Zimmer Biomet Holdings Inc (ZBH) 2002 Q4 法說會逐字稿

Good morning, everyone. My name is April and I will be your conference facilitator today. At this time I would like to welcome everyone to the Zimmer fourth quarter and full year 2002 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 one on your telephone key pad. If you would like to withdraw your question, please press the pound key.

Zimmer would like to note that 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 & Exchange Commission and in the release, the press release issued yesterday. The company makes no commitment to update any forward-looking statements based on new information, future events or otherwise.

Thank you. I would now like to turn the call over to Mr. Ray Elliott. Sir, you may begin your conference.

Thank you, April. Good morning, everyone, and welcome to Zimmer fourth quarter 2002 conference call.

We're pleased to be hosting this call to discuss a solid quarter, our first full year, and sixth report as an independent public company. Today's call will be scheduled for approximately one hour. Joining me on the call are Sam Leno, our senior vice-president and chief financial officer, and Jim Crines (ph), our vice president and corporate controller.

I hope you received a copy of last night's earnings release. If not you can obtain a copy from our Web site at www.zimmer.com. Alternatively, please feel free to contact Sam and we will have a copy faxed to you as well as add you to our e-mail distribution for future releases.

We will begin today's call with brief comments related to fourth quarter and full year results, including an update on our operations followed by a Q&A discussion. Unless otherwise noted, we will be discussing our reported results for the fourth quarter and year compared to prior year pro forma results.

Let me begin with the fundamentals of our consolidated P&L and balance sheet performance. Consolidated sales for the fourth quarter were $370 million, an increase of 19 % over prior year and approximately $12 million higher than consensus street expectations. Worldwide sale in constant currency increased 17%. This continued solid performance was led by volume mixed growth of 13% in the quarter, while worldwide price improvement remained firm at 4%. As a point of interest, the Americas price increase was 5%, matching the previous six quarters. Americas business continued its excellent growth in the quarter at 19% and Europe has dramatically increased growth versus prior year to 34%. We experienced a continued improvement in Asia Pacific sales growth to * 11%. We believe and are comfortable that all of our geographic segments are driving market share increases and local currency.

For the year, total sales increased to $1.372 billion, 16 % over the prior year. Our Americas business and Europe again led the way with growth of 18% and 28% respectively. We will discuss Zimmer's performance versus served market growth in the category and geographic sections. Ticker symbol ZMH on the New York Stock Exchange was plus 36% in 2002, making Zimmer the fifth highest increase in per share value of all large cap companies on the NYSE. Diluted earnings per share for the fourth quarter were 37 cents, an increase of 37% over prior year, and three cents over consensus street estimates. For the year, EPS was $1.31, an increase of 34% over the prior year. In the quarter, cost of goods sold increased only 13 % versus a 19 % increase in our sales based on favorable product mix, price and our continuing successful efforts to reduce manufacturing costs.

Dramatic growth in our Europe business at somewhat lower margins slightly moderated margin expansion. Gross profit dollars increased by 21% and gross profit margins versus prior year improved by 130 basis points to 74.7. This gross profit margin of 74.7 was sequentially a slight decrease of 10 basis points from third quarter 2002. We believe that at approximately 75% year-to-date our gross margins are still the best in the industry. SG&A expenses were well managed at 38.8%, a 130 basis point improvement over fourth quarter 2001, a sequential improvement of 80 basis points from third quarter 2002, and for your reference over three years a whopping 560 basis point improvement from the 44.4% recorded at the beginning of 2000.

For the quarter, SG&A expenses increased only 15% despite a 19% sales increase. For the year, SG&A expenses were 39.8%, a 110 basis point improvement to prior year. We continued to be very pleased with the leverage in our quality earnings gained from new sales. Each incremental sales dollar in the quarter cost only 32 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 operated our working dollars model, driving down cost of goods 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 consistent target of approximately 6% to sales in this quarter at 5.9. Our R & D investments at $21 million for the quarter increased by $4.1 million in absolute terms versus the fourth quarter 2001.

For the year, the R & D ratio to sales was 5.9 %, with more than $80 million expended in this category. We are pleased to report that operating profit grew in the quarter by 29% over the prior year. These operating profit results reflect quality earnings, continuing leverage and a strong increase of 240 basis points versus the prior year. These results also represent for the first time achievement of one of our many milestones, a 30 % operating profit margin. For the year, our operating margin was slightly above 29 %. Net earnings in the period increased by a very strong 39% based on solid operating profit, declining interest expense to only $2.1 million and a significant reduction in tax rate from 36.1 to 33.7, providing a quick return on the one time tax costs mentioned in our second and third quarter calls.

Sam will provide a more detailed discussion of our tax results, the fourth quarter rate and our near term expectations. For the year, net earnings increased by 35%, net earnings not only surpassed a record $72 million for the quarter and more than $250 million for the year, but for the first time in the fourth quarter achieved the magic mark of a 20% ratio to sales driven by a 280 basis point improvement over the prior year.

As previously mentioned, diluted EPS in the quarter increased 37 % to 37 cents with 197 million average diluted shares outstanding. For the year, EPS increased 34 % to $1.31, including an increase of more than 2 million diluted shares outstanding since year end 2001.

I would also like to provide some very brief introductory cash flow and balance sheet highlights. Free cash flow for the quarter and the year were both at the high end of our expectations, registering $73 million and $187 million respectively. Operating cash flow for the year was $220 million. In the quarter, inventories have been increased by only $5 million to a level of $258 million. But as forecasted from previous conference calls, improved by more than 20 days from 268 to 247. It remains our intention to operate the business at approximately 250 to 260 days of inventory for the foreseeable future while our pipeline is turning out 30 to 40 projects. On a normalized basis, Zimmer operates its inventory with high service levels at 210 to 230 days. This continues to represent with our product line a 90 to 120 day cash contribution advantage over the industry as a whole.

Consistent with prior quarters, our flow rate accuracy is more than 98% and our global forecast accuracy on thousands of SKUs is more than 90%. Asset management focus, dedicated infrastructure and attention to metrics continue to drive our efficient inventory performance. We are extremely pleased to report that our net debt has declined by $309 million from $450 million at our spin off in August of 2001 to $141 million at the end of the fourth quarter 2002.In approximately 17 months as a public company we have cut our debt by two thirds and reduced our debt to cap ratio to 30%. We continue to target being debt free during the fourth quarter of 2003 and after only two years of public life excluding any cash utilized for acquisitions. Our industry-leading receivables collections continue to provide support for consistently high cash flow production and help define some of the top balance sheet metrics in the medical device industry.

In the fourth quarter, we reduced our U.S. receivables to a new record of 31 days on a hospital collections business approaching $1 billion in sales. We also would be remiss in not also recognizing the contribution of Zimmer's international businesses that delivered a global year-end receivables number of 52 days, more than a month faster than the industry average

Let's review sales in a little more detail. Reconstructive sales for Zimmer are the recognition of hips, knees, shoulders and elbows implanted into patients during the reporting period. For the fourth quarter worldwide reconstructive sales increased $290 million, representing an industry leading reported increase of 23% over prior year, 21% constant currency and equally strong sequential increase of 12% over third quarter 2002. The 21% constant currency increased over the prior year in the quarter is a particularly important accomplishment since the fourth quarter 2001 versus 2000 comparison was 20%. Twenty-one over 20 is the toughest reconstructive comp in the industry. This is even more significant achievement in light of the annual base of Zimmer reconstructive sales reaching more than $1 billion for the first time. Actual recon results for the year we're $1.062 billion, a record increase of 20% reported and 20% 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 approximately 16% or so for 2002 in the quarter and approximately 14 to 15 % for the year. If this is the case, then Zimmer has continued a long standing pattern growing at a rate of 30 to 40% faster than the market

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 24 % to $160 million versus prior year and 21% constant currency. These results include a sequential growth of 13% and compares to a 21% constant currency growth achieved in fourth quarter 2001 versus 2000. In other words, 21 over 20 as a comp. Excuse me, 21 over 21 as a comp. For the year, knee sales increased 22 % to $586 million and 21% constant currency. Our 2002 knee performance as previously announced included the implantation of our one millionth knee in the United States.

