in every single geographic market -- a good sign with typically few sequential sales growths between the second quarter and the third, due to seasonality.

As mentioned last quarter, our Japan trauma business is small and will take a little time to normalize after the move of production to Puerto Rico.

However, in order to accelerate performance in Japan during the quarter, we converted 19 new trauma coordinator specialists to cover major trauma institutions.

It should be noted that our Americas, other Asia-Pacific, and European businesses had, on a combined basis, a solid 14% growth in trauma during the quarter, and 13% year-to-date.

We believe both of these figures exceed global trauma market growth rates based upon the dominant market leaders' previously announced public reports.

Our Zimmer Periarticular Plates are making accelerated penetration against the same market leader with 103% growth in the third quarter following 61% growth in the third quarter and 67% growth year-to-date.

Our 15 Peri styles and anatomic locations have been fully launched and give Zimmer the comprehensive and best fitting pre-contoured premium plate offering in the world.

Thanks in part to our new hospital in-service blitz teams, our new ZPS, Zimmer Plate and Screw line, has grown by 27% in its early stages versus a slower growth older product line it replaced, while TransFx External Fixation sales have increased for the third straight quarter sequentially by more than 40%.

In orthopedic surgical products, Ortho pad, our perioperative auto transfusion system designed specifically for orthopedics, increased by 63% in the quarter, 75% year-to-date, and has reached the status of a $10 million product line, a full one quarter early.

Let's switch to our new product development update.

As you know, we currently have some 40 major projects in a robust pipeline with more than 50% of those scheduled for release during 2002.

Our goal is to provide you with project name, quarter of release, and whether or not the release continues on schedule.

Although they will not be reviewed on this call, we have just completed the evaluation of 12 new major projects to be initiated during the second half of 2003.

We will disclose those new projects on our next conference call and monitor the key ones for you in a similar fashion to our current disclosure practices.

In knees development and commercialization, our patented Rotating Hinge salvage Knee, the RHK, was released and as mentioned previously is already scoring some strong sales successes.

Trabecular Metal NexGen LPS tibias, 32 new implants were released and similar to the RHK has shown very strong early sales.

As previously indicated, Prolong, our highly crosslinked poly for CR knees, was released ahead of schedule for strong reviews.

We have, of course, initiated three new knee projects, as follows: CR Flex, following in the footsteps of the highly successful LPS Flex, our first implantation, is on schedule for late 2002; a new patellofemoral project with unique concepts went to cadaver work early this fall on schedule; and MIS total knees.

Our initial design surgeon team has done some terrific early work, and I'll update our status under hot topics.

Now, let's move to hip development and commercialization.

The Apollo stem project, 358 new porous hip stems due for phase-in release fourth-quarter '01 through 2002: 160 stems have been released in 2002 including fiber metal taper-extended offsets with HATCP coating and beaded midcoats.

The balance of almost 200 stems will be released along with full instrumentation between the fourth quarter of the year and with some during January of 2003, 30 days delayed.

The new Apollo stems that have been released have already jumped in sales to a $20 million plus product line and even showed an unusual second quarter to third-quarter sequential growth of 13%.

Trabecular Metal Modular Cup: This project has been increased in size by 10 implants to 58 implants and 52 instruments from the original 48 implants.

The project release date was moved, in the second quarter conference call, by 30 days from fourth-quarter 2002 to first-quarter 2003 and remains on that schedule.

CPT 2, our new polished taper stem primary system, with 30 implants, was originally scheduled for third-quarter 2002.

Eight new revision and small stems were added to the scope of this project last quarter and identified in our last conference call.

CPT remains on schedule for fourth-quarter 2002 release.

And in fracture management development and commercialization, Periarticular2, our contoured plating system with 289 new implants for phase-in launch through 2002, as previously discussed has just completed final release.

The ITST, inter-trochanteric/sub-trochanteric retrograde femoral nail with more than 200 new implants, was identified in our first quarter 2002 call as being delayed from our original summer release and continues on that delayed schedule.

We expect to see fourth quarter sales.

And TransFx External Fixation System, with more than 250 new implants, was scheduled for phase-in release through 2002.

The large intermediate and small systems were released in the Americas on schedule.

The Mini sets were identified as being briefly delayed and their release is now fully complete.

In orthobiologics, with our partner Istoe, we initiated some time ago two new animal studies on neocartilage: one to look at earlier mobilization with a graft in a protocol at 4 weeks instead of 8 weeks, and a second study to look at longer-term stability and integration of the [condural] graft at 6 months.

The longer-term animal study is near completion with the first animals being harvested this month.

Surgeries were completed in September for the xenograft work comparing 6 weeks versus 8 weeks with non-light weight bearing.

Preliminary results of the xenograft study will be available in mid-December.

In total, on a rolling 36-month basis, new products represented 18% of our sales in the third quarter and 18% year-to-date: slightly above full-year 2001 at 17% and consistent with our long-term strategic goal to have new product sales between 15 and 20% on an annual basis.

Let's look briefly at the geographic segments.

First, in the Americas, we delivered another excellent quarter in the Americas.

Revenue for the third quarter was 231 million, up 17% over prior year, and that's measured against a difficult comp of 22% for third-quarter 2001 versus third-quarter 2000.

We continue to be very pleased with our progress.

Twelve percent of our growth in the Americas was driven by increases in unit volume and mix while the remaining 5% was derived from price increases.

Our Americas' reconstructive growth in the quarter of 20%, including outstanding knee growth of 22%.

Most importantly though, this 22% knee growth should be judged against the really tough comp of 26% knee growth in third-quarter 2001 versus third-quarter 2000.

NexGen LPS flex MIS Uni's and NexGen LCCK revision knees all made substantial contributions to the Americas' knee performance.

Since there's little mix associated with knees, this would indicate a raw unit growth in the quarter for Zimmer knees in the Americas of more than 17%.

Hips in the Americas increased 16% with Zimmer porous stems at 54% of mix, surpassing for the second quarter in a row cemented stems in unit sales, not just dollars.

Based upon the already-released public reports of our three major competitors, their combined growth in domestic reconstructive for the quarter was approximately 15.5%.

It's clear that 20% reconstructive growth will continue to outpace the rate of market growth through the Americas again by almost 30%.

We have been growing the Americas reconstructive products at 20% or more for 11 consecutive quarters.

Fracture management product sales accelerated by 13%, impacted by our new periarticular plate offerings, ZPS -- Zimmer Plate and Screw System -- and strong acceptance of TransFx External Fixation System.

And Patient Care Ortho Pad, available only in the Americas, continued its rapid acceptance as described in my earlier remarks.

Importantly, the Americas operating margins in the quarter increased by 140 basis points to 46.5% from 45.1.

Twenty-one of [inaudible] U.S. distributors delivered double-digit growth in the quarter.

Ten distributors delivered growth in excess of 20% and every distributorship grew in total.

