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Zimmer Holdings Inc. (NYSE:ZMH)

Q4 2007 Earnings Call

January 29, 2008 8:00 am ET

Executives

Sean O'Hara - Associate Director IR and Strategic Planning

David Dvorak - President and CEO

Jim Crines - EVP Finance and CFO

Analysts

Raj Denhoy - Bear Stearns

Ben Andrew - William Blair

Michael Jungling - Merrill Lynch

Bob Hopkins - Lehman Brothers

Matt Miksic - Morgan Stanley

Kristen Stewart - Credit Suisse

Joanne Wuensch - BMO Capital Markets

Mike Weinstein - JP Morgan

Mark Mullikin - Piper Jaffray

Tao Levy - Deutsche Bank

Steven Lichtman - Banc of America Securities

Doug Schenkel - Cowen and Company

Bill Plovanic - Canaccord Adams

Michael Matson - Wachovia Capital Markets

Bruce Nudell - UBS

Jeff Johnson - Robert W. Baird

David Toung - Argus Research

Sean O'Hara

Good morning, I am Sean O'Hara, Associate Director of Investor Relations and Strategic Planning. I would like to welcome you to the Zimmer fourth quarter and full year results conference call.

Joining me today to host this call are David Dvorak, President and Chief Executive Officer; and Jim Crines, Executive Vice President Finance and Chief Financial Officer. This morning we will review our performance for the quarter, present our outlook for 2008 and conclude our discussion with a question-and-answer session.

Before we get started I would like to point out that this presentation contains forward-looking statements, within the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995, based on current expectations, estimates, forecasts, and projections about the orthopedics industry, management's beliefs, and assumptions made by management. These statements are not guarantees of future performance and involve risks, uncertainties, and assumptions that could cause actual outcomes and results to differ materially from those in the forward-looking statements.

For a list and description of the risks and uncertainties, see the disclosure materials filed by Zimmer with the Securities and Exchange Commission. Zimmer disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

This presentation also contains certain non-GAAP financial measures. A reconciliation of such information to the most directly comparable GAAP financial measures, along with other financial and statistical information for the periods to be presented on this conference call was included in the press release announcing our earnings, which may be accessed on the Zimmer website at zimmer.com, under the section entitled Investor Relations.

At this time I would like to introduce David Dvorak, President and Chief Executive Officer of Zimmer.

David Dvorak

Thank you Sean and good morning everyone. Today I would like to briefly review the results of the quarter. We are pleased about these overall results especially the strength of sales across geographic segments. I will spend a few minutes giving you our outlook for both Zimmer and the industry in 2008. Also I will outline some important programs we plan to institute in infrastructure operations and elsewhere, which we believe will prepare the company for an even more exciting future.

First let's review our fourth quarter results. Consolidated sales for the quarter of $1.73 billion were up 15% over the prior year, 10% in constant currency and we delivered 16% growth and adjusted earnings per share.

Our sales results reflect improvement in nearly every product category and all geographic segments and also include the effect of recent acquisition supporting our Spine and Dental businesses. Based on the already reported results of other market participants, it would appear that market growth accelerated in the fourth quarter and we are particularly pleased to see how our supply chain and our sales and distribution networks around the world were able to respond to this growth in procedures.

The fourth quarter's strong finish caped off an eventful year for Zimmer. With respect to our financial results for the full year, we grew sales 12% over the prior year, 9% in constant currency, and grew adjusted earnings per share 18%.

During the year we made progress on some of our key strategic priorities by expanding our Gender Solutions product offering and adding products from Endius and ORTHOsoft to our portfolio.

We also continued our strong record of cash flow generation and used over $576 million to repurchase 7.2 million shares in 2007. Jim will discuss these results in greater detail, later in the call.

Now, to our 2008 outlook: We developed our 2008 guidance, taking to account our assessment of the market and the opportunities and risks that could impact our performance.

I will now take you through our expectations for sales and earnings. First, looking at the market for our core reconstructive product categories and geographies, we entered 2008 with positive momentum and underlying market demand for orthopedic devices.

While company reports are in for 2007, we expect the results will indicate that the global reconstructive market grew in the range of 8% to 10%. We continue to believe this reflects mid-single digit growth in procedures with a balance. This is due to mix and flat to modest price improvements. We anticipate similar market dynamics in 2008 and slightly higher market growth rates for spine, trauma, dental and extremities, consistent with recent trends.