For the year, Zimmer sold a record 200,000 knee femorals (ph) worldwide and increased knee sales over prior year by better than $100 million on a reported basis. These are consistent and significant market share gains, not in a few countries but everywhere. For example, in the fourth quarter the United States, Germany, the United Kingdom, Italy, France, Switzerland, Holland, Belgium, Spain, Norway, Sweden, Finland, Central and Eastern Europe, Australia, New Zealand, Taiwan and Korea all delivered knee sales growth in excess of 20% to prior year. The successful introduction of Prolong, the specially designed cross-link polyethylene for next-gen cruciate (ph) retaining knee articulating surfaces is delivering great results. After only five months in the market, Prolong is selling at more than 50 % above our own internal plans and already represents more than 10% of our total knee articulating surface sales. This is despite the fact that Zimmer has tended to be stronger in PS than CR. PS knees with Prolong are expected to be available at the end of 2003.

In addition to early Prolong success, we have also recently launched trabecular (ph) metal model block tibiales (ph) and our new HRK rotating hinged knee. Both of which have easily jumped to more than $10 million sales annually almost literally overnight. For the new nex-gen trabecular metal model block, one piece tibial tray (ph) and articulating surface this represents not only immediate recognition, but a real belief in a new porous fixation solution. The subject of tibial ossilitis (ph) from backside wear is bound to see greater independent investigation in published peer reviews. We know it's a more competitive (inaudible) market, but still our MISNG units (ph) have grown on a world wide basis another 45% in the quarter and finished the year with growth close to 70%.

All these results were measured against the toughest comps. For example, fourth quarter 2001 growth was more than double fourth quarter 2000. We recognize that other companies now carry more than one brand, but the Zimmer NG unit finished the year with sales in excess of $32 million and remains the most popular single brand in the world, with peer reviewed survivor rates at ten years of more than 98%. It's the only one we make. It's the only one we carry.

Our NexGen LPS flex knee, a Zimmer lifestyle design product intended to potentially safely accommodate 155-degrees of flection (ph) has continued to gain share in dramatic fashion during the quarter. On a worldwide basis, LPS flex femor (ph) units grew by another 45%and we sold more than 5,000 flex units in the fourth quarter. Based on a strong fourth quarter, we easily achieved a more than 17,000 units for the year as previously targeted.

I'll update you on the progress of its sister product, the CR flex during our project development update. Knee revision continued its upward trend with the NexGen LCCK system delivering a 39% increase over prior year and excellent sequential growth of 14%.Let's take a closer look at hips. On a worldwide basis in the fourth quarter, hip sales increased 22 % to $120 million, a sequential increase similar to knees at 12% and grew 20 % in constant currency. This increase is despite a tough 18% growth comp for fourth quarter 2001 versus fourth quarter 2000. For the year, hips have increased by 17 % to $441 million and 17% constant currency.

Zimmer forest stems (ph) continue to make strong market share gains and continued their more than two year long growth run with an increase of 38% in the quarter. This is the most significant growth we have seen, far outpacing last quarter's 29% increase and well above a tough 22 % comp from fourth quarter 2001.

We will discuss the continued role of cemented to porous mix in more detail under the hot topic section. Porous revision stems along with revision cups and liners continue to be an area of focus for Zimmer and our sales showed a dramatic increase of 46 % in the fourth quarter after a strong third quarter, up 49%. These results include our ZMR product line, which on a stand alone basis remained well above prior year. This performance for ZMR includes what we believe is the correct decision to retool a portion of the line post market withdrawal to better serve both patients and broader geographic surgeon philosophies. During December, we lost a major ZMR size and design extension that was previously planned. Zimmer primary acetabular (ph) shells grew 27%in the first quarter. Trabecular (ph) model block cups augments and shells have quickly become a new $10 million plus product line with sequential quarterly growth in excess of 20%. Despite extremely tough comps and significant penetration, premium priced longevity, highly crosslinked polyethylene liners increased by 41% in the fourth quarter, sequentially 3% higher than the 38% we saw in the third quarter.

We believe competitive surgeon acceptance is growing with the continuing stream of scientific analysis from invivo-retrieval and differentiation, specifically as it relates to Zimmer's longevity brand. On December 20, the FDA approved Zimmer's constrained liner and last week we began shipping the first units for implantation. This single decision will dramatically improve our operating room presence in complex hip revisions. Of course, there was considerable progress on the MIS hip front, but I'll cover that update under hot topics.

In upper extremity joints, Zimmer's (inaudible) shoulder has continued to take market share in the world, with 29% growth in the fourth quarter and 29% for the year. Based upon the fourth quarter, our annual sales run rate for the shoulders and elbows now exceeds $50 million. We will enhance the shoulder product line with the addition of both highly crosslinked polyethylene and trabecular metal. At a single recent Zimmer medical education event, almost 150 surgeons signed up for dedicated upper extremity cadaver and didactic sessions. This level of activity is indicative of both the interest in shoulders and our product line's potential. On a worldwide basis, trauma sales have been at least on a sequential quarterly basis somewhat inconsistent this year, with fourth quarter sales up only 3%.

Above market sales increases anticipated were diluted by the late in the quarter release of our IGS T-nail (ph) in mid December. A sure but slow return to positive figures in Japan after our manufacturing move to Puerto Rico and particularly high previous year quarter reamer set sales. It should be noted that our non-Japan trauma sales however were up 7% in the quarter. A review of the market, scheduled new products, early response to the ITST and potential account conversions does not seem to indicate any significant negative underlying issues. We will complete our filling of the ITST pipeline in the first quarter.

Several sub-segments within our trauma product line continue to deliver excellent results. Our Zimmer perioticular (ph) plates are making accellerated penetration against the trauma market leader with 72% growth in the fourth quarter and 68% for the year. Our 15 perry (ph) styles and anatomic locations are being fully launched and give Zimmer the most comprehensive and best-fitting (inaudible) premium plate offering in the world. Conversely, IM nail sales have been tougher, with some good new products out there from the competitors.

In orthopedic surgical products, Orthopad, our perioperative (ph) auto transfusion system designed specifically for orthopedics increased by 58% in the quarter, 69% year-to-date and continues to sell well above $10 million annually.

Let's switch to our new product development update. As you know, we currently have more than 20 active major projects in a robust pipeline with most of those scheduled for release during 2003. In addition, we have 12 new projects to add to the pipeline, and I will briefly outline them later. Our goal is to provide you with project name, quarter of release and whether or not the release continues on schedule. In knees development and commercialization, our patented rotating hinge knee, the RHK was released and is already scoring some strong sales successes. Trabecular metal NexGen LPS tibial components, 32 new implants were released and similar to the RHK has shown very strong early sales. As previously indicated, Prolong, our crosslinked polyethylene for CR knees was released ahead of schedule and is performing 50% ahead of our own internal plans.

We have, of course, in recent times initiated three new knee projects as follows -- CR Flex, following the footsteps of the highly successful LPS Flex, our first implantation was concluded successfully December 2 in Utah. And since then, ten additional surgeries have been performed. We anticipate a preliminary launch late in 2003. A now patella femoral project with unique concepts completed a early cadaver session on December 14. And of course, MIS TKA, minimally invasive knees, our MIS mini knee will be shown and released on schedule at the 2003 AAOS in New Orleans. We will clinically complete our 100th trial MIS total knee ahead of schedule in February, one year after we initiated the program at least one year ahead of the market. This is, with Zimmer's program, the implementation of a standard LPS flex through a three inch incision with no major muscle invasion, and no aversion or excessive patella stress. Patients are showing 90 degrees range of motion and are walking home in many cases the same day.

Now let's move to hip development and commercialization. The Apollo stem project, 358 new porous hip stems due for phase in release through 2002, 160 stems have been released in 2002. Many of the almost 200 stems released along with full instrumentation during the fourth quarter of 2002. New Apollo stems that have been released have already jumped in sales to a $20 million plus product line. The remaining six inch full coat extended offset stems as well as the eight and ten inch straight and boat stems will be released with dates varying from January 2003 to April 2003.

Trabecular metal modular cup, this project has been increased in size by ten implants to 58 implants and 52 instruments from the original 48. The project release date was moved in the second quarter conference call from fourth quarter 2002 to first quarter 2003 and remains on that schedule. CPT 2, our new colorless 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 the project in the second quarter as identified in our last conference call. CPT 2 was released on schedule during the fourth quarter 2002.

