Zimmer Biomet Holdings Inc (ZBH) 2003 Q1 法說會逐字稿

Good morning, my name is Sheika (ph) and I will be your conference facilitator today.

At this time I would like to welcome everyone to the Zimmer Holdings, Inc. conference call.

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

After the speaker's 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.

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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 forward-looking statements are described in the Company's filing with the Security 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.

The information provided on this conference call and included in the Company's earnings release contain certain non-GAAP financial measures.

Such information is reconciled to the most directly comparable GAAP financial measure, also contained in the release which will be furnished on a Form A-K and may be accessed from the Zimmer Web site at www.zimmer.com.

Mr. Elliott, you may begin your conference.

Great, thank you Sheika (ph).

Good morning, everyone, and welcome to the Zimmer first quarter 2003 conference call.

We're pleased to be hosting this call to discuss a solid quarter and a good beginning to 2003.

Today's call will be scheduled for one hour.

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

I hope you received 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'll have a copy faxed to you as well as add you to our e-mail distribution for future releases.

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

Unless otherwise noted, we will be discussing our reported results for the first quarter, and for the first time since our spin-off, without comparisons to prior year pro forma results.

It's a welcome change for us and hopefully for you to be past that stage in our evolution.

Let me begin with the fundamentals of our consolidated P&L and balance sheet performance.

Consolidated sales for the first quarter were 390 million, an increase of 22 percent over prior year, approximately 5 million higher than current consensus Street expectations, or 23 million ahead of the consensus prior to the pre-announcement.

Worldwide sales in constant currency increased to 18 percent.

This continued solid performance was importantly led by real volume mixed growth of 14 percent in the quarter, or a one percent acceleration in sequential price volume quarterly growth from fourth quarter 2002, and three points better than prior year fourth-excuse me, first quarter.

Worldwide price improvement remained firm at four percent and similarly, the Americas price increase was also four percent.

Our Americas business continued its excellent growth in the quarter at 19 percent and Europe has dramatically increased reported growth gain versus prior year to a whopping 46 percent.

More on Europe later.

We experienced improvement in Asia Pacific sales growth to 21 percent.

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

All ongoing results that I will be providing exclude the accumulative adjustment of $55 million, or 27 cents EPS, related to the change in accounting policy for loaner (ph) instruments.

Sam and Jim will provide a very detailed explanation of the accounting policy change and its implications under their remarks.

Diluted earnings per share for the first quarter were 41 cents, an increase of 46 percent over prior year and three cents over consensus Street estimates.

Excluding the period effect only of the accounting principle change, diluted EPS increased by 39 percent to 39 cents, or one cent higher than the top end of our pre-announcement range of 37 cents to 38 cents.

In the quarter, cost of goods sold increased by 20 percent versus a 22 percent increase in sales, based on favorable product mix, price and our continuing successful efforts to reduce manufacturing costs.

Dramatic growth in our Europe business had somewhat lower margins and the impact of foreign exchange hedge contracts acted as period offsets to even stronger potential margin expansion.

Gross profit dollars increased by 23 percent and gross profit margins versus prior year improved by 50 basis points to 75.2.

This gross profit margin of 75.2 was sequentially an increase in additional 50 basis points from fourth quarter 2002.

We believe that at 75 percent or more, our gross margins remain the best in the industry.

SG&A expenses were well managed at 38.4 percent, a 180 basis point improvement over first quarter 2002 and a sequential improvement of 100 basis points from prior year fourth quarter.

For your reference, over a full three years we have delivered an average of 200 basis points per year, or 600 basis points of cumulative improvement in SG&A, from the 44.4 percent ratio recorded in the first quarter of 2000, to the 38.4 percent recorded today.

For the quarter, SG&A expenses increased only 14 percent, despite a 22 percent sales increase.

We continue to be very pleased with the leverage and the quality earnings gained from new sales.

Each incremental sales dollar in the first quarter cost only 27 cents of incremental SG&A spending, our lowest cost per new sales dollar since we became a public company.

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.

Our ability to drive significantly leveraged operating earnings from every new sales dollar is not only crucial to our strategy and an EPS advantage, but provides broad flexibility for potential reinvestment.

We continue to successfully operate our working dollar's model, driving down cost of goods sold, cost of capital and G&A expenses, while investing in sales and pipeline development.

This particular metric model is in its fourth year of success.

We also continue to execute our strategy to invest in R&D at the top of our class, with a consistent target of approximately six percent to sales and this quarter at 5.5 percent, albeit against a higher revenue base.

Perhaps a better measure this quarter, our R&D investments at $21 million increased by 2.3 million in absolute terms versus the first quarter 2002.

We're very pleased to report that operating profit grew in the quarter by 38 percent over prior year, an increase of 360 basis points versus prior year.

These results represent continuing achievement of one of our many internal milestones of 30 percent operating margin.

This quarter overachieved at 31 percent.

Net earnings in the period increased by 47 percent based on solid operating profit, declining interest expense, down to only 1.4 million for the quarter, and a significant reduction to prior year tax rate, from 35.6 percent to 33.5 percent.

Net earnings not only surpassed a new record of $80 million for the quarter, but for the first time in any historic quarter, driven by a 350 basis point improvement over prior year, over-achieved the magic mark of a 20 percent ratio to sales.

During the quarter we achieved a 21 percent net earnings ratio to sales.

As previously mentioned, diluted EPS in the quarter increased 46 percent, to 41 cents, with 198 million average diluted shares outstanding.

At this point, I'll provide some very brief introductory cash flow and balance sheet highlights.

Free cash flow for the quarter was at the extreme favorable end of our expectations, registering 72 million, while operating cash flow was $105 million.

In the quarter, inventory has been increased by $8 million to a level of 266 million, but as indicated from previous calls, at 247 days, remains low within our near term forecasted range of 240 to 260 days.

On a normalized basis, Zimmer operates its inventories with high service levels at 210 to 230 days.

This continues to represent, with our product line, approximately an 80 to 100 day inventory cash contribution advantage over comparable orthopedic competitors.

Consistent with prior quarters, our flow rate accuracy is more than 98 percent, and our global forecast accuracy on thousands of SKUs is more than 90 percent.

Asset management focus, dedicated infrastructure, and attention to specific working cap metrics continue to drive effective inventory performance.

Our industry leading receivables collections continues to provide support for consistently high cash flow production and helps define some of the top balance sheet metrics in the medical device industry.

In the first quarter, we continued our U.S. receivables at near record levels of 32 days on a hospital collections business with terms of net 30, and approaching $1 billion in sales.

We'd be remiss in not recognizing the contributions of Zimmer's international businesses that have delivered a first quarter receivables number of 55 days, up the normal amount from year end, but still more than a month faster than the industry average.

We're extremely pleased to report that our net debt has declined by $406 million from the 450 million at our spin-off in August 2001, to only 44 million at the end of the first quarter 2003.

In approximately 20 months as a public company, we have cut our debt by 90 percent and reduced our debt to cap ratio to its current position of 12 percent.

We continue to target being debt free after little more than two years of public life, excluding any cash utilized for acquisitions.

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 reported period.

For the first quarter, worldwide reconstructive sales increased to $310 million, representing an industry leading reported increase of 26 percent over prior year, 22 percent constant currency, and a sequential increase of seven percent over fourth quarter 2002.

The 22 percent constant currency increase over prior year in the quarter is a particularly important accomplishment since the first quarter 2002 versus 2001 comparison was 18 percent. 22 over 18 is the toughest local currency reconstructive comp in the industry.

This is a solid achievement in light of Zimmer's reconstructive sales base of more than $1 billion.

Many analysts believe, and we would concur, that on a reported basis, the worldwide reconstructive market grew 10 percent in 2001, what looks to be 15 percent for 2002, and assuming local currency worldwide recon growth in first quarter 2003 of approximately 15 to 16 percent, then Zimmer has, in fact, expanded our rate of growing faster than the market to more than 40 percent, in other words, 22 percent versus about 15.5 percent.

Let's take a look at each global product in geographic segment more closely.

First products.

In the knee category on a worldwide basis in the quarter, knee sales increased 28 percent to 160 million versus prior year, and 23 percent constant currency.

These results include a sequential growth of eight percent and compares to a 21 percent constant currency growth achieved in first quarter 2002 versus 2001.

In other words, 23 over 21 as a local currency comp.

In dollars on a reported basis, this represents knee gains of more than $2 million per week versus the prior year quarter.

Or stated differently, there were some 500 new Zimmer knees implanted every single week this quarter that weren't there in the first quarter of last year.

By anyone's standards, it's a lot of new knees.

Our global knee strategies are obviously paying off with consistent and significant market share gains, not in a few countries, but literally everywhere.

In the first quarter, the Zimmer businesses in the U.S., Canada, Latin America, Germany, Austria, the U.K., Italy, France, Switzerland, Holland, Spain, Norway, Sweden, Finland, Russia, Central and Eastern Europe, Australia, New Zealand, China and Korea all delivered real local currency knee sales growth in excess of 20 percent to prior year.

Even the Zimmer Middle East region, with so many difficulties in that part of our world, delivered a 210 plus percent knee growth in the quarter.

The successful introduction of Prolong, the specially designed Crosslinked Polyethylene for NexGen Cruciate Retaining Knee Articulating Surfaces is delivering great results.

In well under one year on the market, Prolong in the quarter represented more than nine percent of our total knee articulating surface sales and nearly 25 percent of all cruciate retaining articulating surface sales.

Contrary to opinion, the market uptake for Crosslinked and Zimmer knees is only slightly below what early stage Longevity Crosslinked Poly Liners was for hips.

In addition to early Prolong success, we've also recently launched the Trabecular Metal Monoblock (ph) Tibial Trays.

The annual trend on this single product has doubled in only two quarters to an amazing $20 million per year.

For the new NexGen Trabecular Metal Monoblock (ph), or one piece tibial tray, this represents not only immediate technology and commercial recognition, but a real belief in a new porous fixation solution for knees.

The subject of some competitive tibial osteolisis (ph) from Backside Wear (ph) is gaining visibility and will be published in peer review articles.

Our terrific early success with the Trabecular Metal Tibial Tray reflects a changing market.