Our outlook calls for top-line growth for the year of 10% to 11% net sales, on a reported basis, and adjusted earnings per share of $4.20 to $4.25. Sales will be driven by new product introductions and further market penetration by key products launched in 2007, as well as the positive effect of a weaker U.S. dollar abroad.

We attribute approximately two points of sales growth in our range to the impact of foreign currency exchange rates. Several important elements of our product portfolio will impact top line results in 2008.

In our two largest product categories, Knees and Hips, we see the introduction of certain new products as key drivers for the performance this year. We are experiencing a nice stream of new product in Knees this year. We anticipate that the further extension of our Gender Solutions brand and performance of our Mobile Bearing Knee will provide the stimulus to meet or exceed market growth within our Knee franchise.

In Hips, we're working to address a range of mix opportunities. Our new M/L Taper with connective technology product should enhance our competitive position in 2008 and beyond. Although we don't believe we are experiencing unit share losses. Because of these factors we expect to continue to track behind the market on a dollar basis until these mix opportunities are fully addressed.

Now to our reconstructive group: We expect both Dental and Extremities to continue their strong performance and we anticipate it growing at or above market rates in 2008. We expect spine will benefit in 2008 as it did in the fourth quarter from the complete integration of NDS products. We'll continue to look for fill-in acquisitions that can enhance our spine portfolio.

Finally in Trauma: We still have some work to do to capitalize on the opportunities in that market. We expect that our renewed focus on the sales effort will help to improve our performance as we continue to work on addressing key product gaps going into 2009.

As we continue to drive the top line in 2008, we also plan to implement a number of significant infrastructure and operating initiatives that will position us to respond to the growing medical needs of an ageing population. Recent studies indicate that the baby-boomer generation will contribute a 40% increase in arthritis over the next two decades.

We believe that investing today in the infrastructure needed to serve the healthcare market of the future will generate attractive returns in the years to come. For example, moving beyond this year to 2009, we expect to return to at least low double-digit growth in adjusted earnings per share.

Jim will provide further details on the impact of these initiatives, our 2008 earnings, and modeling inputs during this call.

I will now turn to what I determine will be a priority of the highest level for the company. With the passage of four months since signing the Deferred Prosecution and Corporate Integrity Agreements, the continued enhancement of our corporate compliance program is progressing.

We are focused on meeting our obligations under the operational provisions of these resolution agreements and we have embraced the opportunity to make a broader commitment to the ongoing improvement of compliance and business practices that will position us for greater growth.

The terms of the resolution agreements build upon the foundation and incorporated key features of our enhanced compliance program, which we began developing in 2004 and implemented in 2005. The work we have undertaken to address the additional requirements of these resolution agreements has revealed an exceptional opportunity to provide a benchmark of compliance, transparency and patient centrism for the industry.

We will focus initially on three key priorities as we begin to execute a strategy that moves beyond the requirements of the resolution agreements and positions Zimmer to lead in this important area. First, we are reviewing existing consulting agreements to ensure that they are consistent with the fair market-value principles which are a cornerstone of our 2005 corporate compliance programs.

Second, we'll continue to move beyond the Hip and Knee segments of our business with an even more robust enterprise-wide program. And third, we'll enhance our efforts to consistently align all business units throughout the world behind best practices and new standards.

As with any situation in which someone steps forward to initiate change, we anticipate that we may face certain challenges. Nevertheless, we'll carry forward these initiatives, because we believe it's the right thing to do for our company and the industry as a whole. In all cases we commit the fair treatment of our collaborators and we'll endeavor to work with stakeholders to embrace these enhanced compliance initiatives.

Fundamentally, we believe these changes will allow us to continue to deliver industry-leading products, backed by business practices that inspire confidence and trust. As a market leader, it makes sense to us that our leadership position should extend to include innovation in the area of compliance.

Finally, the new initiatives will make it possible for us to focus entirely on what we do best, bringing to market products that enhance patients' lives. At this point Jim will provide some further details on the quarter and our 2008 guidance. Jim?

Jim Crines

Thanks David. I will review our performance in the quarter in more detail, and then provide some additional information related to our guidance, infrastructure and operating initiatives.

Sales of $1.73 billion for the quarter represent an increase of 15% reported and 10.2% constant currency. These results reflect a sequential 240 basis point increase in constant currency growth and more broad based. Growth in the quarter was stronger than anticipated, reflecting an increased underlying procedure demand in the quarter, which was most evident for us in U.S. and Europe knees sales.