On a year-to-date basis, the Americas have increased sales by 18% to 689 million, with knees increasing 24%, hips 15%, and fracture management 13%.

Day in and day out, as it has for almost three years, Zimmer Americas continues to clearly take market share and fire on all cylinders.

Asia-Pacific Revenue for the third quarter was 68 million, indicating a reported increase of 10% and up 8% constant currency.

Asia-Pacific had positive price in the third quarter, and we expect that trend to continue.

During the second quarter, our Asia-Pacific business was led by an outstanding local currency hip growth of 16%, reflecting continued conversion to porous, successful introduction of Longevity highly cross-linked poly, and early sales of ZMR, our modular revision hip system.

When combined with knee growth of 8%, Asia-Pacific reconstructive sales grew at constant currency 12% and well above what management believes is high single digit local currency reconstructive growth for the region, including Japan.

We are particularly pleased with Japan's 12% local currency growth in reconstructive products that matched the region during the quarter.

Excluding Japan, the remaining Austral-Asian, composed of Australia and New Zealand, and other Asian regions, composed of Korea, Taiwan, China, Singapore, Thailand, India, and Malaysia, delivered a minimum of double-digit constant currency growth for all products in the third quarter.

Displaying excellent leverage to sales, Asia-Pacific operating profits increased by 20% constant currency in the quarter, while operating margins in the region increased by 320 basis points to 43.9% in 2002 from 40.7% in 2001, and sequentially by 230 basis points compared to second-quarter 2002.

Japan led this planned leveraged operating margin growth with another 50 basis point increase in the third-quarter 2002 following nearly a 460 basis point increase in the second quarter.

In Japan this increase was due to our completed sales force and distributor redesign, higher margins in reconstructive products, and notably higher margins in fracture products, with a successful shift of production to Puerto Rico.

Year-to-date Asia-Pacific sales increased 4% to 195 million and 8% constant currency.

Hip and knee growth increased year-to-date by 13 and 10%, respectively, offset by short-term but improving declines in fracture, previously described.

Operating margin growth year-to-date in the region has been 11% compared to a 8% constant currency growth in sales.

In Europe, Europe had an exceptional quarter, marked by substantial market share gains across the board.

In the quarter, revenue of 39 million represented a strong 38% increase over prior year and 26% constant currency.

For the third quarter, our reconstructive sales growth in Europe was led by 20% or better local currency growth in all of the following countries and regions: the U.K., Russia, central and eastern Europe, Norway, Sweden, Finland, Iceland, France, Spain, Austria, Germany, Holland, Switzerland, the Middle East and Africa.

We believe almost twice the served market growth was obtained by 13 of our 16 European businesses.

Eight of our 16 European businesses, or half of Europe, grew their reconstructive results by a spectacular 30% or more in the quarter.

On the product front, as you can anticipate, reconstructive implants grew in constant currency by a very strong 28%, led by hip growth at 31% and knee growth at 26%.

Even with very solid reported competitive reconstructive numbers for Europe in the third quarter, it is clear that we are growing far faster than the market.

Hip and knee gains reflected the continuing acceptance of Longevity crosslinked poly, the introduction of our European hip designs, as well as the ongoing clinical implantation systems of Zimmer's new RHK NexGen Rotating Hinged Knee.

Europe operating profits increased by 121% to 6.4 million in the quarter, a 630 basis point increase sequentially, following another 600 plus basis point increase in the previous quarter.

A great job by Europe.

Now, let's go to issues analysis, and from Zimmer's perspective, our hot topics.

We'd like to cover the following five subjects: mix -- an update on the role of mix as reflected in Zimmer's global results; our external development activities -- our targeted segments and philosophies;

Zimmer's sales associates ads -- an update on our plan and actual additions year-to-date; pricing -- the latest interpretations; and of course, Zimmer minimally invasive and transformational technology, activity and development -- lots to talk about there.

Mix -- an update on the role of mix change reflected in Zimmer's results: all calculations, unless otherwise specified are in sales dollars on a worldwide basis.

Mix continues to play a key role in improved sales and profitability and from our perspective really focuses on three comparisons.

First, standard polyethylene hip liner conversion to Longevity highly crosslinked poly.

If you'll recall 1999 was 11% crosslink; 2000 was 59% crosslink; 2001, 77 crosslink; and third-quarter year-to-date is 85% crosslink.

The cumulative shift of 8 points to crosslink year-to-date from year-end 2001.

Zimmer's crosslink poly still represents tremendous potential.

In my own mind, we have at 85% captured a good deal of the potential near-term Longevity conversions for hip liners.

The remaining hold-outs will, in all likelihood, look to longer term data.

However, we have just released CR Prolong for the knee, with PS Prolong to follow later next year.

The average selling price of the knee articulating surface is higher than the average selling price of the shell liner, while a percentage premium charge should be comparable.

We believe Zimmer has just begun another 2- to 3-year cycle of penetration with Prolong crosslinked poly but with an even better potential for incremental gross profit dollars.

Given the unique resistance to [inaudible] claims, the potential for external conversions to NexGen complete knee systems will potentially exceed those we experienced with Longevity liners.

Second, cemented hip conversion to porous hips: 1999 -- 39% porous; 2000 -- 42% porous; 2001-- 45% porous; and third-quarter year-to-date -- 52% porous, a cumulative shift of 7 points year-to-date to porous in units from year-end 2001 for Zimmer, and we believe the market in general is at 55 to 60%.

This still leaves us with room to grow and represents a second straight quarter in more than 10 years on a global basis that primary hip stems and units have a porous majority.

Our results do not include, as yet, the other half of the Apollo project stems to the extent they may have primary applications.

Third and last revision as a percentage of Zimmer's top hip sales: 1999 -- 3%; 2000 -- 5%; 2001 -- 6%; third-quarter year-to-date -- 9%.

In summary, performance after three quarters indicates that we should reach our double-digit revision goal of 10% for 2002.

These figures apply only to hips, and as mentioned earlier, we have a 30% plus growth in knee revision during the quarter, in a market that we expect is growing in the high teens.

External development activity, our external development activity for the most part involves spine, critical mass in Europe -- pain and blood management, compute assisted surgery for MIS visualation, cartilage and non recognat BMT (inaudible) these target areas are consistent with the strategies we have described previously, and in the end may represent alliances and/or acquisitions.

We currently have three full-time Zimmer individuals evaluating external development our current portfolio of options at various stages of discussion including, amongst others, multiple spinal businesses and technologies.

We continue to explore opportunities on several fronts and it still may well be possible to announce something before year-end.

We took the step of forming a spine trauma business unit within Zimmer to ensure that we would have a dedicated internal infrastructure and personnel prior to any agreements being complete.

A note of caution here, though.

We remain unmoved by any strategy that may cause us to go outside of our key stated M&A philosophies.

We will not put our investment grade rating at risk.

The deal must be accretive in 24 months or less without synergies and it must contribute to long-term EPS growth always greater than 15%.