And on trauma development and commercialization, periarticular two, our concrete plating system, with 289 new implants for phase in launch for 2002 as previously discussed has just completed final release. The ITST, (inaudible) femoral nail, with more than 200 new implants was identified in our first quarter conference call as being delayed from original summer release and continued on a delayed schedule. As previously mentioned, ITST was released in the very latter portion of the fourth quarter 2002 providing only minimal sales to that period. We have initiated approximately 12 new internal R & D projects. While we don't have sufficient milestone activity to report to you, the projects themselves represent an intriguing view of our future. Trabecular metal stems, dedicated MIS stems, Zimmer sigmetal (ph) oncology system, a new MIS unidesign (ph) concept, three consecutive advanced levels of our MIS total knee, an advanced shoulder, some MIS spine work and multiple projects in MIS guidance outpatient technologies with our partner Metronic (ph) and others.

At Arthur Biologics, with our partner Isto (ph), we initiated some time ago two new animal studies on neocartilage, wanted to look at earlier mobilization with a graft in protocol at four weeks instead of eight weeks. And a second site to look at longer term stability and integration of the condral (ph) graft at six months. The longer-term animal study has been completed with our university partner and report preparation is scheduled for February.

In total on a rolling 36 month basis, new products represent 19% of our sales in the fourth quarter, 18% for the year, consistent with our long-term strategic goal since 1999, to have internal 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 fourth quarter was $244 million, up 19% over prior year, and that's measured against the difficult comp of 21% for the fourth quarter 2001 versus the fourth quarter 2000. We continue to be very pleased with our progress. Fourteen 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 22% included an outstanding knee growth of 23%. Most importantly, though, this 23% knee growth should be judged against the toughest of comps, a 27% knee growth in fourth quarter 2001 versus fourth quarter 2000. NexGen LPS, MIS u-knees, Trabecular metal tibial components, and NexGen LTCK revision knees all made substantial contributions to the Americas knee performance. Since there is little mix associated with knees this would indicate a raw unit procedure growth in the quarter for Zimmer knees in the Americas of more than 18%.

Hips in the Americas increased 21%, with Zimmer porous stems at 59% of mix, surpassing for the third 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%. It's clear that at 22% reconstructive growth we are continuing to outpace the rate of market growth through the Americas by almost 50%. We have been growing the Americas reconstructive products at a quarterly average of 20% or more for three years now.

Trauma product sales improved only 4%, impacted positively by our new periarticular plate offerings, but offset by the late December release of the ITST nail, strong compettive IM product releases, significant prior year-end one-time set sales, and a very tough 19% prior year fourth quarter comp. In-patient care, OrthoPad available only in the Americas continued its rapid acceptance as described in my earlier remarks. Importantly, the Americas operating margins a core increase by 280 basis points to 47.3% from 44.5. Our sales success in the Americas is truly broad based -- 100% or 24 of 24 U.S. distributors delivered double digit growth for the year. Ten distributors delivered growth in excess of 20% and amazingly on knees 15 distributors had growth in excess of 25%.

For the year, the Americas have increased sales by 18% at $933 million with knees increasing 24%, hips 17%, and trauma 10%.For three years, Zimmer America has continued to take market share both visibly and profitably.

In Asia Pacific, revenue for the third quarter was -- for the fourth quarter was $75 million, indicating reported increase of 11%, 10% constant currency and up sequentially by 10%. Asia Pacific had positive price again in the fourth quarter but struggling health care budget deficits in South Korea will cause this to moderate in 2003. During the second quarter, our Asia Pacific business was led by outstanding local currency hip growth of 16%, reflecting continued conversion of porous stems, successful introduction of longevity highly crosslinked poly, and early sales of ZMR, our modular revision hip system. When combined with very positive knee growth of 13%, Asia-Pacific reconstructive sales grew at constant currency 15% and well above what management believes is high single digit local currency reconstructive growth for the region. We are particularly pleased with Japan's 13% local currency growth in reconstructive products in a market that fluctuates between low to mid single digit growth.

Excluding Japan, the remaining Austral-Asian, composed of Australia, 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 Zimmer product segments in the fourth quarter. Displaying excellent leverage to sales, Asia-Pacific operating profits increased by 23% constant currency in the quarter, while operating margins in the region increased by 150 basis points to 47.7% in 2002 from 46.2% in 2001 and sequentially by 380 basis points compared to third quarter 2002.For the year, Asia Pacific sales increased 6 % to $270 million and 8% constant currency after a slow first half start. Hip and knee growth increased well above market for the year at 14% and 11% respectively, offset by trauma. Operating profit growth for the year in the region reflected acceptable quality earnings at 12% compared to an 8% constant currency growth in sales.

Europe had another exceptional quarter marked by substantial market share gains across the board. In the quarter, revenue of $51 million represented a very strong 34% increase over prior year, 24% constant currency and a huge sequential increase of 30%.For the fourth 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 United Kingdom, Central and Eastern Europe, Norway, Sweden, Finland, Iceland, France, Spain, Italy, Belgium, Germany, Holland and Switzerland. We believe twice the served market growth was obtained by 13 of our 16 European businesses. Twelve of our 16 European businesses or three quarters of Zimmer Europe grew their reconstructive results by a spectacular 30% or more on the quarter. On the product front, as you can anticipate, reconstructive implants grew by a balanced 34% led by hip growth at 35% and knee growth of 33%. Even with very solid reported competitive reconstructive numbers for Europe in the third and fourth quarters, it's clear we are growing at least 50% faster than the market. Hip and knee gains reflected the continuing acceptance of longevity of highly crosslinked polyethylene, the introduction of our European hip and cup designs, as well as the ongoing clinical implantations of Zimmer's new RHK NexGen rotating hinge knee.

Although from a small base, Europe's trauma results improved by 50%. Europe operating profits increased by 33% to $13.2 million in the quarter and almost reached the next milestone of 25% profit margin. This from a business that five years ago lost money on more than $100 million in sales -- a great performance by Europe. With a significant growth trend underway in Europe and the corresponding number of understandable, what is going on in Europe questions at investor conferences, we will take a more detailed look under hot topics at what is driving both the market's growth and Zimmer Europe's growth during 2002.

In addition to Europe I'll try to cover the following six topics briefly under hot topics -- mix, an update on the role of mix change as reflected in Zimmer's global results for the year; our external development activities, or what has become better known lately as why haven't you bought a spine company yet; Zimmer sales associate adds, an update on our plant and natural revisions for 2002; and a few thoughts on 2003; pricing, our latest interpretations by geographic segment; the 2003 AAOS in New Orleans, what to look for and listen to in the Zimmer booth; and lastly, Zimmer's minimally invasive efforts, our activities and developments.

First Europe and our growth analysis. Zimmer Europe continues to experience significant growth over the last two quarters. We have analyzed both the market and our own operations. First the market in general. Based upon reliable data in France, Germany, Italy and the UK we have concluded that the market growth for the last nine to 12 months in hips is 12% with real unit procedure growth at 5%. The balance being mix and price. Knees on the other hand would appear to be growing at approximately 15% with unit procedure growth at a surprising 12%. Trauma appears relatively stable at nine to 10%. We have concluded that the underlying market drivers in Europe are consistent with our own speculation and in several cases consistent with many of the general demographic and mix drivers visible in the North American market.

So what is different in Europe's market growth and why now or throughout much of 2002? We believe five different issues come to the forefront. First, hip implantations have historically been four to one versus knees in Europe. That ratio has declined to two and a half to one as more and more Europeans become comfortable with essentially North American primary knee designs -- u-knees, MIS or otherwise and mobile bearing are both demonstrating strong growth. Secondly, political health care infrastructure. With movements in general from public to private, almost everywhere, new phase in DRGs in Germany, large business groups such as Generale Delfante (ph) in France buying and managing major clinics, and some modest wait list reductions in the UK, including the acceptance of British national health patients at French and Netherlands institutions, the political environment is definitely orthopedics friendly. Thirdly, stabilization in key Eastern European markets, with a growth in new middle classes, more advanced government health care programs. Instead of just trauma services, of movement to total joint procedures. Fourth, navigation is attracting considerable attention as both a clinical and marketing tool increasing and attracting potential patients to technology advancement and go forward decisions on total joint surgery. And lastly, price -- we believe the European market has transformed from essentially a slight negative price in 2000 to about 1% favorable in 2001 to between two to 3% favorable in 2002. Mix factors, however, have been comparable to North America.