The weaker U.S. dollar, compared with the prior year added 4.8% or $44.9 million in revenue in the quarter, approximately $11 million ahead of our previous estimates. Our hedging program resulted in the recognition of greater losses on foreign exchange contracts, which are reported in the cost of products sold. The impact on gross margin in the quarter accounted for the greater part of the decline in margin, compared to both the prior year and prior quarter.

As expected, consolidated price was flat for the quarter. In the Americas, pricing contributed a point to growth in the quarter. In Europe price was a point negative. Germany, UK and Italy reported negative price of 4.1%, 1.7% and 0.7% respectively, while other markets in Europe were flat or slightly positive. Asia Pacific results include a negative price of 1.8%, driven by negative 4.7% in Japan, and offset by flat to positive prices in other Asia Pacific markets.

Turning to our revenue growth by major category, worldwide reconstructive sales increased 15.3%, and reported a 10.2% constant currency, up a 150 basis points from the third quarter. Knee sales lead by the ongoing introduction and launch of our NextGen Gender Solutions Knee improved 10.2%.

Pricing on a global basis was flat for the quarter. Flex knees accounted for 47% of our knees units on a global basis, consistent with third quarter. Achieving these results in quarter one, Flex penetration remained at prior quarter levels. This is a sign that increased investment in field inventory and instrument deployments across our entire knee portfolio is already having a positive impact.

In other knee systems, Zimmer Uni LCCK, as well as our Prolong highly Crosslinked Polyethylene grew in double digits. We launched the Gender Solutions Natural-Knee Flex in the quarter, and that has curbed some of the competitive pressure on that product line.

Geographically, in the fourth quarter, our Knee sales in constant currency increased 9.6% in the Americas, 10.3% in Europe, and a very strong 13.3% in Asia Pacific. Hip sales increased 6.7% in the quarter, reflecting a volume and mix increase of 7.7%, offset by a decrease in average selling prices of 1%. Growth in bone cement cells for the fourth quarter accounted for approximately 100 basis points, as did the volume mix increase for hips.

These results reflect steady growth across our primary hip portfolio, including porous primary stems, total cups and bone cement. Our TM primary, M/L Taper, and EPOCH stems all experienced double-digit growth, offset in part by lower sales of our VerSys Fiber Metal MidCoat, Beaded 6 inch FullCoat, and other cemented stems. TM Modular Cups and Durom and Acetabular component sales reported strong growth, as did Metasul large-diameter heads, with the Metasul brand, realizing over 37% reported growth in sales in the quarter on a relatively small base.

Bone cement sales increased 47% in the quarter on a geographic basis, and in constant currency. Hip sales increased 9.2% in the Americas, with bones cement accounting for 2.5 points of that growth, 4.7% in Europe and 3.9% in Asia Pacific, inclusive of negative price of 3.3%. Extremity sales for the quarter and constant currency increased 30.1%, on a challenging comp of 23.7% in the fourth quarter of 2007. Extremity sales increased 34.7% in the Americas, 19.1% in Europe, and 21.6% in Asia Pacific.

Dental sales continue to grow in double digits at 24.2% for the quarter on a prior year comp of 24.3%. Dental sales increased 7.2% in the Americas, and 63.5% in Europe, including the effect of the distributor acquisition in Italy, which closed in the second quarter. Dental sales increased 11.9% in Asia Pacific.

Trauma sales in the quarter were up over the prior year period at 6.2% constant currency. This growth is up sequentially as we bring greater focus to the sales efforts supporting our trauma product line. We expect this growth to continue to lag the market, and mainly lower sales of Intramedullary Nails, and compression hip screws. Trauma sales in the quarter increased 4.3% in the Americas, 8.9% in Asia Pacific, and 9.2% in Europe.

Spine sales saw a nice sequential improvement from the third quarter, at 17.8% over the prior year fourth quarter. This was lifted by sales of Thoracolumbar Outerbody fusion products, Interbody Spacers, and Dynesys. Spine in the Americas was up 15.1%. Europe increased 27.6%, and Asia Pacific was up 45.6% on a small base. Finally, Orthopedic Surgical products and Other sales grew 6.6% in the quarter, up 3.9% in the Americas, 11.4% in Europe, and 10.8% in Asia Pacific over the prior year period.