Recent excellent Business Week article cited to absolutely no oneness surprise the three most significant -- on deals over $100 million, at least for the buyer's side as overpaying, overestimating synergies, and ineffective integration.

We're in active discussions and would like to add to our brand and product portfolio soon but only if it meets our criteria.

And I hope we'll have some news before Christmas.

If not, you'll know we have been unwilling to abandon the philosophies we have consistently communicated and purposely designed to being flexible.

Sales associates adds for 2002, with the subject of sales force additions continuing to be active we indicated to you during our second-quarter call that we would add some 100 reps and surgical techs during 2002.

Year-to-date as of the completion of the third quarter, we have hired 68 new sale associates, surgical techs and specialists, and we currently have six open, unfilled recollect situations, leaving us close to our third-quarter targets and in good shape to deliver our annual goal.

Pricing.

Pricing discussions being more prevalent lately, with three specific U.S. situations as follows.

First, announcements of improved reimburse of DRG 209 and other relevant codes.

Second, some sector share price volatility a month or so ago that appeared to follow brief comments at J&J analysts presentation.

And third, 2003 price list increase strategy, timing, and customer receptivity.

Zimmer's position is unchanged since we spun the business out in August of 2001.

While we have been pleasantly surprised by the 4% global price, 5 in the U.S., and a little higher reimbursement than anticipated -- essentially 7% versus 4 to 5% -- our own theory has been that price in 2003, 2004 period will tend to stabilize at positive 2 to 3%.

With all major geographies in positive price territory and the U.S. leading the way at 3% or so.

We see absolutely no signs that prices will not remain meaningfully positive.

With respect to 2003 pricing, our competitors execute their new price lists before us, with Zimmer being January 1, 2003.

We expect to fully maximize list price growth for all our products and achieve favorable stick rates comparable to the more recent years.

Minimally invasive surgery activities.

Zimmer's established itself as the orthopedic gold standard for MIS procedures, products, technologies, and training.

We expect that our leadership position will both allow for maximum surgeon conversion, positive patient outcomes, and improved costs and structural changes to the delivery of orthopedic total joint replacement care.

We couldn't be more pleased with the progress in our 3-and-a-half-year-old MIS program.

During this section of the call, we'll update you on several different aspects of our MIS program, MIS total knees, the mini hip, the two incision hip and T 2, our transformational MIS -- for hip fixation and spine.

MIS union he's were covered earlier.

First, MIS total knee progress.

Our plan for MIS total these is similar to hips.

Progress through Mini incision but ship rapidly into landscape technique, instruments and implants allowing for rapid ambulation, low pain, limited tissue disruption, and home the same day.

Our Zimmer patient quality of life parameters are distinctly different than comparative catch-up programs directed at only smaller in situations.

The progress is excellent with our plan to publicly report on our first 100 MIS total knee cases in 2003 on track and accelerated image guidance work with our exclusive partner Medtronic well underway.

We just completed our 60th MIS total knee replacement utilizing the Zimmer LPS high flex knee and sharply improving patient quality of life observations.

On the Mini hip, we have completed more than 1400 successful surgeries utilizing the Mini hip technique with excellent results in a broad range of participating surgeons.

U.S. continuing medical education accredited Mini hip courses are de Mexico and will accommodate 300 to 400 surgeons.

Mini hip demand has been very heavy and serves as both a new surgical offering and a logical prerequisite training vehicle for the two incision technique.

We expect to have approximately 200 Mini hip instrumentation sets active on a full-time basis in the field by early 2003.

In addition to regions within Europe, during the third quarter we launched the Mini hip to selected Zimmer and competitive surgeons in Taiwan, with Korea, Singapore, and Thailand scheduled before year-end.

Zimmer's historical Asian based strength combined with thinner Asian physical seeks and general cultural preferences for less rather than more surgical invasiveness should make our MIS systems is a natural hip.

Text, video, and DVDs for all surgical materials utilizing both the anterior and posterior Mini hip techniques -- has now been added to pace with life.com, joining the MIS Uni and the LPL flex knee in major direct to consumer programs.

Pace with life.com hit almost 75,000 site visits in June and July alone.

The appropriate physician locator network has been initiated and will be expanded over the next two quarters.

Our transformational technology for minimally invasive hip fracture fixation, known internally as T 2, has also made significant advancements in the quarter.

Potentially proprietary instruments and Unic(ph) implants directed by fractures in an MIS short hospital stay methodology have been an active cadaver trials forsix months.

We are pleased to inform you that the results from our cadaver work are positive and during first-quarter 2003 we will move T 2 MIS hip fixation from research to full development.

Our goal will be to perform our first clinical fracture implantation evaluations before year-end 2003 and well in advance of our original internal plans.

The worldwide market for hip fractures annually continues to grow to 500,000 procedures.

MIS 2 incision hip.

We have terrific news and lots of it related to Zimmer's revolutionary MIS 2 incision hip, including the September 18th broadcast by Peter Jennings and the ABC national news.

That single broadcast was seen by 11 million people, and picked up by 41 ABC affiliates.

Requests for the DVD version of the broadcast have come in from around the world.

We have now completed successfully close to 300 patients with the MIS 2 incision technique by 20 surgeons, four of whom have completed 20 or more surgeries.

In addition to publishing some outstanding data with respect to Dr. Richard Berger's first 50 patients utilizing a standardized technique, we have reviewed complications for all 244 IRB patients compared to traditional rates in the literature for new procedures.

Additionally, we have contracted for a three-month post-operative independent x-ray review by a world leader in radiology.

The final reports are anticipated shortly and we fully expect to verify both the early learning curve but also the absolute efficacy of our procedure.

The landscape of joint replacement is soon to change.

Needless to say, the Zimmer 2 incision surgery attracts a lot of tension.

We are currently surgeon two day per week cadaver surgery followed by live surgery at their home hospital.

At 6 to 8 surgeons per week, we have fully allocated our schedules through April 1.

When the MIS institute will expand our capacity to 380 to 500 surgeons for 2003.

Our current sessions include 14 surgeons from Europe and Asia.

The development of 30 to 40 global academic partner institutions by year-end 2002 would expand our capacity on a run rate basis to more than a thousand surgeons per year during the out years.

The MIS institute construction remains on schedule and we are pleased to announce that professor, published author, and world-recognized orthopedic surgeon Dr. Aaron Rosenberg of Chicago will be the first Chairman of the Zimmer MIS Institute's independent advisory panel supported by several teaching surgeons representing hips, knees, computer assisted image guidance, medical assistance, technical educated protocal, technology and other areas.

Even more so than the visible is often what's happening behind the scenes is important.

As it's so often, the devil is in the details.

With respect to the MIS 2 incision hip we will have the following completed before Christmas of 2002.

The detailed surgical manuals and technique rationales.

Patient selection criteria.

Preop patient management, planning and templating.

Unique MIS prey operative and anesthesia Protocols. formats.