The FDA's recent down-classification of porous knees should only stand to enhance what we already know and expect to be broad acceptance.

We're told it's a more competitive Uni market, but still our Zimmer MIS M/G Uni's have grown on a worldwide basis another 40 percent in the quarter.

All these results were measured against the toughest comps.

First quarter 2002 growth was, in fact, more than double first quarter 2001.

We recognize that other companies augment sales with more than one brand, but the Zimmer M/G Uni with both EM and IM Minimally Invasive Instrumentation finished the quarter with sales projecting to more than $40 million annually in 2003 and it remains the most popular single brand in the world.

Our NexGen LPS-Flex Knee, a Zimmer Lifestyle designed product intended to potentially and safely accommodate 155 degrees of flexion, has continued to gain share in dramatic fashion during the quarter.

On a worldwide basis, the LPS-Flex Femorals grew by another 50 percent versus prior year.

I'll update you on the progress of its sister product, the CR Flex, during our project development session.

On a different knee subject and thanks to some effective competitive sub-segment marketing, we also enjoyed a 31 percent increase in NexGen Mobile Bearing sales during the quarter.

The detailed work to support Mobile Bearing down-classification in the U.S. is proceeding well, with the file work ready for final issuance to the FDA in May of this year.

Knee Revision continues its upward trend with the NexGen LCCK System, delivering a 45 percent increase over prior year, helping to drive growth on a unit surgery basis that far exceeds growth in primaries.

Our new RHK Rotating Hinge should deliver several thousand units in new product sales this year.

Of course, there is considerable progress on the Zimmer Minimally Invasive knee front and I'll update our activities later under Hot Topics.

Let's take a closer look at hips.

On a worldwide basis in the first quarter, hip sales increased 25 percent to 127 million, a sequential increase of five percent, and grew 20 percent in constant currency.

Zimmer porous stems continue to make strong market share gains and actually accelerated their more than two year long growth run with an increase of 43 percent in the quarter.

This is the most significant growth we have seen yet, even outpacing last quarter's 38 percent increase and almost two and a half times the solid 18 percent comp from first quarter 2002 versus first quarter 2001.

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

Contrary to current reports, however, at Zimmer we're simply not seeing a slowdown in the potential role from premium mix innovative products, including the movement from cemented to porous.

Porous Revision stems, along with Revision cups and liners, continue to be an area of focus for Zimmer and our sales showed a strong increase of 27 percent.

These results include our ZMR product line, which on a stand alone basis remain well above prior year.

New proximal (ph) support design enhancements for ZMR are expected for the late summer and we anticipate a continued upsurge in sales for Zimmer's entire Revision hip line.

Our continued ability to grow the hip Revision line has clearly been augmented by the December 2002 approval of our Zimmer Trilogy Constrained Liner.

Zimmer Primary Acetabular Shells grew 22 percent in the first quarter.

Trabecular Metal Monoblock (ph) cups alone, without modularity, have quickly become a new $10 million plus product line.

Despite extremely tough comps and significant penetration, premium priced Longevity Highly Crosslinked Polyethylene Shell Liners increased by 38 percent in the first quarter, sequentially up eight percent higher than the dollar growth we saw in the fourth quarter 2002.

We believe competitive surgeon acceptance is growing with the continuing stream of scientific analysis from in vivo retrievals, new RSA studies and differentiations, specifically as it relates to Zimmer's Longevity brand.

We also expect to release in the Americas this quarter a new national marketing package titled Limit Wear, Not Options, that favorably reviews Longevity Highly Crosslinked Poly capabilities and hips versus ceramic on ceramic limitations.

Of course, there's considerable progress on the Zimmer MIS hip front, but I'll cover that update under Hot Topics.

In upper extremity joints, Zimmer's Bigliani/Flatow Shoulder has continued to take market share in the world with 29 percent growth in the first quarter, despite the release of several new competitive shoulders over the last 12 months.

Based upon the first quarter, our annual sales projections for shoulders and elbows continues to exceed $50 million.

On a worldwide basis, trauma sales have improved somewhat with first quarter sales up 10 percent.

It should be noted that our non-Japan trauma sales were up 12 percent in the quarter, equal to or slightly above market.

A review of the market, scheduled new products, early surgeon response to the new ITST (ph) retrograde femoral nail, and potential account conversions does not seem to indicate any significant negative underlying issues.

The ITST (ph) pipeline was filled in the first quarter.

This will make a real difference in future results.

Several sub-segments within our trauma product line continue to deliver excellent results, as Zimmer Periarticular Plates are making accelerated penetration against the trauma market leader with 68 percent growth in the first quarter.

Our 15 Peristahls (ph) in anatomic locations have been fully launched and give Zimmer the most comprehensive and best fitting pre-contoured premium plate offering in the world.

IM nail (ph) sales in general have been tougher to come by, with some good new competitive products catching near term surgeon attention.

In orthopedic surgical products, OrthoPAT, our Perioperative Autotransfusion System designed specifically for orthopedics, increased by 65 percent in the quarter and continues to generate sales approaching $20 million annually.

Let's switch to our new product development update.

As you know, we currently have more than 20 active major products in a robust pipeline with most of those scheduled for release during 2003.

In addition, we have 12 new projects added to the pipeline and another half dozen or so still under pre-phase review.

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, the RHK, was released and is already scoring some strong sales successes.

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

As previously indicated, Prolong, our Crosslinked Poly for CR knees was released ahead of schedule and has quickly grown to represent almost 25 percent of all cruciate retaining articulating surface sales.

We have, of course, in recent times initiated three new knee projects as follows; both the CR Flex Fixed and Mobile continue on plan, following in the footsteps of the highly regarded LPS-Flex.

Our first implantation was concluded successfully December 2nd, 2002, in Utah, and since then 80 additional surgeries have been performed.

We anticipate strong acceptance of CR Flex Fixed with a launch date in 2003.

Our new patella/femoral project with some potential unique clinical solutions continues its cadaver work on schedule.

Our new Fixed and Mobile Bearing Unis, as well as our Oncology Segmental System incorporating Trabecular Metal and Highly Crosslinked Poly both continue on plan.

MIS TK Systems for Minimally Invasive Knees, our MIS Mini and QS, or Quad Sparing, new updates will be covered 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 through 2002 and 2003, almost 200 stems were released along with full instrumentation during the fourth quarter of 2002.

The new Apollo stems that have been released have already jumped in sales to a $20 million plus product line.

On a remaining six inch full coat extended offset stems, as well as the eight inch and ten inch straight and bowed stems with a full line of high use six inch full coat stems were released on March 3rd and our first surgeries were conducted the next business day.

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 delayed to the second quarter 2003 and remains tight, but on that schedule.

CPT2, our new colorless poly paper primary system (ph) with 30 implants, eight new Revision and small stems were added to the scope of this project and fully released last month.

We expect our impaction grafting system (ph), or CPT2, to be available in June.

In antoma (ph) development and commercialization, Periarticular 2, our Contoured Plating System with 289 implants for phase-in (ph) launch has just completed final release and has already contributed to part of our 65 percent growth in Peri Plates.

The ITST, (inaudible) Retrograde Femoral nail with more than 200 new implants was released in late December 2002.

With almost 200 field support sets in place by March 30th, early forecasts indicate being 40 percent above our internal plans for the short nails, with the longer nails to follow.

We've initiated approximately 12 new internal R&D projects, some of which I have already provided initial comments on .

The projects themselves, though, present a reasonable insight into Zimmer's organic growth strategies.

Trabecular Metal stems, dedicated MIS stems, Zimmer's Segmental Oncology System, new MIS Uni unique design concepts, three consecutive advance levels of our MIS Total Knee, a new technology shoulder, some MIS spine and MIS transformational hip fracture work, and a myriad of co-development investment opportunities in biologics, image guidance and the operating room of the future.

In short, they represent innovative premium priced products and procedures, rich in intellectual property and designed more for profitable market share gain and landscape change than for simply filling competitive gaps or line extensions.

In total on a rolling 36 month basis, now products represented 16 percent of our sales in the first quarter, consistent with our long term strategic goal since 1999 to have internal new product sales between 15 and 20 percent 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 first quarter was 266 million, up 19 percent over prior year and that's measured against the difficult comp of 17 percent for the first quarter 2002 versus the first quarter 2001.

We continue to be very pleased with our progress.

A full 15 percent of our growth in the Americas was driven by the increases in unit volume and mix, sequentially up one percent from the 14 percent gain recorded in the fourth quarter for volume and mix.

The remaining four percent growth was derived from price increases.

Our Americas reconstructive growth in the quarter was 22 percent.

In the Americas during the quarter we had better than mid double-digit level gains in real surgical procedural unit volume for hips, knees, shoulders and elbows.

Included in our 22 percent Americas reconstructive growth, knees delivered exceptional results with a 25 percent increase to prior year.

Most importantly, though, this 25 percent knee growth should be judged against the tough comp of a 24 percent knee growth in first quarter 2002 versus first quarter 2001, a 25 percent growth over a 24 percent growth.

NexGen LPS-Flex, MIS Uni's, Trabecular Metal Tibial components and NexGen LCCK Revision Knee all made substantial contributions to Americas knee performance.

Since there is little mix associated with knees, this would indicate once more a surgical unit procedure growth in the quarter for Zimmer knees in the Americas of more than 20 percent.

Hips in the Americas increased 20 percent with Zimmer porous stems at 62 percent of mix, surpassing for the last trailing 12 months cemented stems in unit sales, not just dollars.

In total, we have been growing the Americas reconstructive products at a quarterly average of 20 percent for more for three years now.

Based upon the already public-released public reports of our three major competitors, in market growth in domestic reconstructive for the quarter is estimated to be 15 to 16 percent.

It is clear, therefore, at 22 percent reconstructive growth, we are continuing to outpace the rate of market growth for the Americas again by more than 40 percent.

Trauma product sales improved by nine percent, impacted positively by our new Periarticular Plate offerings and very early ITSG activity, but offset somewhat by solid competitive IM nail releases.

In patient care, OrthoPAT, available only in the Americas, continuing its rapid acceptance, became a $20 million annual product line as described in my earlier remarks.

Our overall sales success in the America is-in Americas is truly broad based.