At least based upon our review, the five Europe issues -- improving hip to knee ratio, political infrastructure changes, stabilization in the growth markets, navigation marketing and price all should be positive in general for most orthopedic competitors and sustainable for some time. Specifically as it relates to Zimmer, our European business growth in 2002, particularly the last two quarters in local currency would appear to be increasing at 50% faster rate than an already buoyant European orthopedic marketplace. While Zimmer is certainly benefiting from a myriad of positive market factors, there are also specific growth factors that enhance our business. First, the ongoing release of a significant number of European designed new products and philosophies developed for Zimmer by European surgeons. Second, the successful expansion of our distribution model in Scandinavia and Eastern Europe, where Zimmer has historically been less of a factor. Third, the early impact and attention provided by innovative new Zimmer technologies, Trabecular metal, crosslink poly, high-flex knees, and of course, minimally invasive solutions. While not every European surgeon converts to any or all of these technologies, there is no question we now have a very real ability to get Zimmer in the door and in front of competitive surgeons

Next, material growth in trauma from a smaller base but dramatically above the market growth. And lastly, perhaps more subtle and certainly more difficult to measure, management stability from senior staff in Europe, through individual country general managers, we've had virtually zero turnover in recent years. We all have been together as a team through turnaround, spin off and now as an independent public company.

I hope that gives you a better feel for what we believe is going on in Europe.

Let's leave to Europe and turn to mix and update on the roll of mix change reflected in Zimmer's results, all calculations unless otherwise specified are in sales dollars on a worldwide basis. Mexico continues to play a very key role in improved sales and profitabilty, and from our perspective in 2002 really focused on three comparisons. First, standard polyethylene hip liner conversion to longevity, highly crosslinked polyethylene. At the end of 2001 we were at 77% crosslink, at the end of 2002, 85% crosslink. In summary, a cumulative shift of eight points to crosslink from year-end 2001. Zimmer's results only include longevity in hips and therefore we know crosslink poly still represents tremendous potential. In my own mind, though, we have at 85% captured a good deal of potential near-term longevity conversion for hip liners. The remaining holdouts will in all likelihood look to a little longer term data. Although recent very positive RSA retrieval results may influence more converts. However, we have as you know released a CR Prolong for the knee with PS Prolong to follow. The average selling price on the knee articulating surface is higher than the average selling price of the shell liner, while the percentage premium charge should be comparable.

We believe Zimmer has just begun another two to three year cycle of penetration utilizing Prolong crosslinked poly, but with an even better opportunity for incremental gross profit dollars. The initial uptake has been much higher than any of us would have expected given Zimmer's somewhat stronger market share position posterior stabilized versus cruciate retaining knees, the future should hold even greater potential. Second, cemented hip stem conversion to porous hips at the end of 2001. Zimmer was 45% porous at the end of 2002, we are 55% porous. A cumulative shift of ten points to porous in units from year end 2001 for Zimmer. And we believe the market in general is now at 60 to 65%. This still leaves us with room to grow and represents the third straight quarter in more than ten years on a global basis where primary hip stems and units have a porous majority. With more than 100 remaining Apollo porous stems still to be released in the next one to four months, the distribution pipeline complete for our epic composite stem and the potential growth in trabecular metal stem applications, Zimmer has many more opportunities for cemented to porous stem conversion.

Third and last, revision as a percentage of total hip sales, it was 6% at the end of 2001, it's 9% at the end of 2002. We just missed our double digit revision goal of 10% for 2002, but barely. With the remainder of Apollo moved to the first quarter of 2003 ended up at 9.4%, and as result I couldn't round it up to 10%. Despite missing the revision progress from 3% of sales in '99 to 9% of sales in 2002 has been excellent given the size of Zimmer's base in total hip sales. External development activity for the most part involved spine, critical mass in Europe, biologicals and base of applications. We continue to explore opportunities on several fronts and have had particularly good negotiations on some very unique spinal technologies. Conversely, we have been less successful with valuation opinions on some available basic spinal product lines. We remain however unmoved by any strategy that causes us to go outside of our key stated M&A philosophy. We will not put our investment grade rating at risk. A deal must be accretive in 24 months or less without synergies and must contribute to long-term EPS growth always greater than 15% among others.

Despite the challenges, we believe that there are far more businesses in need of an exit strategy and far less available venture cap injection funding than in previous times. While various people patiently or impatiently wait for us to do something or anything in spinal, we know that over paying is a poor resolution for our shareholders and in the end represents a lack of discipline that could materially detract from some terrific organic growth we currently have.

Given our status, we will begin a parallel strategy of building our own basic spinal product line in our Puerto Rican plant, where we just initiated a doubling of our capacity. We will continue to push hard on spinal M&A, but not outside our own rules and not because it's a mandatory growth strategy, but rather because it's a good one.

Sales associate ads for 2002. With the subject of sales force additions continuing to be active, we indicated to you during our third quarter call that we would add some 100 reps and surgical techs during 2002. For the year, we've hired 84 new sales associates, surgical techs and specialists. We have nine open unfilled requisitions leaving us close to our targets, with 93 total additions when complete. Depending upon final decisions in areas such as trauma specialists, operating room coverage, and sales managers with or without hospital accounts, we'll be expecting a number in the 80 to 90 range for 2003 on a global basis.

Pricing - U.S. pricing discussion has been less prevalent lately, with the October DRG 209 announcements for 2003. Zimmer's position is unchanged since we spun the business out in August 2001. While we have been pleasantly surprised by the 4% global price and 5% in the U.S., and a little higher reimbursement than anticipated, essentially 7% versus 4 to 5%, our own theory has been the price in the 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. With one exception, Korea, we see absolutely no signs that price will not remain meaningfully positive. The Korean government facing significant budgetary deficit issues has instituted broad medical device cuts including orthopedics. We have quickly developed new product and distribution tactics for Zimmer in Korea, and therefore these changes have no material total effect on our price increase guidance previously discussed.

On January 1, 2003, Zimmer executed our new U.S. price adjustments, generally similar to the level of improvement in DRG 209. 2003 OOSS New Orleans, what to look for and listen to in the Zimmer booth. We are booth 319. It begins Wednesday, February 6, at 10 a.m. through Friday, February 8 at 5:00 p.m. Here is just a small sampling of new products you'll see in the Zimmer booth. In Trabecular metal alone, new Trabecular metal porous tibular components, a trabecular metal (inaudible), a small fracture pin system, a trabecular metal (inaudible) necrosis rod, the all new trabecular metal acetabular system, and trabecular metal augments for the femur, the tibula, and the acetabula. All of these utilized as alternatives to structural grafts. In reconstructed, the rotating hinge knee, the new advocate hip, the CPT 1214 hip system, the proxy lock and new proximal fit and fill system, ZMR line extensions, the 350 stem Apollo porous system, stayfuse and interdigit (ph) fusing system, and of course, the new Trilogy constrained hip liner.

And we finally get the chance to show off our new ITST. With over 200 sets available by the end of January alone, the ITST represents Zimmer's entry into the Gamma nail market. Our nail offers not only improved proximal geometry for easier insertion and improved long nail bow geometry, matching the natural anatomy, but also a one piece leg screw locking cap and an anti-rotation feature. In minimally invasive solutions, we will have our MIS mini knee, our MIS total knee, the MIS hip, and the Zimmer 2 incision. And by invitation only, some potential futures in MIS. We will also feature the Zimmer institute and MIS navigation and software advances cosponsored by our partner Metronics.

I'm willing to bet that MIS will be front and center at this year's AAOS. In the Zimmer theater, located within the booth, some of the world's most famous designing orthopedic surgeons will deliver a total of 24 30 minute presentations over the three days, 14 of which are dedicated to trabecular metal and minimally invasive solutions.

Speaking of MIS, that's my final hot topic for today's conference call. We couldn't be more pleased with the progress in our four year old MIS program. During this section of the call we'll update you on several different aspects of the MIS program. First, our training program continues on schedule with five programs in November, December resulting in 46 new surgeons trained on a two incision hip. Eleven of the 46 surgeons were internationally based and a sales associate and additional hospital personnel, we trained almost 100 people on the Zimmer two incision hip during the final few weeks of 2002.

During the fourth quarter, we added three full-time field training managers to support a growing number of physician practices expanding to Zimmer minimally invasive solutions. Prior to approval for two incision training, surgeons must be familiar with and convert two Zimmer implants, utilize our mini-incision hip as a pre-requisite and sign contractual agreements with respect to use and intellectual product.