Reduced MIS pain medication Protocols; surgical technique in narrative, and animated formats, reduced MIS payment protocals other video nursing and physical therapy MIS care maps, antibiotic and DVT prophylaxis, and preliminary MIS reimbursement coding recommendations.

In time for the February AAOS, we will have additively, Zimmer.com, the institute on-line, customized surgeon personal use practice marketing packages dedicated to Zimmer minimally invasive solutions, and lastly, direct to consumer web and video education programs.

We are also continuing our work with Deloitte & Touche consulting to model various total hospital expenditure, patient cost and savings models utilizing the two-incision at Rush Presbyterian in Chicago.

These models will be reviewed with major insurance companies, workers' compensation, and other payers or influencing groups under Zimmer confidentiality agreements.

Activities with Medtronic, our worldwide mutually exclusive development partner for minimally invasive image guidance have also progressed rapidly.

Our Zimmer image guiders surgical team first members have been initially defined with world leaders such as Dr. Tony DeJoya, the co-inventor of hip nav from Pittsburgh and from Italy Rosoli (ph) institute, Dr. Aldo Coni.

Navigated surgical steps and Constitutions have been designed and prototype array attachment devices are being developed.

We expect MIS 2 incision hip digital surgery software for the use on the current metronics (ph) self stations by the fall of 2003.

More advanced image guidance and visualization utilizing unique technology exclusive to Zimmer has also initiated development.

Like most potentially transformational medical device projects, beyond people and the innovation itself, time to market and resource funding become the crucial issues.

We intend to officially change both.

First, time to market.

Effective with this conference call, we intend to move forward our general release date for two-incision hip for before Christmas 2002.

With classes filling up, the institute work being completed, and the forward materials being on schedule, we believe patient demand will drive the process.

By Christmas we will have invested nearly four years of work into this effort.

We have begun the future work of training surgeons and releasing Constitutions to those completing their MIS studies.

While the AAOS in February 2003 at New Orleans does allow us to attract more than 20,000 surgeons to this procedure, it will also allow us to display the next MIS advances already being planned in the not so distant future of total joint surgery.

That covers time to market.

In short, the time is now.

But what about resource funding or money?

The answer is simple.

Winning means a willingness to invest.

We will double and then some our direct global Zimmer investments in minimally invasive solutions to more than $20 million for 2003.This strategy and this funding have been taken into full consideration in our internal budgets and in the 2003 EPS guidance already provided to you in our press release.

And now let me turn the call over to Sam Leno, our Chief Financial Officer for some additional thoughts on our P&L, balance sheet, and financial operations.

Sam?

Thanks, Ray.

I'll try to add a bit more granularity to Ray's comments while focusing on a few key areas of the P&L, balance sheet, and cash flow statements.

As a reminder, throughout 2001, we discussed the results of Zimmer's operations on a pro forma basis, adjusting to add a full year of interest expense and also to eliminate the $70 million of costs incurred to separate from our former parent.

During this call, our actual results for 2003 will be compared to those same pro forma financials that we reported last year.

The pro forma results of the third quarter 2001 include the addition of $1.5 million in interest expense to cover the period from July 1st, 2001 through our spin date of August 6, 2001.

The pro forma adjustments also exclude $28.7 million of separation costs recorded in the third quarter of last year.

As I've done in previous calls, before I move into the financial statements, I'd like to provide a brief update on our J.D.

Edwards ERP conversion.

The switch-over date for phase 2, which incorporates all of our manufacturing systems requirements, continues to progress well, with our conversion targeted to occur within the next few weeks.

As a result, planning for phase 3, the third and final phase of our system conversion initiatives which consisted of our order to cash cycle, have begun, and completion of this phase is targeted for the March/April 2003 time frame.

Now, a few comments on the profit and loss statement.

In the area of foreign exchange, the weakening of the U.S. dollar across most currencies compared to prior year has turned what has been a negative translation effect on sales into a positive one.

In the aggregate, foreign currency translation rate changes contributed $5.1 million or 1.8 percentage points of growth to our third-quarter sales results.

In constant currency, sales growth for the quarter as Ray mentioned was 16%.

The yen has been strengthening all year, and finished the quarter at an average yen to U.S. dollar exchange rate of 119 compared to 122 for the third quarter of 2001 and compared to 126 at the end of last year.

At the same time, the Euro also strengthened by 12.7%, finishing the quarter at an average U.S. dollar to Euro exchange rate of .98 compared to an average of .87 in the third quarter of last year.

As a reminder, under our former parent, we were required to record the settlement of foreign exchange head contracts in SG&A.

This year, however, we have decided to record them more conventionally in cost of goods sold.

Therefore, we've reclassified them for the four quarters of 2001 from SG&A to cost of goods sold, in order to maintain consistency in reporting between periods.

Our all-in effective interest rate for the quarter continued to be very low at 3.2%, resulting in interest expense for the period of $3 million, reduced from $4.5 million of pro forma interest expense in the third quarter of last year, and also down from the $3.3 million in the second quarter of this year.

As I mentioned on the last quarter's earnings conference call, we have been developing a long-term tax strategy since the date of our spin-off from our former parent and we executed phase 1 of our multifaceted strategy on July 1st of this year.

As a result of this, and a continued focus throughout the third quarter, I am pleased to say that we are now in a position to lower our full-year estimated effective tax rate from the 34.8% reported at the end of the last quarter to 33.7% at the end of Q3.

U.S.

GAAP requires that the year-to-date effective tax rate at the end of every quarter reflects the expected full-year tax rate.

As a result, our third-quarter tax rate of 31.5% includes not only the 33.7% required for Q3 earnings, but also the change in estimate necessary to lower the first six months tax rate down from 34.8% to 33.7.

The difference between the 33.7% tax rate required for our third-quarter pretax earnings contribution and the 31.5% reported for the quarter contribute $2 million of net income or approximately 1 penny per share in the quarter.

EPS without the change in estimate associated with the first six months would have been 32 cents for the third quarter.

Our tax rate for the fourth quarter of this year is expected to be 33.7%, which is the same as our year-to-date tax rate for the nine months ended September 30th of this year.

When developing your models for 2003 and beyond, 33.7% continues to be a reasonable assumption.

In keeping with our focus and commitment to actively manage all aspects of our business in order to be able to take full advantage of the underlying improvement opportunities on each line of the P&L, we were able to deliver another very strong quarter of positive results.

We grew consolidated net sales for the quarter by 17.7%, while growing cost of goods sold by 19.4%, and SG&A by 12.6%.

In constant currency, sales grew at 16%, while cost of goods sold grew at only 14%, and SG&A grew even less at 11%.

The effective growing costs and expenses at a slower rate than sales led to a 23.4% growth in operating profit, a 35.9% improvement in net income, and a 32% growth in earnings per share.

Turning to the working capital portion of our balance sheet, we continued to deliver very strong performance in days sales outstanding, DSO, and that's particularly true in the United States.