Now, let me focus on the rest of the income statement. Our adjusted gross profit margin of 76.4% for the quarter reflects a 140 basis point decrease in prior year, and a sequential decline of a 150 basis points from the third quarter. The decrease in margin is mainly attributable to the impact of foreign currency hedges and geographic sales mix.

R&D expense increased 12% to $51 million for the quarter, indicating higher spending for new product development across all product segments. Selling, general, and administrative expenses increased to $401 million, up 16% to the prior year and they include monitor fees and expenses and higher instrument costs in the quarter. SG&A expenses were also impacted by dilution from the ORTHOsoft acquisition, which closed in November.

Acquisitions, integration, and other amounted to $15.7 million in the quarter, and comprised principally of costs pertaining to 2007 acquisitions, and including an IPR&D charge and contract termination liabilities related to the ORTHOsoft transaction. Adjusted operating profit in the quarter increased 9.8% to $367.9 million. At 34.3%, our adjusted operating profit to sales ratio decreased by 160 basis points from prior year, as a result of the lower gross margin and higher SG&A cost.

Interest income for the quarter amounted to $1.1 million. Adjusted net earnings increased 12.5% to $276.1 million, and adjusted diluted earnings per share rose 15.7% to $1.18, on $234.8 million average outstanding diluted shares. These adjusted earning per share are inclusive of approximately $0.05 of share-based compensation. At $1.12, reported diluted earnings per share increased 9.8% on prior year reported EPS of $1.2.

Let's now turn to our tax rate at 25.1% adjusted for the quarter and 27.5% for the year. The effective tax rate improved, relative to expectations, principally, as a result of higher earnings in profit from our non-US operations. As indicated in the fourth quarter, weighted average diluted shares outstanding were $234.8 million. During the quarter, we repurchased 1,624,000 shares at a total purchase price of $116 million, or an average price per share of $71.23. During 2007, we repurchased 7.2 million shares at the total purchase price of $576.2 million.

As of December 31, 2007, we have remaining capacity to repurchase up to $621 million of stock under our repurchase program. For us, in the absence of significant demands on our cash, stock repurchases remain an effective and efficient use of available free cash-flow.

Operating cash-flow for the quarter amounted to $408.3 million. Depreciation and amortization expense for the quarter increased to $62.4 million. Capital expenditures for the quarter totaled $107.2 million, including $32.3 million for instruments and $74.9 million for property, plant, and equipment, and with $19 million related to infrastructure initiatives.

Free cash-flow was $301.1 million for the quarter. Operating and free cash-flow includes approximately $23 million related to delayed payments under various contractual arrangements with healthcare professionals or institutions.

Finally, inventory days on hand finished the quarter at 258 days, a decrease of 19 days from prior year, reflecting a higher cost of goods and strong underlying demand in the quarter. Our trade accounts receivable days' sales outstanding finished the quarter at 52 days, an 8 day improvement to prior quarter, and 3 days better than prior year.

Now, I would like to expand upon our guidance for this year and comment on our philosophy in this regard. Guidance reflects our outlook for the year, based on a thorough evaluation of detailed business units and corporate operating plans. We are changing our approach by only issuing full year guidance. We want to guide the street, as we run the business, which is with the longer-term perspective and accountability for annual performance.

For 2008, we will provide some more detailed guidance with regard to our spending plans and also share with you our thinking on margins and expense ratios. This should give you more information then you have had in the past to help with your models. We hope for now this will strike the right balance between your need for detail and our desire to stay focused on our longer-term goals and objectives.

As David, mentioned after reviewing market dynamics and our relative opportunities and risks, we expect to deliver 10% to 11% top line sales growth in 2008 and adjusted earnings per share in the range of $4.20 to $4.25. As always, our guidance and assumptions exclude the effect of potential future acquisition or other unforeseen material business event.

Taking a closer look at sales expectations, we anticipate approximately 200 basis points of growth to come from foreign currency and as we have pointed out in the past our hedging program essentially neutralizes the impact of FX to our bottom line. Therefore, our sales guidance assumes a constant currency growth rate of 8% to 9% for the year. This is a step down when compared to the fourth quarter, as we will be up against some tougher comps and continuing challenges in Hips in particular.