Every U.S. distributorship grew significantly, but 13 of our 26 distributorships grew their total businesses, that is reconstructive plus trauma plus surgical products, by an amazing 30 percent in a serve (ph) market growing far less than half that rate.

Just as importantly, the Americas operating margins in the quarter increased by 140 basis points, to 49.2 from 47.8.

That is the bankable payoff for real market share gains.

In Asia Pacific, revenue for first quarter was $70 million, indicating a reported increase of 21 percent and nine percent constant currency.

Asia Pacific had positive price again in the first quarter, but struggling healthcare budget deficits in South Korea will certainly moderate this a little in 2003.

During the first quarter our Asia Pacific business was led by market share gains in local currency hip growth of 19 percent, reflecting continued conversion to porous stems, successful introduction of Longevity Highly Crosslinked Poly and early sales of ZMR, our Modular Revision Hip System.

When combined with positive knee growth of nine percent, Asia Pacific reconstructive sales grew at constant currency 14 percent and well above what management believes is high single-digit local currency reconstructive growth for the region.

We are particularly pleased with Japan's strong reconstructive products growth for the quarter.

Japan increased hip, knee and shoulder local currency sales by 15 percent in a market with mid single-digit growth.

In addition to Japan, Australia, New Zealand and the other Southeast Asian regions delivered a minimum of double-digit constant currency growth, for all Zimmer product segments combined, in the first quarter.

However, Hong Kong and China, normally stellar performers for Zimmer, were somewhat affected by SARS implications relative to elective surgeries, but the revenue impact was negligible on Zimmer in total.

Displaying excellent leverage to sales, Asia Pacific operating profits increased by 27 percent constant currency in the quarter, while operating margin ratios increased by 210 basis points, to 43.3 percent in 2003 from 41.2 percent in 2002.

We're very pleased with our strong P&L management in Asia and market share gaining reconstructive growth in Japan.

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

In the quarter, revenue of $54 million represented a 46 percent increase over prior year, but more importantly, an outstanding 26 percent constant currency growth.

We believe almost twice the served market growth was obtained by 13 of our 16 European businesses for all products combined, and 14 of our 16 businesses delivered reconstructive growth in excess of 20 percent local currency.

On the product front, as you can anticipate, reconstructive implants on a reported basis grew by an outstanding 48 percent, led by knee growth at 50 percent and hip growth of 45 percent.

Even with very solid competitive reconstructive numbers for Europe in the first quarter, it is clear that we are growing it more than double the market, with or without currency.

These gains reflected the continuing acceptance of Longevity Highly Crosslinked Polyethylene, the introduction of our European hip and cup designs, augmenting the ongoing market share gains for NexGen knee brand and Zimmer trauma.

There may be a subtle phenomena that Zimmer Europe has suddenly jumped to growth in the 20 percent plus range only in the last quarter or two.

It's actually not so.

If we look at Zimmer Europe for the last four quarters in local currency, the results are up 24 percent, up 26 percent, up 24 percent and 26 percent again.

If we eliminate price and look only at volume mix, the results are 21 percent, 23 percent, 20 percent and 22 percent.

A very solid sales story for the last trailing 12 months.

We delivered leveraged Europe operating profits that increased by 58 percent, to 14.2 million in the quarter, and essentially already quickly reached the next milestone of 25 percent profit margin to sales ratio.

This from a business that only five years ago lost absolute money on more than $100 million in sales; a great performance again by Europe.

I'll try to cover the following five topics briefly under Hot Topics: first, mix, an update on the role of mix change as it reflected in Zimmer's global results for the year; number two, Zimmer sales associate adds and update on our (inaudible) additions for 2003 first quarter and our plans for the year; pricing our latest interpretations and some additional thoughts on the CMS System and DRG 209; fourthly, Zimmer's Minimally Invasive efforts, our activities and developments; and lastly, industry forecast, some thoughts relative to facts on rumors, the orthopedic slowdown, demise or other tragedies that might befall us.

First, mix.

An update on the role of mix change reflected in Zimmer's results, and 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, in 2002 really focused on three comparisons that we reported to you: Crosslinked Poly versus standard poly; porous to cemented stems; and Revision versus primaries in hips.

For 2003, I'd like to expand our discussion with you by adding Trabecular Metal Penetration as a fourth category and by also adding knee and hips together in both Revision and Crosslinked Poly conversion analysis.

First standard poly conversion to Longevity Highly Crosslinked Polyethylene, Longevity hip liners; as you know, 85 percent Crosslinked, 15 percent standard in 2002, first quarter 2003 is now 87 percent Crosslinked, 13 percent standard.

Prolong to all articulating surfaces in knees; nine percent Crosslinked in the first quarter, 91 percent standard and of course there is no prior history.

In summary, a cumulative shift of two points to Crosslinked in hips for the first quarter versus year end 2002.

From our ongoing penetration to market share gains in hips and cuffs, it's evident that we continue to have the potential for significant dollar mix growth through competitive surgeon conversion to Longevity.

Since Prolong for the knee is only available in cruciate retaining, and Zimmer has a stronger share in posterior stabilized, we have tremendous potential mix shift dollars still in front of us.

Prolong represents 25 percent of cruciate retaining articulating surface sales, but only nine percent of total articulating surfaces.

Prolong for PS procedures will be available in late 2003.

On the cemented hip stem conversion to porous hip stems, we finished 2002 at 42 percent cemented, 57 percent porous; first quarter 2003 is 41 percent cemented, 59 percent porous, a cumulative shift of two points to porous in units for first quarter 2003 versus year end 2002 for Zimmer, and we believe the market in general is now at approximately 66 percent, or two-third porous.

This still leaves us with room to grow and now represents at Zimmer the first full trailing 12 months in more than 10 years on a global basis, that primary hip stems and units have a porous majority.

With more than 100 remaining Apollo porous stems still to be released, the distribution pipeline complete for our Epic Composite stem, the potential growth in Trabecular Metal stem applications, and the exclusive use of porous stems in Minimally Invasive Single and Two Incision surgeries, Zimmer has more opportunities for cemented to porous stem conversion.

For Zimmer, a slowdown in this mix factor is unlikely due to the maxing out.

With a 43 percent growth in porous stems this quarter, we moved only two points in porous/cemented mix and remain six to seven points below the market's relative porous mix in total.

Revision as a percent of Zimmer hip sales 2002, nine percent Revision, 91 percent primary; first quarter 2003, 11 percent Revision, 89 percent primary.

In knee femorals, no prior history recorded, first quarter 2003, eight percent Revision, 92 percent primary.

In summary, we over-achieved our double-digit Revision preliminary goal of 10 percent for hips in the first quarter of 2003.

The Revision progress from three percent of sales in 1999 to 11 percent in first quarter 2003 has been excellent given the size of Zimmer's base in total hip sales and is directly reflective of our extensive Revision hip pipeline investments ongoing since 1997.

The recent approval of constrain liners and some early impact from Trabecular Metal.

Since we continue to have tremendous knee potential at only eight percent sales and a new rotating hinge and international expansion of our LCCK well under way, we're pleased with the results: Trabecular Metal as a percent of recon sales; 2002, 1.6 percent, first quarter 2003, 2.7 percent.

Trabecular Metal has doubled in the first quarter 2003 from 2002 as a percent of Zimmer's reconstructive sales.

We believe this is the next great porous platform.

These results do not as yet include seven new Trabecular Metal related projects, including the Modular Trabecular Metal cup expected to be released in the second quarter of 2003.

Our potential to grow this product line with premium pricing and expand its utilization in not only traditional recon, but also spine and trauma, will provide significant mix expansion capability for several years.

Turning now to sales associate adds for 2003.

As you recall from the year end conference call for 2002, we hired 84 new sales associates, surgical techs and specialists and we entered 2003 with nine unfilled openings.

In 2003 we'd expect to fill the nine openings and hire an additional 80 to 90 representatives for a total of between 90 and 100 additions.

During the first quarter 2003 we added a total of 20 international and 29 Americas sales associates, specialists and surgical techs to give us a big jump on the start of the y ear.

Since virtually all of our sales people are either straight commission or performance-based Zimmer exclusive contractors, sales expenses to revenues track in the preferred linear rather than a front-loaded fashion.

Turning to pricing.

U.S. pricing and pricing in general has become more of a topic lately, hasn't been quiet for four or five months following the October DRG 209 announcements for 2003.

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

While we've been pleasantly surprised by the four percent global price and four to five percent in the U.S., as well as a little higher reimbursement than anticipated in 2003, our own theory has been that price in the 2003 to 2005 period will tend to stabilize at positive two to three percent, with all major geographies in positive price territory and the U.S. leading the way at about three percent or so.

With a few country exceptions such as Korea, we see absolutely no sign that price will not remain meaningfully positive.

Internally our business is built and budgeted around little price with the exception of previously contracted major hospital chain agreements.

The primary concerns that we're hearing seem to be twofold; one, will the 2004 DRG be negative, and two, will new premium price drug alluding stents (ph) or other premium non-orthopedic products affect global hospital budgets to the extent that orthopedics will be directly impacted.

The correlation between DRG 209 and industry pricing is minimal on any given single year basis.

It is not linear to the prospective payment system, or PPS, with the exception of implants are part of the bundled resource code calculated annually and based upon 18 to 24 months of lagging indicators, essentially the resource cost to perform the procedure.

The base rate is adjusted for a whole series of factors including such obvious things as labor, salaries, insurance, drugs, medical supplies, tertiary care and, of course, medical devices.

Further adjustments consider urban versus rural and variable to smallest surgeon medical education requirement differences.

Implants in orthopedics tend to represent 20 to 25 percent of the bill-out charge, but interestingly represent less than five percent of the total system cost of arthritis.

Hips and knees represent the single most successful elective surgery in the world at 98 percent.

Prices in the early to mid '90s did not decline due to CMS DRG 209 reductions, but rather because of the failed attempts of managed care, the loss of surgeon strength in the decision making process, overextension of demand matching, and the potential advent of real or perceived Clinton healthcare legislation.

It is clear that there was no a linear relationship since two of our four major competitors announced their annual price increases prior to having knowledge of the CSM DRG 209 changes for the upcoming year.