Consolidated DSO for the third quarter was 55 days, which is 5 days below the same period last year, and 2 days lower than the last quarter.

In the U.S., we finished the quarter with 32 days of receivables, 5 days below the third quarter of last year and one day below the last quarter.

In this quarter, we also saw sequential quarter improvement in Asia-Pacific of 9 days, and in Europe of two days.

As Ray indicated earlier, inventory days on hand increased in the quarter to 268 days at the end of the third quarter, an increase of 14 days over the 254 days reported for the second quarter.

This sequential quarter growth in inventory days continues to be attributable to not only investments in inventory to support new product launches expected to occur this year and next year, but also to the seasonality factor of the slower summer sales months.

Finally, our international inventory tends to turn at a slightly slower rate than the U.S., and as a result, as our international revenue growth continues to increase, it does have a bit of a counterbalancing effect on the improvements being made to improve the velocity of our U.S. inventory turns.

Having said all that, as Ray indicated earlier, we're still targeting to finish this year at about 250 days of inventory on hand.

Operating and free cash flows for the quarter were $55.4 million and $46.7 million, respectively.

And for the first nine months were 137 million and $113.3 million respectively.

Key drivers to our strong cash flow for the quarter include our 36% growth in net income, as well as our improvement in DSO in the third quarter when compared to both prior year and prior quarter.

We typically generate between 150 to $200 million of free cash flow annually, and I'm pleased to say that we are on track to achieve those results again this year.

Capital expenditures were $8.7 million in the quarter, and $23.7 million year-to-date, and are targeted to be 35 to $40 million for the year.

As we've mentioned in previous calls, maintenance capital tends to be in the vicinity of $25 million annually, and the balance of our capital needs are driven principally by unit volume growth and new product support.

Overall, our balance sheet continues to strengthen.

As a reminder, we started our life with a new public company with zero equity and $450 million of net get.

During the 14 months since our August 46 spin-off date, we've increased our equity to $286 million.

At the same time, we have decreased our total debt from 201 million to 249 did you understand and we've increased net debt, by $222 million to 228 million.

Our debt to total capital at the end of the third quarter is 46%, and by the end of this year, it should be well below 40%, excluding any acquisitions that may be completed by now -- between now and the end of this coming year.

Our interest coverage ratio is 35 times.

Return on assets is 30%.

And return on shareholders equity is 117%.

As we discussed on the last call, if we look at the impact of FAS 123, accounting for stock options as an expense, the effect on prior years can be found in footnote 10 in our 2001 10-K.

But for this year, based on the total options issued and outstanding as of today, the full-year effect on 2002, if we were to expense employee stock options would be a reduction of $12 million in net income and a reduction of 6 cents per share.

As you know, our guidance in previous quarters has included only the effect of volume growth and mix, but has omitted pricing.

In today's guidance, which covers the fourth quarter of 2002 and the full year of 2003, we have tried our best to incorporate the expected -- the expected effect of volume growth, mix, as well as pricing.

Given the volatility that we have seen this year in foreign currency movement and also noting that the current spot rates for significant currency that affect Zimmer's international businesses are at levels that approximate the year-to-date exchange rate averages, our guidance, therefore, continues to exclude any effects of foreign currency movement between periods.

As stated in our earnings release last night, we expect revenue for the fourth quarter to be in the range of 350 to $360 million, or a range of 12.5 to 15.5% growth over prior year.

And this is very consistent with the current First Call consensus revenue estimates of $355 million for the fourth quarter.

As a reminder, this year's fourth quarter is being compared to a very difficult comps from the first quarter of last year.

At the same time, we're also comfortable with the existing fourth quarter First Call consensus estimates for EPS of 33 cents.

Our fourth quarter guidance results in revenue expectations of a range between $1,352,000,000 and $1,362,000,000.

At the same time, EPS of $1.28 for the full year 2002 is, again, confirmed.

In addition, our guidance for 2003 includes revenue growth of 13 to 15%, and earnings per share growth of 15 to 17%.

Our guidance for 2003 revenues at both the high and low ends of the range maintains our policy of a minimum of 1 to 2 percentage points planned revenue growth above anticipated reported market growth.

The earnings per share growth implies 200 -- 2003 EPS at a minimum of 5 cents above the current 2003 full-year First Call consensus estimates of $1.42.

Our earnings per share guidance also incorporates a statement made earlier by Ray that we will be doubling our direct global investments in Zimmer's minimally invasive solutions to more than $20 million in 2003.

And now, I'll turn it back over to Ray for a few final comments.

Thanks, Sam.

It was a strong quarter, again, and one that we're pleased with.

Our fifth report as a public company.

It continues to be a thrill for us in a little over a year of independence.

We belong to a vibrant investment space in both medical devices and orthopedics.

We're constantly asked, will the good times continue.

We reply that the good times aren't here yesterday.

The oldest of the baby boomers is only 57 years young.

We are seeing growth from what I refer to as the book ends phenomena.

Our growth is a combination of the traditional arthritis sufferers with increasing suplment of the very old whom out lived their implants and are the beneficiaries of high priced per surgery revisions the.

The very old are combined with younger patients seeking relieve from generational abuse of their joints primarily as weekend warriors.

The really good times don't start until about 2004 when the demographics really kick in, but these book ends of the very old and the young that I just described will very successfully bridge our growth to the baby boomers.

If that wasn't enough, we have solid competition to keep us constantly sharp.

Every day in the field is a dog fight just as it should be.

Of course, we'll keep trying to flawlessly execute the Zimmer business model.

Superior reconstructive growth rates, industry leading margins through intense close attention to price, mix, and manufacturing cost opportunities, and our working dollars model for reinvestment into improving SG&A ratios and top of the class R&D pipeline development.

Will continue to generate leveraged earnings, strong free cash flow, improved earnings, and all of these driven by aggressive management action.

Our future strategies for Zimmer are unchanged since our spin.

New geographies with greater critical mass in Europe, now high growth adjacent markets through external development primarily devoted to spine and of course developing new products that that growing baby boomer population will meet those new patient needs with lifestyle designs built into the product, advanced revision choices, innovative or the biological and material solutions, direct to patient programs, and setting the gold standard for minimally invasive surgery and landscape changing delivery of orthopedic care.

I read the other day that a fellow competitor thought MIS hip surgery might be a niche market with too much frenzy.

Let's think about it.

It may not be hip surgery for absolutely everybody, but still, there are 6500 experienced global surgeons doing more than 40 joints a year.

These MIS surgeries should be applicable to, say, 25 to 30% of patients times approximately $3,000 per surgery times the 80% of the hip market that Zimmer doesn't have.

That equals a new market opportunity, at least for us in MIS hips alone of $350 million.

That's some niche.

It's probably worthy of a little bit of frenzy.

Given our time to market and investment commitment, I guess we'll find out.

Thank you for your time this morning and we look forward to your questions.