Earnings guidance for 2008 reflects the expected costs for a number of ongoing infrastructure and operating initiatives referenced in our press release. As David, indicated these initiatives are needed to serve the healthcare market of the future. Earnings guidance also includes dilution related to the ORTHOsoft acquisition and incremental monitor fees and related compliance expenses.

Working down through the P&L, we anticipate our consolidated gross margins to be in a range of 76% to 77%, most likely in the middle of that range consistent with our fourth quarter results. Compared with the full year 2007, this is a sequential step down due to two principle factors. In 2008, we are facing increased manufacturing costs due to higher material and quality cost. With foreign currency bolstering the top line, we anticipate further losses under our foreign currency hedging program.

We are also in the process of finalizing plans to accommodate at least 100,000 square feet of additional international manufacturing capacity and consolidating distribution in Europe. The rationale for expanding now is to diversify our manufacturing network and reduce risk, take advantage of possible lower tax jurisdictions, and prepare our supply chain for increased future unit volumes globally.

At the same time, our product portfolio has grown in size and complexity, and for example, contains an increased number of PMA Class III devices. Due to these circumstances, we are also upgrading our quality systems infrastructure to ensure Zimmer product quality is never compromised.

Moving along to R&D, you should expect R&D expenditures consistent with 2007 between 5% and 6% of revenue and here as well most likely in the middle of that range. Now, as we go to SG&A, I will outline the impact of monitor fees and related compliance expenses, as well as the infrastructure and operating initiatives.

To start, as disclosed previously, we anticipate $0.02 to $0.03 per quarter in SG&A expenses related to external monitoring. We also will be implementing the compliance related initiatives that David described and had planned in some additional expenses for these efforts.

We will be absorbing on a full year basis $0.03 of dilution related to the ORTHOsoft acquisition, as previously disclosed. We are making necessary investments to our global IT systems. Since our spin-off in 2001, we run our businesses on multiple IT platforms. In 2007, we kicked off a global initiative to build out a single global IT platform on SAP.

As we enter 2008, we plan to implement SAP in our Asia Pacific operating segment. Also, we are upgrading our field base U.S. inventory and instrument tracking systems on the same SAP platform. This would allow us to drive further efficiencies in operations and improve sales force effectiveness. Our guidance includes implementation as well as ongoing infrastructure costs related to this project.

As we have mentioned throughout 2007, we intend to position our field base sales and distribution networks to more effectively respond to changes in daily surgery demand patterns as well as new business opportunities. This necessitates an increase in instrument deployments and the amortization of these investments is reflected in SG&A.

Finally, to capitalize on growth opportunities with our smaller business units, we are investing in 2008 in sales force, instrumentation and other selling expenses related to our Spine, Dental and Trauma business units. Altogether with monitor fees and related compliance expenses, as well as the cost for the various infrastructure and operating initiatives, we expect SG&A for 2008 to fall within a range of 39% to 40% of sales and likely to be in the middle of that range.

Below operating profit, we anticipate a tax rate of around 28.5% above our final rate for 2007, due a higher mix of earnings and profits from higher tax jurisdictions in 2008. As we mentioned on our third quarter call, in the absence of any changes to sourcing, we would anticipate upward pressure on our consolidated tax rate over time.

Our planed manufacturing expansion outside the U.S. should provide us with the opportunity to counter this upward pressure and maintain, and possibly lower our effective tax rate after we get the increased international capacity online. We anticipate weighted average shares outstanding for 2008 to be approximately 234 million shares.

When we derive at our GAAP earnings per share, you should assume subtracting acquisition, integration and other costs of approximately 27 million, when estimated at $0.08 per share. Turning to cash flow, we anticipate capital expenditures in the range of 470 million to 500 million, reflecting the capital components of many of our 2008 infrastructure and operating initiatives already detailed. Instrument capital in 2008 will be in a range of 155 million to 170 million. Traditional PP&E is expected to be in a range to 315 million to 330 million, including a 100 million for infrastructure and our international manufacturing expansion.

Estimated depreciation and amortization expense for the year is in a range of 260 million to 280 million. As we have indicated in the past, we expect to continue to apply available free cash flow towards stock repurchases. We continue to monitor our cash flow against the other strategic priorities and if we are unable to find opportunities to meet strategic and other criteria, we will consider either increasing or accelerating our repurchase activity.

David, I'll turn the call back over to you.

David Dvorak

Thank you, Jim. This is an exciting time at Zimmer. We believe that 2008 will be an extremely productive year, as we strive to execute three major priorities. First, meet or exceed our stated goals for financial performance.