The collective premiums over the last two to three years of porous products, increased Revisions, Crosslinked Poly and other alternate bearings, Trabecular Metal, et cetera, would exceed the near term impact of drug alluding stents (ph), and yet I'm unaware of any situation where the combined affect of orthopedic premium products has caused a decrease in the hospital's global cardiovascular budget.

Therefore, the reverse is also unlikely.

Orthopedic surgeons control vast patient populations by reputation and referral.

These patient bases can be and, if necessary, will move between hospitals if many surgeons truly felt their patients and their decisions were being compromised by the desired product not being available.

Zimmer's use of the conservative two to three percent price guidance reflects the belief that hospitals will seek share, will be a little more sensitive to appropriate demand matching, and that our success in recent times of five percent per year will catch the attention of hospital administrators.

Whether DRG 209 is plus five percent or minus five percent in 2004 will have little bearing on our list price increase and the stick rate.

In short, for Zimmer, our guidance for almost two years since the spin has, in fact, in advance, already incorporated the concerns in recent articles.

Minimum invasive surgery activities; we are very 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 MIS program.

First, the 16,000 square foot Zimmer Institute officially opened on schedule March 31st and introduced an independent board of 10 surgeons to develop curriculum and advanced training processes.

The surgeon board is chaired by Dr. Aaron Rosenberg (ph) of Rusk (ph) Presbyterian in Chicago.

During March alone we trained 40 surgeons, six physician assistants, five nurses and 37 sales associates.

April is fully booked for another 40 surgeons with approximately 10 percent in both months considered non-traditional or competitive surgeons.

We have secured agreements with our phalanx of suppliers of anatomical and cadaver material.

With these two sources we now have the capability to train in the U.S. with back-to-back courses 50 weeks per year, a total of 500 MIS Two-Incision surgeons and 500 MIS Quad Sparing Total Knee surgeons.

More about the MIS Quad Sparing Knee later.

To date in the program we have trained more than 150 surgeons on Zimmer MIS hips.

During March we traveled to Asia to officially open our MIS institute partner in Singapore, the Singapore General Teaching Group, Chungaluk (ph) in Bangkok, and Perth in the Royal Melbourne in Australia.

The Royal Melbourne is a long standing competitive account and will also be under the direction of Chief Dr. Steven Graves (ph), a Zimmer partner in stem cell and biological research.

Two major competitive North American signings should occur in May; not the first quarter as I anticipated, primarily due to the shear amount of legal paperwork.

These U.S.

MIS institute partners represent several million dollars in new business and will be the subject of separate press releases.

In Zimmer OrthoGuidance (ph), our MIS guidance program, three full-time engineers are just being added to drive Phase I of our electromagnetic MIS program with our partner, MedTronic (ph).

Development of traceable OrthoGuidance (ph) instruments for the MIS Two-Incision procedure continues on schedule and StealthStation (ph) software packages for both the MIS Two-Incision and the new Quad Sparing Knee are projected for fourth quarter 2003 release.

Clinical trials, surgical techniques and videos are planned to coincide with the release.

Beginning in May we'll augment a series of in-licensing agreements with major corporations focused on integrating MIS procedures into the operating room of the future.

The in-licensing agreements through the remainder of 2003 will be the subject of separate public announcements.

The Shell facility for our MIS orthopedic operating room of the future has already been incorporated into the recently completed Zimmer Institute.

On the development side, our new MIS QS, or Quad Sparing Total Knee, is moving very rapidly, with instruments 90 percent complete and implants designed for DesignFreeze (ph) initial production through the next two quarters.

The target clinical characteristics of our Zimmer MIS Quad Sparing Total Knee would be an average incision of 10 cm, minimal blood loss, no violation of the major muscle groups, no patella aversion, same-day-as-surgery ambulation, 90 degree range of motion, and home the same day as surgery with the potential for outpatient capability.

Despite heightened competitive activity, most of their procedures are really smaller incision, muscle-snip designs that in one form or another have been around many years, very different from our Zimmer QS, Quad Sparing.

With respect to MIS marketing, collaterals were extremely busy with MIS hip programs.

During April and May we will roll out our physician marketing toolkit to more than 100 surgeons, and concurrently in May, a national DTC video campaign.

Our Two-Incision surgical technique DVD is nearly completed, with RFPs out to multimedia vendors to take our existing DVD and convert it to advanced education interactive formats.

Our MIS Surgical Protocol video animation binders are near completion, including anesthesia protocols and patient care maps.

Where appropriate, we've linked all of these activities to our European PR agency group for extension into those countries as appropriate.

We were asked recently, how we'll be certain of success in MIS.

A great question.

We have continued to believe that quality to quantitative improvement in patient quality of life and proof of economic value add to the system are key.

In the very short term, this data simply is less available.

In reality, it is our intention to provide a billing code initiator, a product code required solely for Zimmer to MIS procedures that will allow our databases to clearly distinguish between MIS and open procedures in the billing process.

This is a failsafe mechanism.

In the meantime, we have three indicative, if less sophisticated methods.

One, our soon to be five new U.S.

MIS field training managers covering cases are working six days a week at 70 hours per week and spending one-third time in the Zimmer Institute and two-thirds of their time on the road.

Perhaps more compelling, the Zimmer versus brand Fiber Metal Taper is the clear hip stem of choice for Zimmer MIS hips.

There has long been a large base of several thousand stems, but with stable modest growth for the last few years other than some participation in the move to porous.

Despite this history of modest growth, in the first quarter 2003 sales were up 75 percent, not in dollars, but in units.

Of course, lately when the hospitals read a public relations announcements of major conversions due to MIS of target accounts that were previously low market share positions for Zimmer, will add additional clarity and proof of success.

One thing is certain; the circumstantial evidence all points to substantial early Zimmer market share gain impacts directly traceable to our MIS leadership.

Lastly under Hot Topics let me switch to industry forecasts, speculating on an orthopedic slowdown, demise or other tragedies.

I can only respond from Zimmer's perspective, but let's look at each of the issues.

Slowing price; this was just covered under Hot Topics and it doesn't bear repeating.

Suffice it to say our guidance already takes some slowing into consideration and has remained at two to three percent for the U.S. since our spin-off.

While a larger change in DRG 209 may have some psychological or negotiating impact, it has little linear correlation in the foreseeable future.

I expect price to stabilize as we've planned and guided at two to three percent.

Point number two; mixed benefits may slow.

As indicated in my previous remarks, from Crosslinked Poly and other alternate bearings, to Revision relative to primaries, to porous in both hips and knees, to Trabecular Metal to higher flexion, there are no such signs of a slowdown and, in some cases, there is acceleration.

Its possible mix will slow on some of these in the future quarters, but 90 percent of Zimmer's multi-project pipeline is devoted to new mix enhancing products which we hope improve patient benefits.

Point number three; our elective procedures may slow.

The hard demographic data suggest this is near impossible without a major arthritis solution.

The numbers suggest the opposite and small blips up or down relative to layoffs in an economic turndown for people without extended insurance coverage could hardly move an industry with multiple million procedures annually.

These are speculative concerns which, while popular, simply have no supporting data.

Point four; our sales comparisons toughen in the second half of 2003.

While this is generally true, I'm not certain how in Zimmer's case reconstructive comps could be much tougher than they have been already for the last 10 quarters or so.

Virtually every Zimmer prior year comp in local currency is 15 to 20 percent.

While low to mid double-digit growth, if, in fact, it did occur, would, in reality, represent a slowing, it will only be judged in the context of the relative performance of other sectors and the impact the potential slowing would have on EPS gains.

Zimmer has not been structured around a high and inflexible fixed cost base.

In short, there will probably be some slowing against endless tough comps, but this is tantamount to predicting death and taxes.

At Zimmer we've proven to be both resilient and competent at delivering leveraged EPS gains to date.

The guidance says it all; we believe for Zimmer for the final nine months of 2003, sales and earnings will both exceed the top end of our originally provided guidance.

Point number five; foreign exchange gains lessening.

It is true that the tailwind, assuming current rates apply for the year versus 2002, knowns will not continue.

But with a conservative hedge structure, Zimmer looks to philosophically manage the knowns and, therefore, neither benefit or lose greatly on the earnings line.

Our own communication and internal analysis focuses closely on by-country local currency performance metrics.

Recent analyst reports indicate the OUS, or outside the U.S., recon growth rate for the first quarter, it slowed to 11 to 12 percent in local currency.

While this may be true, Zimmer's OUS comp was 20 percent in the first quarter.

And lastly, sector rotation.

This one can be classified as your guess is as good as mine.

At some point, if only for psychological migration from defense stocks, our post-war economic recovery, this will undoubtedly be true.

In the near term, though, at least relative to the S&P 500, it seems less likely.

Current S&P 500 forecasts for 2004 are predicting 10 percent growth in earnings and you could speculate that 10 percent will be well below both orthopedic and medical device targets.

No, I don't think I'll buy our demise just yet.

Do we have at Zimmer some things in common with the orthopedic bears?

Sure.

I think the price in foreign exchange tailwinds will subside accordingly over 2003.

Comps do get tougher, but for Zimmer, those predictions are already in our guidance and, frankly, would still leave us, as previously mentioned, over-achieving the top end of our previous revenue predictions.

We need and want external analysis, but they can become self-fulfilling bear prophecies.

I think I'll stick, based on the facts, with being a Zimmer bull.

On that note, let me turn the call over to Sam Leno, our Chief Financial Officer.

Sam?

Thanks, Ray.

I'm very pleased to be able to report another terrific quarter, starting the New Year as strong as we finished 2002.

We communicated our guidance for 2003 and for the first quarter, initially during our fourth quarter conference call, with sales growth expectations for 2003 over 2002 of 13 to 15 percent and leverage earnings per share growth expectations of 15 to 17 percent, two points faster growth in our top line.

Midway through March, with January and February behind us and visibility to the first two weeks of revenue for March, we increased our first quarter expectations for sales and earnings per share in a pre-release on March 14th.

In that pre-release we communicated our-that our expectations for sales growth would be a range of 382 million to $387 million, exceeding our previous guidance by 15 to $20 million., and earnings per share growth of 37 cents to 38 cents, exceeding previous guidance by three to four cents.