In order to put the future demand in perspective, we have put more than 200 mini-hip instrument sets alone into the field during the last few weeks. Also during the fourth quarter, Dr. Kas Serucal (ph) successfully performed the first Zimmer two incision hip in Japan, and during a recent medical conference more than 300 surgeons listened to Zimmer MIS surgical techniques (inaudible) in a standing room only environment. Since its inception, more than 402 incision hips have now been completed in six countries. At our Tuesday night analyst meeting in New Orleans I've asked Dr. Richard Berger (ph), professor of orthopedic surgery at Rush Presbyterian (ph) in Chicago and a Zimmer key developer of the two-incision hip to join our presentation. The MIS institute in Warsaw remains on schedule for our March 31, 2003 grand opening and the institute's new brand will be marketed beginning in February. The first European MIS training course will be held next month in Paris. We have identified 20 of our potential 30 global institute satellite partners, and with the first four we are in various stages of negotiating long-term joint strategic plans between Zimmer holdings and their entire institution.

From a commercial point of view in the case of two of these institutions, Zimmer will improve from less than 20% market share to a contractual compliance requirement in excess of 80%. As an adjunct to the MIS institute in Warsaw and our exclusive MIS co-development relationship with our partner Metronics, we hope to announce two additional technology partners in the next two quarters. This collective partnership will work on the design and development of the operating room of the future and inpatient, outpatient concepts directly in support of our minimally invasive solutions. With respect to economic models, we are now at the validation test stage of the reimbursement models that will be utilized with both payers and providers. These models will be utilized to demonstrate the economic effectiveness of the value proposition at the heart of Zimmer MIS procedures. This preliminary validation work continues to be carried out by Deloitte and Touche Consulting, soon to be called Braxton (ph) Consulting. Ten hospitals are slated to be involved in the data development, including four U.S. alpha sites located in Illinois, California, Pennsylvania, and New Jersey. Three additional data development efforts are under way. Firstly, key Zimmer developing surgeons are completing phase one anesthesia and pain protocols to dramatically improve the patient post-surgical pain relief, including the potential future elimination of narcotics. On our behalf, one of the country's top health care legal firms is developing a guide book for Zimmer surgeons and their institutions with respect to MIS related reimbursement coding. And lastly, Zimmer internally is developing new MIS outcomes vehicle driven by our focus on patient quality of life -- developed under a Zimmer brand called the patient diaries, these documents will qualitatively and quantitatively track a long list of improvements, utilizing Zimmer MIS and the patient's return to normal life.

As we've said so many times in our efforts to put confidence in surgeon's hands, our Zimmer MIS program is not about the patient having a small incision, but rather about that same patient living life big.

On that note 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 performance - Sam.

Thanks, Ray.

I'm very pleased to be able to report a terrific quarter topping off an equally terrific year and financial performance for Zimmer in this our first full year of results following our spin off from our former parent. As in past calls, I will try to add a bit more granularity to Ray's comments while focusing on a few specific key areas in the profit and loss statement, balance sheet and cash flow statements for both the fourth quarter and the full year 2002.

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 2002 will be compared to the same pro forma financials that we reported last year. The pro forma results of the fourth quarter 2001 exclude $13.9 million of separation costs. Also, in the fourth quarter of 2001 was our first full quarter as a stand alone public company. And therefore, unlike the first three quarters of 2001, there were no further pro forma adjustments necessary for interest expense. As I have done on previous calls, before I move into the financial statements I would like to provide a brief update on our JD Edwards ERP conversion. Phase two of our conversion, which incorporates all of our manufacturing systems requirements, was successfully completed during the fourth quarter. We are now turning our attention to phase three, the third and final phase of our systems conversion initiatives which involve certain aspects of our order to cash cycle. The program modules associated with this phase are being tested and verified now with completion targeted to occur in the second quarter of 2003.

And now a few comments on our financial results. We finished the year with a record quarter hitting basically on all cylinders, including sales growth, operating profit margins, working capital management, free cash flow and debt reduction. In the area of foreign exchange, the continued weakening of the U.S. dollar across most currencies compared to prior year has turned what had been a negative translation effect on sales throughout 2001 in the first two quarters of 2002 into a positive one for the third and fourth quarters of 2002. In the aggregate, foreign currency translation rate changes contributed $5 million, or 1.6 percentage points of growth to our fourth quarter sales results.

In constant currencies, sales growth for the quarter was 17.2%. For the full year 2002, the effect of foreign currency rate changes was zero as the favorable effects in both the third and fourth quarters of 2002 neutralized the unfavorable effects that occurred in both the first and second quarters of 2002. The yen, which had been strengthening all year, began to level out in the fourth quarter and finished the fourth quarter on an average yen to U.S. dollar exchange rate of 123. That compares to the same 123 for the fourth quarter of 2001. At the same time, the euro strengthened by 11%, finishing the quarter at an average U.S. dollar to euro exchange rate at parity compared to an average of .9 in the fourth quarter of last year. As a reminder, under our former parent, we were required to record the settlement of foreign exchange hedge contracts in SG&A. During 2002 we recorded them more conventionally in cost of goods sold. And as a result, we have 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.

A commonly asked question is what will the foreign exchange effect on 2003 sales growth rates if the foreign exchange rates hold for the balance of the year? If the yen holds at 118 and the euro holds at 1.08, the effect on sales will be a 2003 versus 2002 increase of $28 million. That's $12 million for the yen and $16 million for the euro. As a reminder, we do manage our foreign currency exposure on both the yen and euro through the use of forward contracts. We have 2003 hedge contracts in place for the yen and an average for the year of 126 compared to 115 for 2002, and for the euro at .96 compared to .87 for 2002. The effect of these hedge positions had been included in our recent guidance for 2003. Our all ineffective interest rate for the quarter continues to be very low at 4%, resulting in interest expense for the period of $2.1 million reduced from $4.4 million in interest expense in the fourth quarter of 2001 and also down sequentially from $3 million reported in the third quarter of 2002.

Zimmer's year-to-date effective tax rate for the first nine months of 2002 was 33.7%. And I indicated during our last quarter's earnings conference call that this rate should hold for the balance of the year. My expectation at that point was accurate and we recorded an effective tax rate of 33.7% for the fourth quarter of 2002.

And when you are developing your models for 2003 and beyond, an effective tax rate of 33.7% continues to be a very reasonable assumption. Our profit and loss results for the fourth quarter continued to demonstrate our commitment to deliver sales growth in excess of market growth and to leverage cost of goods sold and expenses to grow at a slower rate than sales. As a result, in the fourth quarter we were able to deliver sales growth of 18.8% while at the same time grew gross profit by 21%, operating profit by 29.3%, and earnings per share by 37%. Similarly, for the full year 2002 over 2001 we increased sales by 16.4%, increased gross profit by 18.3%, operating profit by 26 % and earnings per share by 33.7%.

Turning to the balance sheet, we continue to deliver best in class performance in days sales outstanding, DSO, particularly in the United States. Consolidated DSO for the fourth quarter was 52 days, which is equal to the same period last year and three days lower than the last quarter. In the U.S. we finished the quarter with a new record low of 31 days, four days below the fourth quarter of last year and one day below last quarter. This quarter, the fourth quarter, we also saw sequential quarter improvement in Europe of 14 days, at the same time Asia Pacific was in line with last quarter's performance. During last quarter's earnings call we communicated our target and finished the year with 250 to 260 days of inventory. I'm pleased to say that we overachieved that target finishing this year with 247 days, three days better than our target, 21 days below the third quarter, and 26 days above last year due to the building of inventory necessary to support our new product launches.

Operating and free cash flows for the quarter were $83.2 million and $73.2 million respectively, and for the full year were $220.2 million and $186.5 million respectively. Key drivers to our strong cash flow for the quarter include our 39% increase in net income, as well as our improvement in DSO, days inventory on hand, and the cost payable days to pay in the fourth quarter compared to prior quarter.

Many public companies place emphasis on the growth of EBITDA as a surrogate for cash flow. While EBITDA growth is also important to Zimmer, driving strong growth in real cash through both operating and free cash flow is even more important to us because real cash flow is our source of debt repayment and will also become a critical source of acquisiton capital. We typically generate between $150 to $200 million of free cash flow annually, and our $186.5 million of free cash flow represents 16.4 % over prior year. And that took us to the higher end of that range.

Some of you may recall that our capital expenditures for 2001 were $55 million, which was a direct result of the spin off from our former parent. During 2001 we established our first information technology hardware infrastructure and invested in our new JD Edwards ERP systems and expanded our manufacturing and distribution capacity. We indicated at the end of 2001 that going forward our capital expenditures would drop back down to our historic levels. Capital expenditures were $10 million during the fourth quarter and $33.7 million for the full year 2002. Slightly favorable to our targeted range of 35 to $40 million. Maintenance capital continues to be in the vicinity of $25 million annually with a balance of our capital needs driven by unit volume growth as well as new products.