Second, implement the infrastructure and operational initiatives that will prepare Zimmer to participate in the future growth of the market in a significant way. And finally, to develop and market exceptional products under compliance standards for collaboration that consistently earn the trust of our stakeholders.

We pursue these priorities with a commitment to ensure that healthcare professionals will choose our products based on their commitment to provide the best patient care. That's the basis upon which we want to compete and the surest path forward to maximizing shareholder value.

And with that I would like to now open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions).Your first question will be from the line of Raj Denhoy of Bear Stearns.

Raj Denhoy - Bear Stearns

Good morning guys.

David Dvorak

Hello Raj good morning.

Raj Denhoy - Bear Stearns

I wonder if I could just ask briefly, you mentioned I think half way through your comments, about a return to low double-digit earnings growth in 2009. I'm just curious; maybe you could just give us some more detail around that. What expenses particularly in '08 are leveragable and really if you are going and what product initiatives might payoff and better top line growth come 2009?

David Dvorak

Yes, we don't intend to go into detailed guidance with respect to 2009 at this point Raj, but we want to give you an indication, that because of the earnings per share projection in our 2008 guidance, that it would be our intension to see improved leverage in the P&L and the go forward year. So, we want to just cash that in terms of at least low double-digit growth in earnings per share in 2009. I think that the one area that one would anticipate is that obviously after the first quarter of 2009 the monitoring expenses would taper off and that will improve margins.

Jim Crines

Yeah, Raj this is Jim. There are as well, some one time costs associated with some of the infrastructure initiatives that we will incur in 2008, that will not carry over to 2009. I think as we've indicated we feel very good about our Knee portfolio, and are looking to address some, and mix opportunities on the Hip side as well going into 2009, and all that together we believe will put us in good position to return to as David indicated at least low double-digit earnings growth.

Raj Denhoy - Bear Stearns

Okay then just one follow-up. You know one of the questions though has risen over the last several months about to the longer term profitability of the company and what you guys are planning, I guess to fundamentally alter the long standing goal of this $0.03 to $0.50 of every dollar dropping through in profitability. It sort of sounds if I am reading in to what you are saying that, perhaps returning to that outlook in '09 and beyond is really in the cards?

David Dvorak

Well we again believe that we are going to be able to restore the leverage in the P&L on a go forward basis and to the extent that we can provide you with definition to that 2009 we believe will return to at least low double-digit earnings per share growth.

Raj Denhoy - Bear Stearns

Okay very good, thank you.

David Dvorak

Thank you, Raj.

Operator

You next question will be from Ben Andrew of William Blair.

Ben Andrew - William Blair

Just wanted to follow up on a couple of those things, you made a comment about investing to serve the healthcare markets in the future. Can you go into a little bit more detail, what you mean specifically by that if you can please?

Jim Crines

Yeah Ben, this is Jim. A couple of the infrastructure investments in particular, clearly the manufacturing expansion we have planned outside the US, is a step towards getting the company ready for what we anticipate will be a step up in unit demand, within this market.

As we march towards the point where baby boomers hit that age, the average age of a total joint replacement patient, which in our history has been around 67 to 68 years old. Those baby boomers today are just this year turning 63. The upgrade, as we go through that, upgrading our quality systems infrastructure investing in the IT platform.

That's something that we are going to be able to leverage in a number of different ways. Driving out some efficiencies in administrative functions, as well as potentially driving out some efficiencies and the management of the inventory and the instruments, which I think as you know is a key to servicing procedure demand within the hospitals on a daily basis.

Ben Andrew - William Blair

Okay, and what sort of assumption are you making about global price or as much detail as possible there, as we look into '09 and longer time in that same trajectory.

Jim Crines

Yeah, this is Jim again Ben. At this point we see no change from what we've been experiencing over the past couple of years, which again is some modest price reductions outside the US, offset by modest price increases inside the US. And I guess when people ask it by price they are often asking as well about mix opportunities. We believe those mix opportunities are still there to the extent that we, or any of our competitors for that matter, bring new and unique devices to the market, particularly those that offer improved patient outcomes.

Ben Andrew - William Blair

Okay and then just two other questions. When you talk about increasing manufacturing outside the US in tax advantaged areas, are you talking Switzerland or are you looking Asia to get a little cost down or can you be more specific?