As you've seen by our press release last night and by Ray's comments just a few moments ago, we actually came in a bit over the top of both the revised sales and earnings per share expectations.

I'll try to add a little more detail to Ray's comments while focusing on a few key lines of the profit/loss statement, the balance sheet and cash flow statements for the first quarter.

I'll also describe in detail the change that we've made to the way in which we account for instrumentation, which is now comparable to all of our publicly reporting competitors who do disclose their accounting method for instrumentation.

With 2001 totally behind us from a year-to-year comparison point of view, as Ray indicated we will no longer make comparisons to prior year pro forma results.

All of our comparisons will be made to last year's reported results.

Before I discuss our financial results for the quarter, I'd like to address a change in our method of accounting for instruments implemented in the first quarter of this year.

As a reminder, we do not sell our instruments.

They are made available to surgeons who use Zimmer products to facilitate the implants, but title to all instruments remains with Zimmer at all times.

As we have indicated many times during our past earnings calls and at healthcare conferences, as well as our disclosure in the footnotes to our financial statements and our 10-K and past 10-Qs, we have been using an expense based method of accounting for instruments.

Under this method we historically recorded instruments as prepaid expenses at the time that they were acquired or manufactured, and they were expensed to SG&A in the year that they were placed into productive service.

This method was required by our former parent.

Throughout the industry, however, there are two principle methods of accounting for instruments; one is the expense based method that we've been using and the other is the asset based method, and both are acceptable GAAP accounting methods.

We have researched all of our public competitors to determine the most common method used throughout the industry.

Some of our competitors do not disclose this critical account policy probably, but those that do universally utilize the asset based method.

Under the asset based method, instruments are initially recorded as assets in the balance sheet.

Once they have been placed into service they are depreciated over their expected useful lives, which typically ranges from one to seven years.

We believe that while both methods are acceptable under U.S.

GAAP, the asset based method is the more preferable method of the two and, therefore, have elected to change our accounting method to the asset based method effective January 1st of this year.

Let me briefly explain the effects this new accounting method will have on our financial statements.

When instruments are manufactured or acquired, they will be recorded as fixed assets into property, plant and equipment and will no longer be recorded as prepaid assets in other current assets.

They will be depreciated over their estimated useful lives, which will range between one and seven years with the majority of them depreciated over five years.

The depreciation expense will be recorded in SG&A so there will be no classification difference from the former expense based method.

On a cash flow statement, the cash required to acquire or manufacture these assets will be part of capital expenditures, just like all of our other fixed assets, and will no longer be used to determine cash flow from operating activities.

But because free cash flow is derived by subtracting capital expenditures from cash flow from operating activities, instruments will continue to be included in determining free cash flow.

Finally, when calculating EBITDA, earnings before interest, taxes, depreciation and amortization, while accounting for the cost of instruments as depreciation expense versus a direct operating expense, Zimmer's EBITDA can now be computed consistently with its competitors.

The most straightforward way to make this change to ensure that depreciation expense in the future is consistent with the expense that would have been recorded historically if the asset based method had been in place all along, is to record a cumulative effect of this change on the assets in service as of January 1st, 2003.

As indicated in the lower portion of the consolidated statement of earnings attached to our press release for this quarter, we recorded a cumulative effect adjustment which increased income by $55.1 million net of tax, or 27 cents per diluted share.

The net book value of instruments in service is now the same as it would have been had Zimmer been using the asset based model all along.

The effect of the change in methods on first quarter earnings is lower operating expenses of $4.2 million, or just a little over one cent per share, than we would have had under the expense based method.

At our request and initiation, the details of this accounting change have been reviewed in advance by our independent accountants and they will provide a profitability letter that will be included in the Company's first quarter 10-Q.

In summary, there are several advantages to making this change.

First, Zimmer is now on the same accounting method as our public competitors and, therefore, financial performance comparisons can be made with consistency.

Secondly, the new policy better matches expenses with associated revenues over the periods benefited by these deployed assets.

This is especially important during times of significant new product introductions.

And finally, we believe that expanded disclosure of this significant account policy is good for the industry and should add useful insight for both buy and sell side analysts.

And now I'd like to briefly discuss the highlights of our financial performance for the quarter.

Our sales growth from 22.3 percent over the prior year to 17.6 percent in constant currency represents the most significant year-over-year growth since becoming a public company.

The growth consists of 14 percent from volume mix, 3.6 percent from price, and 4.7 percent from foreign exchange.

In the area of foreign exchange, the continued weakening of the U.S. dollar across most currencies compared to prior year contributed $14.7 million to our sales growth for the quarter.

The yen strengthened by 11 percent over the first quarter of last year, while the euro strengthened by 22 percent.

If the current FX rates hold for the balance of this year, the effect on sales growth will be a 2003 versus 2002 increase of $26 million; $9 million of that would come from the yen and $17 million from the euro.

The yen strengthened throughout most of 2002 with the first quarter of last year averaging 132 and in the fourth quarter averaging 123.

Similarly, the euro strengthened throughout last year with the first quarter averaging .88 per euro, and at fourth quarter at parity.

As a result of the strengthening of these two major currencies throughout last year, that effect-the effect on sales growth in each quarter of 2003 will diminish as this year progresses.

As a reminder we do manage our foreign currency exposure on both the yen and the euro through the use of forward contracts.

We have 2003 hedge contracts in place for the yen at an average for the year of 126, compared to 115 for 2002, and for the euro at .95, compared to .87 for 2002.

As a result of the use of these forward hedge contracts, first quarter operating profit growth was virtually unaffected by the weakening U.S. dollar.

Our all of net (ph) effective interest rate for the quarter continues to be very low at about four percent, resulting in interest expenses for the period of $1.4 million, reduced from $3.6 million of interest expense from the first quarter of last year, and also down sequentially from the $2.1 million reported in the fourth quarter of 2002.

Zimmer's effective tax rate for the first quarter was 33.5 percent, compared to last year's first quarter tax rate of 35.5 percent, and last year's full year rate of 33.7 percent.

The 20 basis point improvement from full year 2002 rate is the result o establishing a more tax efficient structure in the middle of 2002 combined with continued strong growth of production from our Puerto Rican manufacturing facility. 33.5 percent should also be a good rate to use in your forecast models for the balance of this year.

Overall, our profit and loss results for the first quarter continued to demonstrate our commitment to deliver sales growth in excess of market growth and also to leverage cost of goods sold and expenses to grow at a slower rate than sales.

As a result of that focus, in the first quarter of this year we were able to deliver sales growth of 22.3 percent, whereas profit growth of 23 percent, operating profit increases of 38.2 percent, and diluted earnings per share up 46.4 percent before the effective accumulative adjustment related to our accounting change for instruments.

Well we rarely talk about EBITDA, because our focus is to deliver continuous improvement in operating and free cash flow.

It's interesting to note however, that our EBITDA margin as a percent of sales, is 36.3 percent for the quarter.

Turning to the balance sheet, it continued to deliver best in class performance in DSO, particularly in the United States and solidly DSO for the first quarter was 55 days, which is equal to the same period last year, and three days higher than our finish for 2002.

The increase in DSO from the fourth quarter is in part due to continued rapid growth in Europe, some collection seasonality in the Asia-Pacific region, and a one-day increase in the U.S. finishing the quarter at 32 days.

Days inventory in hand were 247 days, equal to the end of 2002 and up two days in the first quarter of last year.

Our target, as Ray mentioned for 2003 is to average between 250 and 260 days of inventory, in order to continue to support new product introductions throughout the year.

Accounts payable days have increased to 60 days up three days from 57 days at the end of 2002.

Operating cash flow for the quarter was $104.8 million and under the expense method for instruments would have been $78.1 million compared to $32.5 million last year, more than double.

Capital expenditures for the quarter were $33 million, consisting of $26.7 million for instruments and $6.3 million for all other fixed asset additions.

Free cash flow, which is operating cash flow less capital expenditures was $71.8 million for the quarter.

Effectively the new accounting method for instruments results in a reclassification of instrumentation acquisition costs, effective January 1st, 2003 from operating cash flow to capital expenditures.

As a result, free cash flow remains unchanged under the asset-based method of accounting for instruments when compared to the expense-based method, and therefore remains a true test of our financial performance.

Increased net earnings and holding inventory turns at a relatively constant level are key contributors to our improvement in operating cash flow for the first quarter 2003, versus the first quarter of last year.

As we have seen in all previous quarters, our balance sheet continues to strengthen.

Total debt has been reduced to $76.9 million, which represents a reduction of $80 million in the last 90 days alone since the end of 2002.

Net debt, total debt net of cash has been reduced by $97 million to 44 million.

We have $523 million of additional debt capacity on our $600 million bank facility and we can use this capacity as a source of acquisition capital.

We have no plans to buy back shares, or to issue dividends.

We have reduced our debt-to-cap ratio to 12.4 percent, down from 30 percent at the end of 2002, just 90 days ago.

Absent any cash that we may use for acquisitions and assuming continued good financial performance, we expect to be debt free in the third quarter.

In our press release last night, we provided updated 2003 guidance for both sales and earnings per share.

We expect revenue for the full year to increase 16 to 17 percent over 2002.

As a reminder, the costs get increasingly more difficult throughout the balance of this year and the effect of foreign currency on year-to-year growth rates will diminish due to the weakening of the U.S. dollar throughout all of last year.

Our guidance incorporates the expected effects of volume growth, mix and pricing, and assumes a foreign currency exchange rate to remain at constant levels for the balance of the year.

We expect that we will continue to grow revenue at a minimum of one to two percent above anticipated reported market growth.

We also expect diluted EPS to increase 23 to 24 percent for the full year 2003 over 2002 implying diluted EPS of $1.61 to $1.62 before adding in the four to five cent impact of changing to an asset-based model for instruments, and also before the 27-cent impact of the one-time cumulative effect adjustment from the change in accounting for instruments reported in the first quarter.

Our earnings per share guidance also incorporates the fact that we will be doubling our direct global investments in Zimmer's minimally invasive solutions to more than $20 million in 2003, with greater (inaudible) ending levels occurring at a second half of this year than the first half.

Additionally, capital expenditures for the year should be 35 to $40 million, plus an additional 75 to $80 million for instruments.