As many of you know we started our life as a new public company with zero equity and $450 million of net debt. While we are grateful to our former parent for allowing Zimmer to begin with investment grade balance sheet we knew we had to pay down debt quickly and build equity even faster. Today the balance sheet looks like a very different company. During the 16 months since the August August 6 sin off date we have our equity to $367 million from zero. We have decreased total debt by $293 million to 157 minimum and we have also decreased net debt, total debt knelt of cash by 309 million to 141 million. Debt to total cap at the end of the fourth quarter is 30%.At the rate that we generate free cash flow excluding acquisitions na may be completed in 2003, our net debt position should be close to zero early into the fourth quarter of 2003. Our interest coverage ratio is 56 times, return on assets is 32% and return on stroir shareholders equity is 116%.

As we discussed on the last several calls, if you look at the impact of FAS 123, accounting for stock options as an expense, the effect on prior years can be found in footnote ten of the 2001 10-K. Based upon the tolls options issued and outstanding as of today the full year effect on 2002 and on 2003, if we were to expense employee stock options wb a reduction of six cents in earnings per share in each of those two years. As you recall from the guidance discussion during the third quarter conference call, our guidance in previous quarters included only the effects of volume growth and mix, but omitted pricing. In our current guidance which covers the full year 2003 we tried our best to incorporate the expected growth, mix an pricing. Given the volatility that we have seen this year in foreign currency movement the guidance assumes no movement of foreign currency translation rights rates. Zimmer completed a year out posting the market in revenue growth. Our comps continue to be more and more difficult.

As stated in the earnings release, we expect revenue growth for the full year and first quarter 2003 over 2002 to be in the range of 13 to 15% while earnings per share growth should be in the range of 15 to 17%.These growth rates imply full year 2003 revenue expectations to be in the range of $1,550,000,000 to 1,578,000,000. At the same time earnings per share to be in the range of a dollar 51 to a dollar 53. This implies first quarter 2003 to be in the range of 361 to 367 million an earnings per share to be in the range of 32 cents to 33 cents. Our guidance also maps our policy of requiring a minimum of one to 2% planned revenue growth above anticipated reported market growth. As a reminder our earnings per share guidance incorporates the statement made in the last quarter call that we will be doubling the direct 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 closing remark.

Great. Thanks, Sam.

Let me make one minor direction correction in my comments. I indicated I was inviting Dr. Berger to the analyst meeting in New Orleans. That's an error. I should have said the Wednesday an list meeting. It was a strong quarter an year we one we are pleased with. Sixth report as a public company. It continues to be a thrill for us. Some of the year's highlights allow us to celebrate our own internal goals. We surpassed, sold more than 200 knee femoral. 75% gross margins, created quality leverage that reported more than a billion dollars in net earnings nd sought after 30-20 come 96, 30 % operating margin and 20% net margin. Almost 200 million in free cash flow reduced t debt to cap-ex below 30% and people stuck together as always. With the industry's lowest sales force turnover rate, incredible average of 16 plus years with Zimmer for our more than 1400 war saw based manufacturing employees and senior management team without change. That old saying delivers sage advice. Stay with those that brought you to the dance and we have. Not only in people but also the formula for operating this business.

Our formula is not fancy. It depends on metrics and execution and easy to communication. It returns to the business. Discover innovative premium products to improve a patient equality of life requirements. Put competent tools in the surgeon's hand and drive market growth profitability. Industry's best working capital and asset management an drive the business to maximize free cash flow. Utilize this cash flow in three ways, pay down debt, make accretive acquisitions take fit, and/or accelerate organic R & D at growth rates higher than sales. Use the acquisitions or the R & D to close the loop again with more innovative premium new products and procedures to attract new patient and competitive surgeons for market share gains. Simple formula that has been very successful for us. Thank you for your time.

We look forward to the questions. April, would you take over depend please?

Yes, sir. Thank you at this time I would like to remind everyone to ask a question simply press star and then the number one. We will pause just a moment, sir, to compile the Q & A roster.

Thank you.

You're welcome.

Our first question comes from Avi Horrab (ph) of JP Morgan.

Good morning, guys, congratulations on the quarter. Ray, you do a good job breaking out mix for us. If you look just at Europe can you give us a sense of where you think mix is by product high, such as highly crosslinked porous, poly, perhaps where you think the market is, where you think your bigger opportunities lie?

Well, you made a key opinion. We don't break it out. I'll try to answer the question in a different way. I think the mix program -- my sense is the market has about two and a half to 3% of mix in general in hips and knees. That's not Zimmer, but the market. I would suggest to you given the release times an the newness of some of the mixes, particularly the Trabecular metal an the flex on the knee side, I would suggest that we are a little bit behind that curve and therefore our growth in Europe would be much more oriented to procedural market share gains than it is to mix and price. Of course, price we have identified for you in Europe as one to 2%

Okay. If I can follow that up, just looking at the trauma business, it has been a little bit up and down the last couple of quarters. Can you maybe talk about what you are expecting from the market in 2003? An then perhaps comment on where you think you should play out both in the U.S. and overseas?

I think the market is going to be nine to 10% growth as far as I can tell. It does have some earnings variations in it. As we all know, weather can be, if it's significantly different weather, car accidents and such change. Nine to 10%.We have been a little inconsistent, the IT S T and some of the timing has fluctuated the numbers. As I commented, there were some inordinate sides reamer set sales that I didn't notice until we started doing the comp comparisons until after the results and for this presentation. The other thing I've noticed and I would compliment striker on this, people have come out with a couple of real good I M nails. There's a particularly good one, the T two. You have to battle that early when people come out with a big program. I don't see us being off the market number. The IT S T will have a good impact. The other products are coming along nicely. It fluctuated a bit by quarter.

If you looked at the first half versus the second half of this year, you think you could be up in the U.S. single digits in the first half and maybe accelerate to the double digits in the second half?

Avi, you and I have talked enough that I don't give guidance by product.

Well, I try.

I'll let you have a good try at it.

Gentlemen, our next question comes from the line of Milton Schuch (ph) of Bear Stearns.

Good morning, guys. Couple questions. As Europe is growing to be a larger percentage of your corporate sales what type of impact do you expect on gross margins? Will that offset or nearly offset some of the improvements you have made in operating efficiencies or manufacturing's efficiencies? Second, turning to product mix, ray, with the Prolong in the knees, where do you expect that to top off as converge interest rate? Mechanical issues are faced there are different than the hip and the hip is 85%, maybe you expect this to convert 40, 50% of existing liners?

Yeah, okay. First on Europe, I think what we've always said is, I mean, I don't think we are necessarily thinking it is going to continue to grow at 3030% rates, but Europe continues to look attractive for us, obviously. We have lots of room to grow there. Mostly what I have said in investor conferences, I'll stand by it, it's certainly possible that any given quarter with Europe growing at that rate we could have some basis points reduction in our margin. Where it is today or restrained margin expansion, depending on how you look at the world. I think we can run into danger by getting overly ratio crazy. One the reason we look at margins to make sure we are doing the exponents of the business properly and to look for down sides in our part and places to improve.

I don't have any trouble saying to anyone, investors, analysts or otherwise, that if our margin drops, you know, 20 basis points or 30 or whatever it may be because Europe is growing at 30% and dropping a lot of money to the bottom line, I'll take the cash to the bottom line and explain the margin contraction. It is possible Whether we can do enough to offset it in manufacturing, I hope so. Then we get the benefits of all of it. I don't see anything in our management of any of the components cogs lines or Europe that disturbs me in the slightest, including dropping the margin a bit as long as we are generating tremendous leverage in Europe to take the cash to the -- secondly on Prolong, it's a tough one to answer. Our own internal gut feeling in some of the planning is we might get to the 50, 60% range. You said 40, 50, I don't know that I would argue with you. None of us believe it will get to the levels of hip liners. I'm surprised at the take off it has had already on a C R basis only. I'm not sure we won't be proven wrong.

You mentioned possibly internally developing projects in spine in the Puerto Ricon facility. Is that heart wear? Hooks, screws?