We would appreciate one question per person followed by only one directly related follow-up question.

Laura, I'll turn it back over to you.

At this time, I would like to remind everyone in order to ask a question, please press star, then the number 1, on your telephone keypad.

We'll pause for just a moment to compile the Q&A roster.

Your first question comes from Bruce Jacobs of Deutsche Banc.

Hi.

Thanks so much.

Congratulations, guys.

Thanks, Bruce.

Can I just first ask a question on the guidance of 13 to 15% revenue growth for next year?

I think I heard you say that includes price, and is it -- is it the 2 to 3% price that you mentioned earlier in the call, and therefore, is the implication that your underlying assumption about your base business is a little bit more aggressive than the kind of early 8 to 11% revenue guidance?

I think it is.

That's a good question, Bruce.

We changed this and we've sort of commented many times on one on one's that in our efforts to have no pricing -- and I think half the time we confuse people, having it bounce around, so we decided to go to a more traditional method, so that is correct.

And our underlying assumptions have increased to the higher end of the range, so if you think about Sam's specific comments, we put in the 2 to 3% price.

If it ends up being 4 or 5, we will be the first to say we're -- we're happily surprised and our results should reflect it being that much higher.

But what we use is the 2 to 3.

We've used the 10 to 11 underlying base, so that's at the very high end of the -- of the old range.

We've, in other words, eliminated the 8 and 9% part of it.

And then as Sam mentioned we try to put 1 to 2 points on of internal plan growth and guidance growth to you that says we'll grow faster than the market.

If you add all that up, taking the lows and highs, it gets to 13 to 15%.

Okay.

But currency is not in that estimate?

No, currency is still zero, because for the simple reason that the spot rates that Sam described and the averages we're running at would allow us at this point to determine that as zero currency.

So, again, should price be higher or currency be favorable on a reported basis, you're going to see numbers higher than that, obviously.

Great, okay.

And then just one follow-up question.

You obviously have been talking for some time about your interest in the -- making an acquisition, yet we haven't seen anything quite yet.

Is that more a reflection of the dearth of properties out there, the prices, or, you know, what should we infer from the fact you've been quiet on that front thus far?

Yeah, I think it's -- again, we get asked this a fair amount.

First of all, in the first several months of being public, if you take a look at the 14 months, the tax spinout structure and some of the restrictions on us were quite significant.

So I think people expected to see us sort of come out day one and do a spinal acquisition.

Well, that would have been impossible under any circumstances, and we -- we tried to explain that.

As you look at the last four or five months, though, that's not true.

We have some freedom to more or less do, within reason, as we please.

We are in conversations with people.

It truly reflects, perhaps, a tough negotiating style and very specific M&A philosophies that I -- two or three I briefly communicated on the call.

When we're out in public sessions, particularly with our direct investors, we look them in the eye and we're very clear with them on what our rules are with respect to acquisitions so I think it reflects perhaps our negotiating style and our own philosophies more than the dearth of properties or inactivity.

Great, okay.

Congrats, guys.

Well done.

Thanks, Bruce.

Your next question comes from Bill Plovanick of First Albany.

Great.

Thank you.

Great quarter, gentlemen.

Thanks, Bill.

My question is in regards to reimbursement.

With the shift to the MIS causing reimbursement problems in Medicare, do you expect a problem with reimbursement because it's going to be an outpatient procedure and Medicare is cutting back on the outpatient reimbursements?

I don't at this point, although -- although it's valid to bring up.

I think a lot of what we'll see is same-day home but in-hospital procedures.

I think we're a little bit of ways away -- our next model for MIS, if you want to call it that, that we're working on right now takes us to a home the same day outpatient model, perhaps with surgeon investors along with the hospital, so I think that's a model down the road.

I think we'll probably see in-hospital activity, home rapidly, lower cost, and I think people will want to, at least in the early stages, have a little more protectiveness to concerns with having it done in the hospital versus outpatient.

I would suggest, though, that it still requires a different focus on the part of the hospital, and as we look at it -- that's why we're talking to insurance companies and others.

Today, per diem is a factor in the -- in the earnings and income of the hospitals, and of course that has to be dealt with by efficient hospitals won't mind it but less efficient ones will.

The other major issue is, 50% of the people leaving the hospital for -- after hip surgery do not go home.

Today, they go to tertiary care centers, nursing homes, rehab, large rehab chain institutions, and so on.

I see that going away.

I just simply don't think that's going to happen.

I think, you know, virtually all of the people that we do at MIS, I believe will go directly to their homes the same day that the operation is completed.

Great.

Thanks a lot.

I appreciate that.

Newer next question comes from Katherine Martinez of Merrill lynch.

Thank you.

Just first on Europe, could you just give us a sense, it sounds like a lot of the growth is coming from a shift to some of these higher-end premium-priced products, whether it's the cement less systems or some of the new flex designs.

My sense had always been there really had been limited dollars even for some of the base cemented products.

Any sense for where the additional funds are really coming from to really pay for this technology?

I think one of the things we're seeing -- two things perhaps, Katherine.

First of all, the mix, even though we don't disclose it to you separately from price at -- or separately from units, I should say, at Zimmer, I will tell you qualitatively that mix is not as high a proportion in Europe as it is in the U.S. or North America.

So first of all, it's not as much.

But to answer your yes, there are a number of countries that are starting to switch a higher mix of their business to private versus public care, and I think that's certainly part of it.

We tend to more focus on the -- on the U.K.'s that have a national healthcare system and long waiting lines.

The fact of the matter s if you look at Zimmer's strength, which is in the southern part of Europe, primarily Spain and Italy, you've got a significant amount of switching going on to public -- or private institutions and that's beneficial.

Secondly, in our case, we're seeing dramatic growth in some of the new countries where we've put plans together to penetrate that incremental sales.

That's skinned Naeve yeah and certainly eastern why you were being part of that as important growth factors.

Thirdly, a lot of our European designs are just kicking in.

We just didn't have those, if you go back two or three years and they start to kick in now, threaded screw cups for Germany, SKF, SKT targeted hip stems (incomprehensive) stem cell these are things Zimmer didn't have.

So if you put all of that together, it's got some pretty nice impacts for us.

Okay.

And then just separately, could you just give us any sense for what prolong knee liners represented as a total of your knee liners in the quarter.

No, I don't want to share that information at this point.

I would rather do that when it's got an established base and when the PS product comes along.

So it is something you will eventually be breaking out.

You bet.

Okay.

Thank you.

Newer next question comes from Greg Simpson of A. G. Edwards.

Thank you, guys.

Actually, if I could follow up on Catherine's question a little bit.

Ray, can you talk a little bit more generally about Europe?

The question was asked, I guess on the Stryker call last week, are we seeing the same kinds of market trends, demographics kicking in?

Appear and then I do have a follow-up.

I think -- I think we are.

And I would agree with their comments and I would concur with those comments.