Of the 35 to $40 million we consider approximately $25 million as maintenance capital, and the additional 10 to $15 million as capital required to continue to fund our unit sales increases.

And finally our effective tax rate of 33.5 percent for the first quarter should be a good rate to use in your models for the balance of the year.

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

Great.

Thanks Sam.

It was a strong quarter to begin 2003, one that all of us at Zimmer are pleased with.

It's hard to believe that by the middle of the summer, we will have been a public company for two years.

So 90 percent of our debt is gone; sales have compounded at 16 percent since public inception; net earnings at 34 percent, and ZMH's stock increased by more than 60 percent; and MIS is definitely not a fad.

During the quarter, we drove our reconstructive business up by 22 percent and enjoyed consistent, across-the-board market share gains by product group and virtually every country and geography that we operate.

Those same sales and careful attention to manufacturing costs and mix, combined with a stinginess in G&A has allowed us to once again produce strongly leverage earnings.

Those same sales and industry leading margins have been invested in the top of our class in research and pipeline development for new products.

We overachieved our internal goals of 30 percent operating profit and 20 percent net profit.

Our intensity with respect to free cash flow is a combination of leverage earnings strategy and a focused industry-leading working capital management.

This quarter they combined to produce a reduction in net debt to 44 million, the elimination of almost all of the entire U.S. debt, more than $30 million in cash on the balance sheet, and a new debt-to-cap ratio of 12 percent.

We made a positive and important change in our accounting principle for loaning instruments, loaner instruments that will provide for our current and potential investors a more meaningful EBITDA comparison to public competitors.

EPS beat both original and pre-announcement Street consensus.

We made significant technological, clinical, and market share advances with our trademark minimally invasive solutions, highlighted by the on schedule opening of the Zimmer Institute.

Lastly we increased our guidance, including the accounting principle change to 165 to 167 for the year, implying sales and earnings performance for the remaining nine months of 2003 at rates of growth higher than the top end of any previous guidance provided.

We look forward to your questions.

Sheika (ph), I'll turn it back over to you for Q&A please.

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

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

Your first question comes from Milton Hsu with Bear Stearns.

Hey good morning guys.

Hey Milton.

Morning.

Ray, turning to prolong, you mentioned that the initial uptake pattern of prolong is similar to that of longevity.

Could this suggest that you know, some of the surgeons, the concerns about delamination has kind of alleviated?

And also does that change your projections for what this, you know, the potential market the penetration two or three years down the road.

I think it's a little slower than longevity, because I think longevity had a lot more hype around it at the time, and there was frankly, more competition around it.

It is going faster than our internal plan.

I think part of it, the concerns initially around the product itself, really go away when you explain the FDA 510K filing, the claim we've got for resistance to the lamination, and in fact the actual structural change in the production of prolonged that is in fact very different in its formulation from highly crossed since longevity.

So I think all those things considered, it has changed our internal plans.

We are, we are frankly surprised by the uptake being as high as it is.

OK, so overall, maybe back to what you said last quarter, penetration, maybe 40, 50 percent?

Yes, I'm thinking now that it's, that it's going to be at that rate.

I think we're sort of unchanged on that, because obviously we saw the trend going back and it wasn't necessarily public information, but we saw the trend going back.

So we're thinking it's at that rate or better now.

The other big factor that comes into play is CR is not our mainline strength, I mean we'd like it to be the fact of the matter is, we're very strong is PS.

We haven't released this yet in PS.

This is in fact, only in CR, so I think that again, gives us a lot of confidence.

And last question for Sam.

R&D was a little lighter than we were looking for.

Are you still talking in the roughly six percent, you know, as a percentage of sales in R&D expenditure?

Yes we are, in fact R&D dollars were, as Ray mentioned, up a little over $2 million, exactly on our plans, but the reason that it's smaller percent as a ratio to sales, is the strong revenue growth, and R&D is not a variable cost.

It's a fixed and in some cases, that fixed variable.

OK, thanks.

Yes.

Your next question comes from Mike Weinstein with JP Morgan.

Hi.

This is actually Raj Denhoy for Mike.

Just a couple questions actually on the model.

The out margin in the first quarter was pretty impressive at 31.3 percent.

As you look out over the balance of the year, do you expect that to moderate somewhat or should we still see it at about this sort of 31 percent level?

Well I think the best way to look at it Raj is to look at the drop through that we've put in our expectations and earnings growth a much faster rate than revenue growth, and just work your way back up.

And I think you'll see that on a year-to-year basis, there's got to be operating profit margin expansion.

How it's going to modulate from one quarter to the next really depends on the sales volume within each quarter.

OK, and it should be, I guess still be a little bit of a benefit also from this accounting change with instruments that should play through.

Yes, yes, that what we said, it's, it should be about a penny a quarter, it's four to five cents for the year.

We saw in the first quarter it was 1.4 cents, it's not quite two, but it does moderate like that throughout the course of the year.

I would also say as I made in my prepared comments, our expenditures for MIS will continue to ramp up as we go through this year, so that'll cause a little more growth in SG&A in the second half and the first half.

Great.

Not a lot, but some.

OK, could you turn to Europe for a second.

How much of or is any of the growth there been driven by any changes in the selling structure.

In a sense, are you, is it still mostly distributorships or is it direct sales reps, has there been any change there that might be influencing the growth rates.

No in fact, I was intrigued, because I had a couple calls.

I think there was a Morgan Stanley tours, I forget who it was now, but I was intrigued by a couple of phone calls I got from friends indicating that our growth may be from the buyout or purchase of distributors was what I heard, and the, at least in the years I've been heavily involved, I think we've bought out two distributors, one we bought out last year, I think, and of course when you buy them out, you're buying out the margin they gain if you will, for revenue gain.

The total impact that I'm aware of on an almost $200 million business would be something like four or $500,000 of total revenue gain.

So the only thing in there is that that I'm aware of.

The rest, we've had our distributors in Spain and Italy and many places for 15 years.

There's no change in the commission system.

There's not change in the selling system.

There's a change in the focus and in obviously in the new products, and of course the environment over there is pretty healthy.

But I did get a little bit of humor out of that distributor buyout thing.

I don't know what percent 400,000 is on 200 million, but it isn't much.

Right, yes.

One more thing I would add Raj, if we were ever in the future to buy back a distributor and it were to be a big number, we'd be obligated to disclose that.

Right.

We'd make it very clear.

Good point there.

Great, and just one final one.

On the down classification of mobile bearing knees, I think you indicated you're going to submit something in May.

Yes, that's correct.

The file goes in, there's a preparation file that's been heavily worked on and this is with Zimmer, a number of companies, Asma (ph) and that's filed, it goes in, because there hasn't been a pre-decision on sectionally to down classify part of that and that file is a support file that goes in to look for a final conclusion, and I don't know what the, I'm not the regulatory expert, but I don't know what the time frame is after May in which they'll make that final conclusion, but we are looking for a materially significant down classification of mobile being sometime after May, and again I wish I could give you a better answer, but government regulatory decision making is not necessarily always quick.

So you don't have any, even a, you know, rough, rough estimate, are we talking ...

Well it's supposed to be in 2003, I mean I know that much, but again, I, you know, I'm kind of hesitant, only because once it gets in the government hands, I'm not sure.

But it is supposed to be in 2003.

OK, thank you very much.

You're welcome.

Your next question comes from Katherine Martinelli with Merrill Lynch.

Thank you.

Just wanted to follow up Ray, on your comments on MIS training.

I think you had mentioned you've trained about 150 surgeons.

Yes.

Is it too early in the process to have some insights into how many procedures these guys are now doing when they're post the training and back in their own practices?

And how do you guys track that?

It's a little early, although it's not too early with obviously the Rich Bergers (ph) and the Fiber 6 (ph), it's too early for most after that.

We track it through our distributors, because obviously the surgeries are posted and we're in all of them.

What we're seeing, and I'm going to give you the general answer, but I think it's accurate.

What we're seeing is nervousness when they go back if it's the two incision.

I mean, no nervousness if it's the mini-incision.

We send out proctors and the field people that I mentioned that are working 70 hours a week to work with them at their elbow on the first two or three.

And we're seeing the same pattern that it takes them a while, they're very, very careful on the first patient they select.

This is not a first one that comes into, because they want the perfect patient for the first two or threes.

So that's one issue.

Secondly, we see virtually the same learning curve, where they we really struggle on the first two or three.

They get better on the next five or six, and then from about 10 to 12 surgeries on, it's very good.

We'd probably, I'd have to look up the accurate answer.

My guess is we've probably got 25 or 30 surgeons that are in that, beyond-the-learning-curve stage.

All the rest, have either been one or two or three.

I don't think there's anybody, there may be a few that have done none, I don't known, but most of them would be in that one, two, three, four range, because most of them are recent trainees.

But we do track it very carefully, as you might imagine.

Great, that's very helpful.

And question for Sam, really just a clarification.

When we're looking at the restated numbers reflecting the accounting change for last year's base, going from the 28 to 29 cents, are we reconciling that by reducing the SG&A level?

I just want to get clarity on that and should we assume the additional, I think you said four to five cents that we'll see is pretty even through the rest of the year, just again, adjusting for SG&A?

Yes, all the change from a direct expense method to a depreciation method, all that is self-contained within SG&A, so there is no reclassification difference.

So to get to the 56.2 last year versus the old number of I think 54.6, we're just adjusting SG&A?

56.2, what is that number?

Of net earnings, that reconciles with the 29 cents last year to compare to the 41 cents this quarter.

Oh, excuse me.

Yes, the, it was 28 cents last year, it's all in SG&A.

Oh to get to the 29?

Yes.

OK, great thank you.

Your next question comes from Bob Hopkins with Lehman Brothers.

Thanks and congratulations on such good numbers.

Thanks Bob.

Couple quick questions here.

First, unless I missed it, I don't think you gave us the typical update on the outlook for Zimmer to potentially get involved in the spine market or the biologic markets or a couple of the other focus areas that you guys had talked about or have been talking about for the past year or so.

And I was wondering if you could give us an update there?

Yes, you're absolutely right.

There's two reasons why I didn't.