The latter. We have always said one of the options -- we have not done a lot of work about it at this point, they're out talking to people. One of the things we have seen in the spine is not only the growth in the market and all the things we all see, but we noticed in talking to everybody, other than the couple of big players at the top, everybody out-sources the manufacturing. They are missing the opportunities in the terrific margins you see in the spine. They are missing the opportunity for vertical integration. We have a great plant in Puerto Rico. We renegotiateed the tax position, doubling the size of the work force an we have great folks. We have vertically integrated, huges, screw, wires, plates into a plant anyway. The reason we are parallel starting this project now to take a look at buying drag frogs, buying rights or drawing our own, is simply because the valuation process has been unsatisfactory in the basic areas an we need to make sure we don't lose time in entering the market. I see the whole Puerto Rican opportunity as terrific. Whether we acquire or go internal.

Thank you.

Thanks.

Gentlemen, your next question comes from Bruce Jacobs (ph) of Deutsche Banc.

Thanks. Congratulations, guys. Can I ask a question just on the minimally Ip vase I have hip product, can you at all set our expectations on what sort of ramp we might see and what impact if any it will have on overall hip growth an talk about where pricing is on that product?

On the first part of that Bruce, the way we are thinking about it and planned it, that's why Sam commented on the 20 million. The $20 million of investment in '03, we are assuming for planning purposes here a zero return on. In other words, it's all in and nothing back. The assumption being that everything we are doing is for the future and the training we are doing is all existing for the most part existing Zimmer surgeons. Therefore they would have been doing our hips anyway. The assumption on the favorable side is that starting the fourth quarter we will start to see revenue pay back from competitive surgeons. The one thing we haven't gauged in that we've already seen early and we did not plan for it is the ability of existing Zimmer surgeons that are trained and use this as an effective marketing tool to in fact increase their own market share. Therefore we get more hips anyway.

We have not accounted for that because we don't know how to account for it. From a pricing point of view, these are existing stems, as you know x for the most part. Our plant at this stage is to sell the implants at as high a price as we can, as the market will bear. We are looking at various methodologies that will allow us to do different things for the instrumentation point of view, look at per case revenue systems and look at some of the other various combinations. That work is being done partly by us and partly by Deloitte and Touche or brakes ton cult consulting. We haven't concluded where we will end up on the various marketing strategies on price. But as of today we are selling the stems, cups an liners as high a price as we can and the market will bear. It is existing product.

One other question with respect to price in the U.S. It sounds like it was close to the reimbursement, I take that to mean the six to 7% range. You guided to more like 3% price. Have you gotten push impact on the price increase which causes you to be conservative? What's the difference for -- there is always a difference between what you take and what you realize. I'm wondering what the main Reno for the Delta is.

Two fundamental reasons. One you hit on. The 7% or anything in that range, I think it eye pretty close to that when you average it, and I think in reality coincidentally it makes the R G 209. I don't think we planned it that way. It is list price. We have contractual agreements in some aces. We have capped policies. We have the so-called stick rate factor history. We can calculate pretty much within reason what is going to stick an the estimate is in that range. Secondly, I said for 18 months now that while while I'm thrill and I hope I'm wrong and it stays at five forever. I hoped -- I'm always positive on a disposable basis at two to 3% with the U.S. being at the high end of that, about 3%. I don't have a statistical backup for that. It's my best judgment on what is going on in the industry. On the push back question, no, we have not had, to the will best of my knowledge, any significant bush back on it whatsoever.

Thanks again.

Your next question comes from the line of Katherine Martinez (ph) of Merrill Lynch.

Thank you. Just a couple questions. First, a clarification, Sam, on some of the guidance. Just wanted to make sure that does or does not assume a currency benefit? Because it does seem with where the parities are right now you would be looking at a pretty significant currency benefit in the first ort quarter of the year. It wouldn't be linear, pretty weighted into Q1.

When we set the guidance at the end of the third quarter, as you recall, Katherine, it was late in October when we announced the third quarter earnings, we assessed the foreign currencies at that point in time. We hadn't really changed them since then because they are pretty volatile, as you know. It's anybody's guess what is going to happen at the end of the year year to the two big currencies. They are bouncing around. The end isn't too far from where it was at then of the third quarter. The Euro moved a bit, as you know. But on the whole because the yen is a big part of the business although we don't believe it will have a material effect unless it continues to move in the direction it's going today.

Okay. I'm sorry, just be clear. You are not assuming in any of your guidance right now any currency benefit in the top line?

We are assuming to the extent that the currencies had moved and at the end of the third quarter versus what the average is for 2002, there clearly is a currency benefit. You have to assess the movement since the end of the third quarter to see if there's any more.

Fair enough. Secondly with respect to C N S in your comments regarding the reimbursement increase for D R G 209 being better than expected helping on the pricing side, is it fair to assume that the flip of that argument, flip side of that argument would be that come August, if there is any change, if it was a negative one or 2%, that the, it would be more difficult to get that price increase in place an the counter argument or push back from hospitals would be based on where reimbursement has gone?

You're saying the new reimbursement for next year?

If we get to August and D R G comes 209 comes out and it's down 2%, which wouldn't be that meaningful but would it limit your able to go back to the hospital as we get to the next shot of price increases and have to give something back to offset what they are losing on the.

I don't think it's a situation of give back. As you know, the C M.S. is a very complicated formula. It is a lagging indicator of about anywhere from 18 months to 24 months. I would suggest to you what would happen under those circumstances is two portfolio. One, we don't do the price increases according to the D R G. We do them according to competitive strategy on a by line item basis. The fact take we came around the D R G is simply coincidence and nothing more. Second, it might inhibit your ability to get considerably higher price questions increases. But as you know, our guidance has consistently been two to 3%. I still believe that's where it is going to settle in. I don't think any, unless it was dramatically negative reimbursement, would have much effect on that. Thirdly, inside our business we do not allow people to plan the business in here using any price or at least using very little. We take a look at what the absolute minimum is we are sure we can get. But we don't get carried away with allowing people to plan the business based on substantial unsubstantiated significant price increases. I'm where I was in August of '01 and I haven't changed very much.

Great, thank you.

Your next question, gentlemen, comes from the line of Kurtis Kruger (ph) of Banc of America.

Hi, guys. Can I ask if I can understand a little bit better, you drew attention to the out margin hitting the 30% level and cue dose to you for that. Could you give us a sense of how that might contour into the new year? It would be nice not to fall below that in any of the quarters and if we could potentially see a rise again through the year like it did this last year.

Are you saying I should just agree with you and we can conclude it will be 30 each quarter?

No, it's sort of a ratchet effect. It won't go down again and go up potentially from there.

It's certainly one of our internal targets to hit the 30-20. We think that's a great place to be in this business, in a growth business. You are going to see it fluctuate simply because the quarters vary in terms of their sales application to fixed costs. Our out pouring of new products. I would like to average around that figure. There is no question. Whether we drop below it in any b driven given quarter or in fact go above it and hit 31 I don't think is a big issue one way or another. We don't look at it as we must have a recorder. The recorders vary in the application of dollars, but I would certainly like to average it, yeah.

I think you mentioned to one of the analysts that, the question about the less in advice I have hip systems that are out there an how you made appear investment like that. Give Can you give us a rough ballpark in what we might see in revenues in the knew year here from that? Would it be ten, 15 20, $50 million revenue?

The planned assumption at this point is zero increased revenue directly associated with MIS. We planned it that way to be conservative. I believe we will see revenue under the context of what I described in the previous question. That is this: A, I think we will be training competitive surgeons on or before the beginning of the of fourth quarter. That's new business. Secondly, I'm seeing something that I didn't expect to see this early. I'm seeing some of our own surgeons get, you know, significant market share gains because they have the capability to do this and because patients are coming to them. We did not plan either of those things and we only planned the $20 million hit with virtually no return. So I can't tell you what it is going to be any more than that because I don't know.

That's fair. Thanks, Ray. Any alternative materials, hip materials? If you could remind us as to what you are doing in terms of ceramic, metal to metal?

We are not doing anything metal to metal. We have to. We went crosslink poly all the way. Ceramic are is our back up position. Not only the fact that we describe ceramic heads, but the more interesting, ceramic one. We have the Trilogy product called the A.B. in Europe. That has been there now for, I'm going to guess and say a year on the exact date. In terms of the U.S. marketplace, we have been working with our friends and partners in plex on their clinical work on ceramics here. We don't have our own product but we do work with them, assisting in their trial, so so. That's the limit of our involvement. We placed a lot of faith in crosslinked poly.

Gentlemen, the next question comes from the line of Greg Simpson (ph) of A.G. Edwards.

Ray, the numbers are so good, I'm willing to show up Tuesday night for the analyst meeting and I'll sit and wait for 24 hours.