I think by and large we're seeing exactly the same demographics that we see kicking in, the so-called book ends phenomena that I just described in my summary is certainly very true in Europe.

People are living much, much longer in those countries.

Lifestyle has improved.

The young are coming in earlier and certainly the -- the baby boomer phenomena is consistent on a global basis, but is -- but is most visible or more visible, if you will, in Europe with those people being in their late 50s.

So I don't think there's anything different there.

I think some of the additional things we're seeing that create Europe as being more attractive, some of those I just described as being Zimmer specific.

Other things, like a conversion to more private as a percentage of total versus public should apply equally well across all competitors.

Okay.

And then as a follow-up, Ray, as we see the baby boomer effect kick in, it's my sense that you'll see it in knees before in hips.

From jogging or whatever, the wear and tear is probably greater on the knees.

Is that part of the reason that the extremely strong growth you're seeing against very, very tough comps, is that -- how big of a part of the reason is that?

I think you're right.

It should be marginally higher in knees.

I think that's a fair comment.

But I think there's a compounding factor that's going to make knees even higher, and that's that the relative ratio of hips to knees on a global basis is still highly in favor of hips, and that's nothing to do, you know, with physiological issues or with arthritis itself.

It's to do with the history of replacement surgery, Europe versus North America versus Asia.

So I think you're going to see a little higher natural activity on knees.

And that's going to be exacerbated higher by the fact that the ratio of hips and knee replacements will settle in on a global basis closer to one to one, and as I say, right now, it's distinctly in the favor of hips.

So I think you're going to see very strong knee positions.

Okay.

Thank you very much.

You're welcome.

Your next question comes from Bob Hopkins of Lehman Brothers.

Thanks very much, and again, as others have said, congratulations on a great quarter.

Thanks, Bob.

Very quickly, a quick question on MIS.

You guys have stated on this call that the roll-out now looks like it's ahead of earlier projections.

I'm wondering if you could comment on, you know, what that might mean for 2003 in terms of some of the specifics that we look for on number of doctors that you might be able to train and then perhaps the percentage of your total hip revenues that you think might come from MIS as we look to '03, '04, and '05, and then I have one follow-up.

Okay.

The second one, I can't comment on.

We're literally leaving this session and starting a whole week long of budget, so I haven't seen the final budget reviews or breakdown.

Certainly the MIS Minis and the two-incision will be prominently displayed in our budget and I'll try and share that answer maybe on the next call or separately at the next conference, because I don't know the answer to it right now.

The first part of that is really -- really related to being filled up, I think, more than anything else.

I mean, our classes are -- are so filled up that we expect to see a high degree of activity, but from a revenue growth point of view, Bob, as I've mentioned so many times -- and I'm going to call it 90/10 because I don't know the real answer but I think that's a safe answer. 90% of our training is going to be Zimmer surgeons.

I've said to people all the way along, don't look for huge revenue growth in the first six months or whatever of our MIS activity after full release because we have to train Zimmer surgeons first.

It would be total inappropriate to ignore their loyalty, and frankly their high degree of interest.

So I look for MIS to have stronger impacts in the latter part of the year, and certainly in '04.

This is -- this is getting out in front of the curve with training and starting earlier, so that we can move on more quickly to training competitive surgeons.

Okay.

Any estimate -- well, I guess we'll save that for later.

The follow-up question on the M&A side, when you guys were initially spun, you said that your primary focus would be on smaller acquisitions, I believe.

Now, maybe that was because of some of the structural issues, but has that changed at all?

Should we still anticipate the focus on smaller acquisitions or is the potential for this to expand out a little bit more?

Well, I think there's two answers to that.

The -- when we were initially asked the questions, first of all, regardless of what we wanted to look at, we were limited to small acquisitions and there still are limitations relative to the tax structure and spin structure in this country, so that's one answer that it's not so much to do with strategy, it's to do with tax limitation.

The second answer is, if you focus on spine, there really aren't, you know, very much in the way of large opportunities.

The spinal market is comprised primarily of smaller technologies and smaller companies.

So we look at everything -- you know, all the names that you can think of from the biggest to the smallest, we clearly look at analytically, but if you're focusing on adding spine technologies, I think there's some limitations inside there because they don't exist beyond a certain size.

Is there any dollar amount that we should be thinking about, in terms of structural -- the structural limitation, given the tax rules?

No, not at this point.

I think we're past the stage -- the real ruling is a bright line, I suppose -- heavy bright line at 6 months, somewhat of a bright line at 12, at two years you're free, and in between 12 and 24 months I think you have quite a bit of freedom, so I don't think we restrict ourselves at what we look at at this point.

Yeah, there are no practical limitations, Bob.

Thanks very much, guys.

Appreciate it.

Okay.

Your next question comes from Rick Wise of Bear Stearns.

Good morning, gentlemen.

Good morning, Rick.

I guess I'd like to focus on your comments, your earlier comments, Ray, on manufacturing cost reductions that were obviously a helpful factor in the quarter.

What's left to do?

What opportunities do you have left?

When will we see them?

How will it affect margins?

And maybe you want to bring into that the positive mix shift.

The bottom-line question here is: How far can you take gross margins based on the way the business is currently constructed?

Well, I think it's -- it's a good question.

I think if -- you know, for those of you on the call that have been to our plant and toured it -- and many have -- you can see we've made a nice beginning at robotics and automation.

I think what we constantly tell everybody is that we're sort of 10 to 15% robotic to automated for lack of a better definition, so that continues to be a significant opportunity.

And what we tell our employees here is that we'll continue to take that direction and create jobs in more interesting and more advanced technologies.

In other words, higher skill levels, to -- to increase their employment and training.

So there's a nice plan to do all of that, and a -- you know, in a very reasonable way.

That drives down costs.

Secondly, our Puerto Rican facility is getting to where it's very full.

We have the ability to double the size of that plant and it is a very attractive operating base.

As you know, we don't run 15 or 17 plants.

Our policy is to run, you know, 5, 6, 7 days a week, if we could, full out, three shifts, and run a high absorption basis.

That continues to be a very strong opportunity.

And lastly, if you think about expansion, you know, to Bob's question on spine, most of the spinal companies that you look at actually don't manufacture their own products.

They job everything out.

So as we look at Puerto Rico on, our integration strategy on a spinal acquisition would not only include integration of the business into our spinal trauma area but in fact the withdrawal of outsourcing and converting that into Puerto Rican production.

Now so there's three or four things right there that all have huge opportunity to impact to potentially increase margins.

Let me follow up and just add, so when we're looking out at our model for the next couple of years and getting to your numbers, we should assume the gross margin number continues to rise and maybe a related question to that is, are we now permanently below 40% for SG&A as a percentage of sales as well?

Well, I mean those are -- those are awfully defined permanent things.

I understand you're trying to build a model but you know as well as I do there's a huge number of offsetting factors in there.