First of all, we're in good negotiations with a couple of smaller spine companies and another little bit larger deal that we're looking at.

And the reason I didn't, first of all there isn't really anything new to tell you.

We continue to be very harsh with respect to valuation.

We tell people that, you know, I've said many times before, we do not overpay.

We've got accretion versus dilution rules and all that.

So there's no point in repeating it endlessly over the phone.

But there is another reason why I didn't, and that's that I found that a couple of these companies, n to current ones, but things we've shut down, were ending up sort of breaking faith on discussion and CA's and I ended up having surgeons calling me saying, gee you really ought to buy this company, because they're really good products.

I use them.

And I felt that the leakage was becoming unacceptable.

So what I've done around here and in the course of this call is to be a little bit more tightlipped about what we're doing, because I'm not very happy with the leakage.

The fact of the matter is though there isn't a huge amount to update you on.

OK, thank you.

And now a follow-up on MIS updates.

You mentioned in your prepared remarks, that during the month of May we could possibly see some MIS agreements signed with some U.S. hospital systems.

I'm wondering if we could just put a little bit more detail behind that if possible?

You know, are these large systems?

Are they current Zimmer customers?

Just any further details you could provide there would be helpful?

Yes, I want to be, I have to be a little careful on this, because that kind of disclosure would be problematic for their PR department.

I will tell you this, they are large, they represents several millions of dollars in sales.

The agreements will be five-year agreements, so it's multi-millions depending upon how you want to view the five years.

They are driven by MIS.

They will become full institute teaching partners, and in the case of one, to the best of my knowledge, we have zero market share.

We may sell something there, but it's essentially zero, to me anyway.

The other one, I think we're about a 10 or 15 percent market share player.

In both cases, we would go up dramatically, not to 100 percent, but in excess of 75 percent share would be a number that I think they would probably aggress is acceptable.

Great.

Thank you and just one last one on the MIS, just a more general question, I mean you guys' performance this quarter was great across the board.

To what degree do you think that you're investment in MIS is resulting in any kind of benefit to you today?

Obviously not in terms of sales, but just in terms of, you know, perhaps goodwill or the physician community or getting more people attracted to Zimmer technology in general, or is it too premature to say that?

Well no I don't think so.

I mean in my comments, I've actually changed my opinion a little bit.

I felt and expected to have no impact this year, where it's a training year, it's a $20 million investment year.

And conservative or otherwise, we guided and frankly planned for no anticipated impact.

I've really changed my mind and I don't know if you caught the part Bob where I talked about admittedly circumstantial evidence, but there is a lot of things in our results, particularly I'm focused on that fiber metal paper results, which is a real fundamental in our product line.

Even with porous, cement to porous conversions being high, 75 percent growth in unit salsa and that is the dominant primary choice of all these trained surgeons to utilize as a Zimmer stem in their MIS surgeries.

So I actually think there is benefit.

I don't know if I could quantify completely, but I think the circumstantial evidence actually has changed my mind.

I think we're getting benefit now.

The other thing is, as you can tell from the competition there's a lot of activity created around this and that activity, you can view in two ways, one, gee the competitors are jumping in, but that's no surprise.

I view it the other way.

I think it's given MIS broader and more significant public coverage and that leads people back to us, because we started a lot of this and we really are the leader in it.

So I think all those things are pointed to sales gains.

Great.

Thanks very much.

You're welcome.

Your next question comes from Greg Simpson with AG Edwards.

Thank you.

Gentlemen, good morning and congratulations on a truly impressive quarter.

Thanks Greg.

Guys, couple things, first for Sam, on the accounting change this is actually an issue you and I have spoke about a few items.

In the past you'd indicated beside the loaned instrument issue, there are a couple other less significant accounting policies that also, I guess kind of worked to the detriment of reported numbers.

Have those also, and then they were significant enough to be disclosed.

Have those also been changed or will they be changed in the future?

Well clearly the most significant one is the one we just got through dealing with.

We always look at our accounting policies to be sure that we're, that we're keeping pace with rapid changes in the literature coming out.

But we've made no other changes that amount to anything significant at all.

OK, and then for Ray, where do we get into, I mean at what point do you feel comfortable, you've talked in the past about doing direct to consumer in MIS.

At what point do we get there?

Do we get there later this year?

You haven't given a lot of detail on that at this point?

We have two campaigns coming up this year.

One is Greg, and I don't know that I have the dates completely straight in my mind, but they are relatively full DTC campaigns.

They are planned, they're not ex-budget.

I mean they're planned in our budgets, obviously, so there's no, there's no change from our impact in that.

We're also going to be doing a lot of things differently this year, some things that we haven't done before in getting to our target audiences, not just DTC, but some of the marketing took kits to surgeons, DBD's for patients interactive, things like, a good example is doing some things at the U.S.

Open, as an example, which is a very prime demographics market, particularly when you get into the seniors end of golf.

So there's a lot of things like that, all of which are planned into our budget.

OK, and then Ray, one last question.

I've asked you in the past about ceramic, and that's kind of a gap in your product line.

I realized we're very early and it'll probably roll out in a fairly conservative fashion.

But how much of a concern is that to you, and you've obviously addressed, you've got a lot to go on the mix side.

But how much of the, how much of a concern is that to you that gap in your product line?

Well, two things, first of all, remember with Inplex (ph) that we are working on, and we're operating from, but there is a clinical program underway utilizing trabector metal (ph) on the shell with ceramic liner, number one.

Number two, Zimmer does have a product in Europe called Trilogy AB that we've had out there for two years that's doing very well.

The issue is U.S. ceramics.

I would suggest you, two things, first of all, I think it's going to be driven hard and well by striker and Trilestrophy by Right (ph), and I think it's going to be there as an attractive alternative.

It has some positives in the very young patient group, but it's also very, very highly priced and there are a number of significant limitations to ceramics.

Most people think of sort of the chipping history.

I don't know whether that's going to be real or perceived in the future.

It sounds like it's probably going to weigh a fair amount, but there's a lot of other real issues, like more limitations in range of motion, inability to use different kinds of liners, raised lips and so on.

A lot of people, you know, get under the impression that ceramic is bio-inert, it's not bio-inert.

It causes a number of osteo reactions in the body, and it creates of course wear that we think is just comparable based on science with Highly Crosslinked Poly.

So there's some pretty good arguments that we're going to put forward, but you know, to answer your question, I think it's going to be a player in the market.

I'm not overly concerned about it, but it's going to have a place, certainly with younger patients and when you've got good companies marketing it, I mean, they're going to do a good job on it.

OK, all right.

Thanks again guys, and congratulations on the quarter.

You're welcome.

You're welcome.

Your next question comes from Bruce Jacobs with Deutsche Bank.

Hi, congrats on the quarter as well.

Just a quick question, I know Sam and Ray you mentioned the increasing the guidance for 2003.

Have you commented or would you comment on your long-range revenue growth outlook and whether or not that has changed, and perhaps touch on the, you know, the components of that growth expectation?

I don't know, you know, we can, but we don't pre-guide to future years, Bruce, essentially is our policy as you know from the spin.

I'm very, as you can tell from the commentary, with respect to the, you know, sort of decline over at the (inaudible), I mean other than foreign exchange and what I have always believed as lesser price, you know, I believe this industry in Zimmer will continue to be very robust, but until, you know, we see all the factors come into play, and in our case, any guidance we would give would always be without acquisitions, with spines.

So I mean, for us.

Right.

We intend to have much faster sales growth rates by definition than we have today, because we intend to grow by acquisition.

But I don't want to start pre-guiding our strategic plan in the middle of '03.

That's fair, I mean I guess what I was getting at is historically you've said that your revenue objectives were I think in the low double-digits with mid-teens kind of type EPS growth, and I was just getting at whether or not those estimates still stand, and particularly thinking about your comment that you expect over the next couple years, two to three percent price, you think mix is going to be very strong, and I can't imagine why unit growth, off to slow, that kind of points me to mid teens type of growth over the next couple years, and I just wanted to know if I'm doing the math right there.

Well our, first of all we have never guided on revenue past current year, what I think you're talking about is we do, we have provided guidance that we would look to always have EPS growth in excess of 15 percent, and we would judge acquisitions accordingly on their ability to deliver that.

In terms of your comments on mix, obviously, I'm pro mix, I think it's still going to be there, even if the current mix related factors change a bit.

I believe surgical unit procedures are absolutely going to be there in the kind of eight to 10 percent range, and I'm speaking mostly U.S., because the databases are better; and you could therefore argue you know, assuming we're correct on two to three prices.

It does get you to mid-teens sales growth, assuming foreign exchanges even money.

I agree with you on all of that.

I just think there's a lot of complexity of this industry and I'm always hesitant to get too far out in guidance when I don't have, you know, data to support it.

That's fair.

One other quick question if I could.

The, could you guys talk a little bit about revisions?

To me it kind of seems like a double-edged sword.

On one hand, it's the source of some nice growth and some great mix benefit.

On the other hand we've heard many hospitals complain about the time and the cost and I'm just wondering how you think the system will manage what, you know, what could well be an onslaught of revision procedures?

And does it create capacity issues at the hospital level?

Yes, it's an interesting problem.

I mean one of the things, not Zimmer, but Zimmer and the industry, the group of us have been trying to do and unsuccessfully is split out an independent reimbursement code for both the hospital and the surgeon on revision, and we've been, to date, very unsuccessful, because it would have a huge effect obviously on the global budgeting process.

I think what you're going to see happen, there's a couple things we're seeing happen right now.

It's, for the hospitals that are in less strong economic situations, they are really reticent to do a lot of revisions, as you might imagine.

And I think what we're starting to see is in private partnerships, revision shifting, you know, to a different group of surgeons or conversely, revisions being more centralized or showing up at a lot of academic institutions, you know, where they're being done in higher volumes.

My guess is and in particular, if revisions get and continue to get more complicated from a technical point of view, I think you're going to see revisions shift to more urban, more academic kinds of environment.

I'm really hesitant to use that center of excellence terminology, because I think it gets abused.

But this may be one where it does go in that direction.

And you're not, you're not concerned about just overall capacity, and I guess this gets to the unit growth in the business overall.

Are there issues with surgeon capacity that are cropping up yet?