Bless you.

You gave out so much information on the calm, but let me ask you a question about Europe. You certainly described what is driving driving that growth. Does the strong performance you guys are enjoying over there, does that make you more or less motivated or interested in making an acquisition to bolster your present Z presence or you're doing so well now that you're willing to grow your way into a bigger size?

We are thrilled with the performance, but one of the things you note if you look at our earnings over there on great performance, we built an infrastructure an management group over there purposely, that now creates earning anywhere in the 17 to 25% range as opposed to an average of mid 40s for Asia and America. The reason for that is not that the business is poorly run. It's because we built an infrastructure that can withstand more sales, particularly in the northern part of Europe. We are much stronger in the south. While I'm really thrilled with the performance of our people over there it hasn't changed a single thing. I want a much larger, quicker, more dramatic growth over there and much better earning is really what I'm talking about and organically it would take -- you know, I'm not getting younger. Organically it would take longer than I would like to spend. I don't think anything has changed.

Great. Thank you. Two follow-ups, if I could. One, on ceramic. What is your expect expectation? Striker and Wright obviously wisely don't want to be too specific on what they expect when we finally get in the ceramic on ceramic approvals here in the U.S. What is your expectation as to what that will do to the market dynamics, especially here in the U.S.?

We are not speculative on my part an I sort of looked a little bit at their product lines to the extent I can. I think there's going to be some reasonable utilization of it with a very young patients. I think it's a good go-to strategy. I don't disagree with it. I'm not a metal on metal fan. We just -- I am not the science person here, but we have done so much looking at that and concluded that's not where we want to be. I'm not sure that won't level out over here. Ceramic on ceramic is a good go-to choice. I don't know what %age they will become, but I've seen numbers as low as five and high as 20. I'm thinking it's going to be 10 10 % of the market. Again, I'm the competitor you're asking. I think it's more important that they provide the answers to you.

Okay, thank you. Finally, then. To follow up on Kurt's question, asked in a little bit different way. Is there a long-term target, you can define long-term anyway you want but along term target on operating margins you might be willing to speak to?

Yes.

Yes, there is and no, I wouldn't speak to it. We don't give guidance on the range and EPS and sales. Yes, we have interesting targets.

Good.

One thing I would say, Kurt was focused on the fourth quarter, we got the best leverage of all the quarters of '02, giving us that 30%, but for the full year the operating profit margin was 29-point 2%. If you look at the guidance, the guidance is suggesting that EPS will grow at a couple of points faster than revenue. It can't get there throughout without strengthening in operating margin margins. Don't look at it in one quarter than key off that. We are getting better an better in the venss but look at the effect of the full year an as you develop your models, what sort of operating profit margin improvement you need to have to get that exa extra couple points of kick in that the EPS growth line.

Fair enough. Gentlemen, congratulations again and look forward to next week.

Thanks.

Gentlemen, your next question comes from Bob Hopkins (ph) of Lehman Brothers.

Thanks very much and good morning.

Hi, Bob.

Two very quick questions on minimally invasive. One, I'm wondering if you can look out on the next two, three, maybe four years and give us a sense as to what kind of penetration possibilities are out there in terms of sort of structural limitations to the market. How good could this get after some time passes and some physicians get trained and so forth? And then secondly, clearly you guys are in the lead here. Investing almost infinitely more money than anybody else. To what degree, though, longer term do you think about this as a protectable franchise on MIS? An that's it.

Both good questions. If I look out five -- I'm going to stay with the hip unless you want me to answer both. If I look at the hip based on what I know right now an surgeons we talked to and assuming the following, that's that we do not do patients that are morbidly obese, we do not do revisions and we don't do (inaudible). I don't necessarily agree that will be the case. I think we'll beat a couple of those situations. If that is the case, I certainly think this looks like it will apply to 30, 35 % of incoming patients. I'm not the one na makes the call on that. That's input from surgeons. I think if we can't convert everybody to porous or find a way to use cement and we can get to the revision situation which we may very well do over time, then obviously that number goes up.

On the second question, protectable is not worth. Depends on what you mean by protectable. We have a ton of associated I P in, from epic and peak and Trabecular metal and fiber metal an various designs designs and so on. To the extent that you can link an MIS friendly hip stem with I P protect t pro protected technology and some I P protection in instruments an a great system like Metronic has as a partner, you can become a tough combination, either from an I P or marketing point of view. I still believe an I go to conferences where people say yeah, but anybody can do this. It's just instruments and implants and anybody can -- anybody can do it. There may be some truth to that in a way, but I have been around this business long enough to know that two-year lead, strong partners, great IP, a teaching system an patients coming in and asking for it and some consumer direction in the business gives you in some ways as much protection as you might have as you had with patents, as an example. So I think it's protectable as long as you are determined and aggressive about being the leader and not had letting anybody take it away from you.

Very fair. One quick follow-up. I think it's time to spin off one of the things that you talked about as far as opportunities downstream was the opportunity perhaps to partner with either pharmaceutical or biologics companies as distribution partner. Any update on that opportunity or potential?

I didn't update that one and maybe I should have. We've got two conversations, actually the pharma companies have slowed down, not us. We have two that are really, really interesting on going. I don't bring them up for the last couple of times in the calls not because there is not activity, but they have been slowed down for technical reasons as opposed to not wanting to distributor work with us. I actually initiated two weeks ago an opening conversation on a their one where I think the orthopedic surgeon can be a gate keeper and advisor back to the general practitioner. But I don't bring it up. There's nothing to keep there. I just don't bring it up because I don't think there's enough progress in it because of technical issues they have. I don't plug it in here just to say it for the sake of saying it.

Great. Thanks very much for the comments.

Thanks, Bob.

Gentlemen, the final question comes from the line of Bill Plovanic (ph) of First Albany.

Great, thank you, good morning. Just a couple questions. First on the spine, a little more clarification. Considering the fact that you are focusing on the MIS an the knee and hip business, could we see you focus on that area in the spine as well? Number one. And then number two, just a little more detailing on your comments in regards to re-too long a portion of the Z M R line, if we could.

Sure. On the first one the answer is yes, absolutely. In fact, we are both working on and looking at some things internally as well as talking -- some of those unique technology companies in spine I was talking about as opposed to the baseline products are in fact involved in some of the opportunities within their shops, looking at strengthening the MIS position. The re-tooling word I used to Z M R is no different than the press release or feedback we gave people and output we gave people. It is a peculiar situation. It's great product line, very well accepted, but we did have some breakages primarily in Europe. The break aways were because of philosophical difference. It's not -- you know, the surgeon is never wrong an we are never wrong. He's never right, we're never right.

There are some differences in terms of proximal support philosophy. This product, especially when you get out into reduced types of bone, type two, type three, so on, this requires proximal support in order to be effective. Our tern concern is, we can leave it out there and it's a great product, or we can take it off for lack of a better term, fatten or thicken that proximal area appropriately, modify the proximal, retool it an put it back on the market so that we have a better opportunity to make sure patients and surgeons are happy with it. That's all there was to it. It was a market withdrawal because, by classification in general anyway, because there's not a risk here if it's used properly an there's no design flaws in the product. Nevertheless, we have an obligation here. You know, you sate hate to see the words recall floating around or stuff like that. It damages, people are jumpy in the marts markets now. We have an obligation to patients and surgeons, too. It was not a recall, but it's hard to explain that to people. Our obligation is do what we are doing from a regional point of view, put it back on the market, make sure patients and surgeons are comfortable with it. That's what we did.

Great. One question for Sam, if I may. Sam, on the guidance for the first quarter, you know, if we look back, the past couple of years from the first quarter to fourth quarter to the first quarter, industry itself, it's difficult to find a first quarter that is below fourth quarter on a revenue basis. Usually we could see a tick down in EPS to the first quarter from the fourth quarter as well but not to the degree that you are guiding to. I wonder if you can comment on that further, please.

We look at the figures on a quarter by quarter basis as well as the full year. The best guidance we can come up with, given the investment, the MIS, the fact that we have a different set of hedge contracts going into '03 from '02 and a variety of factors like that, the guidance that we gave with the first quarter being on par with our expectations for the full year, we believe is appropriate.

Okay, thanks a lot. Again, fantastic quarter.

Thank you.

Gentlemen, at this time there are no further questions. Are there any closing remarks?

No, I don't think so. Thanks for your help, April and for everybody still listening, we'll see you in New Orleans.

Thank you for participating in today's conference. You may now disconnect.