The manufacturing opportunities I just described, you know, could be offset by - by other things hatching, so I mean from a model point of view, we've consistently performed, you know, opportunities to increase margin.

Certainly if we had a spinal business added in, clearly at spinal margins you'd have the opportunity to increase.

On the SG&A side, we're a leverage-based company.

We try to specifically drive high sales of high-margin product and leverage fixed cost basis, but you got to be careful on the expense side.

You know, we're going to always reserve the right, Rick, to -- assuming we can drive higher margins -- to determine at any given quarter or year how much of that we want to withdraw and drive back into the expense lines, particularly in our working dollars philosophy into R&D and into -- into sales, so I don't like giving out information that says forever, forever, you can permanently count on us to be under 40.

The trends are good and the directions are there and if I was building the model, I'd lean that way but I'm -- you know, I'm not going to apologize some quarter down the road if we elect to put some heavy increases into things we're trying to grow.

Appreciate that, Ray.

Congratulations.

Thank you.

Your next question comes from Abby Horrab of J.P. Morgan.

Good morning, guys.

I just really have a quick question here on your acquisition strategy.

I mean you've laid out a couple of ground rules that you plan on following when you do pursue an acquisition.

Do you -- do you think about the top line at all?

Would you do an acquisition that potentially could deflate Zimmer's longer-term top-line growth as well?

Growth rate, you mean?

Yes.

No.

You would not?

No.

That long-term would deflate it?

Yes.

No.

No?

No.

Not in the long-term.

I mean I might do something in the short-term if there was a performance weakness in the company and they had a short-term sales issue.

I -- I would certainly -- that wouldn't bother me.

But I'm not going to -- I'm not going to naturally reduce our growth rate, no.

And Ray, it's Mike.

I think maybe what you're just trying to ask to cover here is that you could trade EPS upside and, you know, cost savings such as what -- such as what, you know, Stryker generated with the Halmedica purchase in exchange for what would be a lower long-term top-line growth rate which is, in part, what they did.

Well, I think -- yeah, and I mean I think the Stryker example is a good example.

I think that's the answer I just gave because I'm sure when Stryker purchased Halmedica, they had no intention of continuing the strike -- the Halmedica prior three-year growth rates but, rather, assumed that effectively integrated, they could drive a higher growth rate with targeted Halmedica products and still derive all the savings and EPS, so I would view the world the same way.

I would take a short-term prior issue and try and drive it into a higher sales growth, but I wouldn't knowingly go into an area that I felt either had longer-term lower growth rates or would cause us to have lower growth rates.

I wouldn't do it knowingly and I wouldn't do it for the long term, no.

Okay.

Can I just ask one follow-up question?

I just want to make sure we're clear on the guidance for the fourth quarter.

Yep.

Your -- you did say the tax rate should be at the 33.7 level?

Correct.

Correct.

But Sam, is your advice for us not to change EPS estimates for the fourth quarter?

Yes, it is.

We're comfortable with the 33 cents that is currently in First Call's consensus.

Yeah.

I'm adding those -- those are both right answers.

If I was going to take the two areas, Mike, you know -- and this is -- is -- call it color added to the guidance, if you will.

We are heading into -- of course our comps are just getting tougher and tougher, so I'm -- I'm comfortable with -- I do not see a ton of up side on that sales range we gave out.

I -- and it's mostly -- the market's really attractive, obviously, for all of us, but our comps are just getting so darned tough that I don't see a lot of up side there.

If there's any up side at all, there might be a little up side on the EPS, if I was picking between the two.

But I -- but I do not see it on the sales side.

It's getting tough to -- as I say, after, you know, heading into your 12th quarter with 20% of recon, it gets tough to do.

Sure.

So, you know, that's my own sort of ad lib'd color on the guidance, if you will.

Thank you.

Good quarter, guys.

Thank you.

Your next question comes from Scott Davidson of U.S.

Bancorp Piper Jaffrey.

Hi-, good morning.

And congratulations.

Thanks, Scott.

Thanks, got Scott.

You spoke on the call a little bit about how you are planning to scale certain aspects of the organization, specifically R&D, and physician training with the MIS institute.

Can you maybe look a little bit further down the line and talk about how you're going to scale other aspects of Zimmer and specifically the sales force?

Maybe it's early to talk about kind of head count adds for next year, but just in general terms how would you see, you know, needing to add resources in other areas to leverage MIS?

Well, I think it's -- I think it's important and I think it's more than MIS.

I think it's -- it's MIS and it's getting into the concept of hopefully we'll be in the spinal business.

We go through a pretty thorough strategic planning process.

In fact, I'm leaving tomorrow to do another one with all of our U.S. distributors.

Where we go through the strategy plan with them, both potential acquisition amy -- not targets necessarily, but volumes and markets -- MIS, to your point, and we take a look at everything from instrument needs to warehouse sizes to sales ads to surgical tech ads to make sure that we're scaling the business up effectively.

We currently have building expansion work design that we're initiating for Puerto Rico that would ultimately double the size of that operation.

So we have an operating plan process we go through, but the strategic plan we actually share as much as we can with not only our distributors and people around the world, but people in functional areas here as well.

It's one of the reasons we put together a spinal trauma business unit infrastructure and people before we actually have done the acquisitions, so that you've got a structure to integrate them into.

Thanks, and then a related follow-up.

Obviously you're getting great growth in Europe but can you talk about whether the infrastructure in place over there is sufficient to carry the business going forward or would you envision changes there as well?

Oh, no, that's absolutely a pleasant one to answer.

My problem has been the other way.

We've -- we've had great people over there, and good team we've put together, but it is expensive -- unless you've got critical mass size, it's relatively more expensive to run that European business because we all know there is no Europe.

You've got to have regulatory people everywhere and so on and so on.

So actually it's quite the opposite.

We are getting tremendous leverage as you can tell from the earnings ratios and absolute dollars because we're not having to add a tremendous amount of infrastructure over there.

We are, in fact, getting sales growth on the current infrastructure, and I don't see that infrastructure requiring significant additions, as long as we stay as an independent.

Now, if we do acquisitions over there, that changes the game, but as we are today, we can grow Europe significantly on relatively the same operational structural base, so that's one of the nice parts of growing over there now as we're driving that leveraged earnings.

Terrific.

Thank you very much.

Thanks.

There are no further questions at this time.

Mr. Elliot, are there any closing remarks?

No, that's fine.

Laura, thanks very much and thanks to those listening.

We're going to be around.

We're heading out tonight to that distributor meeting but we're around during the day, if you've got follow-ups and we'll be - be happy to answer them.

Thank you for participating in today's Zimmer holdings third-quarter conference call.

This call will be available for replay beginning at 11:30 a.m. eastern standard time today through 11:59 p.m. eastern standard time on Tuesday, November 5th, 2002.

The conference ID for the replay is 5639560.

Again, the conference ID number for the 5639560.

The number to dial for the replay is 1-800-642-1687 or 706-645-9291.