No I don't think at this point.

I think if you look at, and you get a lot of this from the double AOS databases and the research people there, but I think if you look at some of the projections for people as they split out of MD and specialize and then sub specialize in orthopedics, there are some concerns, not only with the capacity, and this had several years, but with the capacity to service probably baby boomers coming through, but also with the years and technical expertise required to do effectively do revisions effectively.

So there are some concerns out there, but I don't think they're in the near term that I'm aware of.

Guys, thanks again, and congrats on the great numbers.

Thanks.

Thank you.

Your next question comes from Robin Young (ph) with Health Point (ph).

Hi guys, thank you.

I've got three questions, and if you don't mind I'm just going to ask each of them and then listen to the answers, just interest of time.

How much of the 26 percent, that's 22 percent constant currency growth can you attribute to the product mix?

You had four percent from price, four percent from currency.

How much of the remainder would you attribute to product mix?

My second question is could you explain in more detail how the billing code initiator drives your MIS revenues?

And in that, I'm hearing something about a price in differential between MIS and standard and if you're up to it, if you could explain what that might be?

My last question, I think the down classification from old bearing knee is going to happen pretty quickly after you submit your data, and with that, it would be helpful to hear from you your experience with your mobile bearing knee in Europe, and if you think there's any sort of tie we could make between the European experience and the possible U.S. experience?

And that's it.

Thanks.

OK, thanks Robin (ph).

On your first question, we have never broken out mix and we don't intend to do so now.

We have indicated that we think the industry mix is probably around three percent or so.

It may be, it's going to vary amongst manufacturers depending upon what they're up to at the time.

But we've elected not to do that, because there's so many things coming in and out of it at any given point that it gets you into you know, a level of disclosure that becomes so detailed, almost an SKU basis that I think it will become really cumbersome for us, and I don't know if it would be that helpful for you.

The billing code initiator is, has nothing to do with pricing or billing.

It would be the opening and utilization of a coded packaged item, it may even be in the instrument area that is an indicator.

Think of it as a green light.

It's an indicator to us that that procedure has been, you know, MIS based.

It's not necessarily anything that we would bill for, in fact it's probably a zero bill kind of item, but it will allow the billing code system, if you will, to pick up the fact that it was an MIS procedure.

MIS's standard pricing, our view at this point, and we're just finishing up some of the early work on the 10 alpha beta sites that we're working on, on hospital analysis for economic value-add of MIS.

I would tell you at this stage, we are seeing significant systemic cost reduction potential from the kind of program we're putting in place.

In other words, not just the implant and smaller incision, but in fact, changes in anesthesia, changes in drug protocol, hopefully elimination of narcotic drugs, which are expensive and so on.

The absolute pricing for the implants at this point, our early think is we wouldn't change that.

We have tremendous margins and we look to gain market share while providing patient and economic benefit to the, obviously the patients and the hospitals and surgeons.

Last question on down classification, I'm happy, excuse me, to hear you say that it could be quick.

I, our position at this stage is we've had a product in Europe.

We have a very good mobile bearing product, and we have one as you can tell from my comments that we're building into the Uni.

The product we have in Europe, it has had what I would call modest success in earlier times, but is dramatically improved, frankly since there's been a higher degree of interest in mobile bearing.

The product in Europe is called the MBK (ph).

We've got good data on it now.

We have a huge number of surgeons using it.

And it's performing pretty well, but it's been there, we've had that product for, I'm going to guess and say three or four years, I don't know the exact date.

So we're feeling very good about the potential of down classification benefiting us.

Whether we'll do additional things with the MBK (ph) and add things to it or make it somehow better for the U.S.

I think that's still up for grabs.

Great.

Thank you.

You're welcome.

Your next question comes from William Plovanic with First Albany Corporation.

Great thank you, good morning.

Hey Bill.

Sam, first of all, for you, is there anything else in the gross margin line that really pushed it up?

I think a while back you were getting some benefits from some currency gains.

Did that help you or hurt you in the gross margin line this quarter, number one?

And number two, just Ray, your thoughts on the Smith and Nephew Centerpole (ph) merger and do you think that there are any holes in your European business you think you could fill in with that?

Let me talk about gross profit margin.

The gross profit margin you're seeing is pretty natural as a function of mix, as a function of our continued focus on manufacturing automation.

I would say though that one of the take-aways in margin is clearly the difference in this year's FX contracts for both the yen and the euro versus last year.

You know, contracts for us this year are less favorable, and therefore that does take away some gross profit dollars.

But on the whole, I think you're seeing natural performance in the company.

On the second one, I guess my general thought is at this point, we've done a reasonable amount of analysis on the Smith and Nephew Centerpole (ph) to look for the things you're just talking about, both in the U.S. and Europe.

We've been a profiter in confusion in the last two major mergers, and I think have done well by them.

I think for us, if you think about where we're strong, we're looking for overlap, sales reps, opportunities, generally speaking in Northern Europe.

I mean we're pretty strong, in fact we're very strong in Spain and Italy, particularly.

The overlaps in opportunities that may come about I think are more likely to be in Northern Europe, and so of course, I'm sure, like everybody else, we're looking at where to benefit from those with, you know, with Europe being the prime motivator.

Great.

Thank you.

You're welcome.

Your next question comes from Mark Landy (ph) with Leerink Swann.

Morning gentlemen.

Hi Mark (ph).

Morning Mark (ph).

Sam, as Europe grows and becomes more meaningful, how does that impact the gross margin going forward?

Well, because Europe operates at a lower gross profit margin due a variety of issues, one of which is pricing, the pricing environment is very different in Europe as you know.

It would have a diluted effect on margin frankly.

But as we introduce new products, as Ray pointed out, new products often improve margins.

So Europe as a whole though, without the upside benefits of pricing and margin, if it were just that would tend to take margins down.

So as we think over gross margin, going forward, should, you know, should the new products outweigh the drag from Europe or should we think of maybe it staying steady or maybe just coming down a smidgen?

Is that like asking whether our margins are going to expand or contract?

In a way, yes.

We don't give line item analysis on P&L's, but we do share with you that we have always believe that any hedge effect combined with dilution of margins in Europe, we have the capability to offset with continued automation and standard cost reductions, combined with not only product mix, but also the other positive factors of geographic mix.

So we don't give line item analysis, but we don't sit here being overly concerned about margin contraction at that line either.

and just further on Katherine's question, relative to SG&A in '02.

Should that, as a percentage of sales mimic what you're going to do in '03, given that you've given us kind of sort of an idea of where it's going to be, or would that be an incorrect assumption?

You mean in terms of the accounting change?

Yes.

Yes, you know, we don't have the ability to go back, because accounting doesn't allow us to go back and restate history.

That's the nature of the cumulative effect going forward.

But I think Katherine's underlying assumption is not far afield.

It's a pretty level comparison, year to year, by and large.

And then lastly, you did mention Trabeculum (ph) and spine, could you maybe just comment a little bit on that, probably an internal project where that might be in the works?

Yes, I'll take that one.

We, at this point, we have a very full and surprisingly complete product line spine through Inplex (ph).

When I say we, I'm speaking on their behalf now, because they do the work on that.

ALS (ph), clips (ph), Vertigo Body (ph), VB's (ph), all of those products are there today, being built and being sold outside of the U.S.

In addition to that, we've got a this, at least on the mechanical bench, and in some limited testing, a great looking Trabector metal (ph) cage, and if you think about Trabector metal (ph), it is an absolute natural for a cage, because of it's obvious design capabilities.

But the fact that unlike other products that are similar sprays and coatings, it's back to this issue that it's a very strong independent standing structure.

So there's a great, in fact there's a great literature package, which I imagine Inplex (ph) will be happy to give you if you wanted, on the, they've done a nice job and it's a beautiful package, on their spinal products, but there's a very, very good looking product line within Inplex (ph).

Maybe just one question, which I don't know if you'll give me the answer to, when would you be filing and moving all of that data to the U.S.?

You're talking now on the Inplex (ph) and spine?

Yes.

That's one I couldn't answer.

I think you would have to get to our regulatory people or I'll find you an answer or we'll do it collectively with Inplex (ph).

That's not in my knowledge base.

Superb quarter guys.

Thank you very much.

Thank you.

Your next question comes from BJ Hailey (ph) with Prudential Securities.

Hi gentlemen.

Great quarter.

Thanks for taking the call.

Thanks.

You've briefly touched on Smith and Nephew Centerpole's (ph) potential acquisition.

Could you very briefly comment on how you view that changing the competitive dynamics in Europe and in the U.S.?

And then could you humor us with you know, talk about your, comment rather on your ability to make a bid on Centerpole's (ph) would be, specifically on any type of restrictions that may have been in place after the spinout, hypothetically speaking of course.

Let me obviously take the first one.

And I'll try and keep myself away from your humor as best as possible.

On the first one, you know, I think we regard it generally as strengthening of two companies.

I mean I don't want to get too far into commenting in other people's deals to be honest with you, on a public basis.

But, you know, we've analyzed it.

I think it's got some goods and bads in it.

We analyze very carefully to PJ&J (ph) and striker and Helvetica (ph) at the time, and I think you reach the conclusion that there are some benefits to them.

There's always huge difficulty in integrating these deals if you don't have an exceptional integration plan, and it's never clear whether one plus one ever equals three.

And of course, from our point of view, we tend to be the sharks on the edge, and we're trying to pick off all the benefits for us, you know.

So you know, I look at it from our point of view as probably more opportunity than risk.

The second part, you know, I don't know what part of humor you want to jump on.

I mean I don't ever comment on stuff like that.

I know there's always tons of speculation.

It's good that you ask the question, because it probably gives the audience some humor, but you're not going to get an answer out of me.

So I'll just laugh along with you I guess.

Thanks guys.

You're welcome.

Your next question comes from George Kim (ph) with Searchlight Capital (ph).

My question has been answered, thank you.

At this time there are no further questions.

Mr. Elliott, are there any closing remarks?

No that's great Sheika (ph).

I appreciate the support and just thank the folks who have been on the line and we're around if you need us for extra questions or commentary.

Thanks very much.

thanks everybody.

Bye now.

Thank you for participating in today's conference.

You may now disconnect.

END