David Dvorak

Well, we are not ready to announce yet a location, I think in the near future we will be, I would tell you that most likely to be in Europe not Asia Pacific.

Ben Andrew - William Blair

Okay, and then finally what is your view of the long term cost savings opportunity with SAP as you get it fully implemented, and when would that be kicking in?

David Dvorak

That, it will be a couple of years before we really have the opportunity to leverage that investment, it takes as you can imagine with this kind of initiative, a couple of years before we are able to get through all of the operating segments. As I indicated, we're going to begin with Asia-Pacific in 2008. We'll move on to North America and then Europe following that. So we are a couple of years out before we'll begin to really be able to leverage the investment.

It's one of the ways in which we pointed out earlier, we're going to look to drive efficiencies through the P&L and return to leveraged growth and earnings per share. Beyond that then it's kind of hard to give specifics at this point.

David Dvorak

But I would also say, Ben, that it's obviously a key piece of our infrastructure that will allow us to do future integrations more efficiently and effectively. So that's an important part of our strategy on a go-forward basis as well.

Ben Andrew - William Blair & Company

Okay. Thank you.

David Dvorak

Thank you.

Operator

Your next question will be from Michael Jungling of Merrill Lynch.

Michael Jungling - Merrill Lynch

Yes, sir, good morning. I have three questions please. Firstly on SG&A, did your Q4 2007 number benefit from reducing consultancy agreements with doctors? Secondly, on FX contracts using current spot rates, what is the actual headwind to gross margins from foreign exchange contract losses? Thirdly on the share buyback, can you comment on why you did not raise your share buyback program, given the current tough valuations? I don't fully understand that given the excess capital that you currently have. Thank you.

David Dvorak

Sure. Michael, thanks for the questions. To respond to your first question, the answer is no, the SG&A expenses were not reduced in anyway by consulting payments. Any payments would have been accrued even if the payments weren't made at that point in time. So there is no impact on our SG&A expenses in that area.

Jim Crines

And then, Michael, this is Jim. I'll address the other two questions that you had. First of all, on currency, I guess, we've guided people to think about this by first looking at the lift, we would expect to get on the top line. With respect to 2008, we've indicated that accounts for 200 basis points, so the 10% to 11% growth that we have forecasted.

And then, to the extent that we've indicated, that gets neutralized on our operating profit line through the hedging program. You could basically apply, do the math, apply our operating profit ratio to that lift and you get a sense of what the headwind is going into 2008. Again, that is something that we have taken into account in the guidance we provided on gross margin.

On share repurchases, I wouldn't get too focused on a single quarter's activity, as you're hearing on this call, the company has some major infrastructure investments underway. Some of the cash that we'll report out, we have on the balance sheet as of December 31st is not resident here in the US. So, we don't necessarily have access to all that cash to repurchase shares.

We did, as it turned out in 2007; invest over $500 million -- returned over $500 million of cash to our shareholders through that share repurchase program. So again, I wouldn't get too focused on a single quarter.

Michael Jungling - Merrill Lynch

And I have just a very two quick follow-up questions. The gross margin for 2009, will that be impacted by foreign exchange losses based on your current FX hedging program? And secondly, if I look at SG&A divide by sales it does appear if you exclude monitoring charges to be one of the lowest or so that we've seen for many, many years. Can you explain why the SG&A came in so low? Thank you.

Jim Crines

Sure. So again, with regard to 2009, currency we do hedge out 18 to 24 months. So there will be some carryover in 2009, but certainly not as significant. Assuming exchange rates don't change from where they are today, the losses that are running through the P&L in 2008 would be more significant than we would expect to see in 2009.

And then, on SG&A, I think what you're seeing there is more the impact of seasonality within our business. Our fourth quarter does very typically tend to be the lowest -- we kind of experience the lowest SG&A ratio as a percent of sales relative to other quarters within -- particularly relative to the third quarter. So I really don't think you're seeing anything else other than that.

Michael Jungling - Merrill Lynch

Because if you see the monitoring chart of the sales, I am guessing $6 million, $7 million, $8 million or so in the fourth quarter. On a like-for-like basis, your Q4 SG&A to sales is meaningfully lower to Q4 of 2006. That really was the question?

Jim Crines

Yeah. I would tell you Michael that this maybe something we'll just need to follow-up on after the call. We see -- you take up the -- as you pointed out the $6 million to $7 million, say, of monitoring fees and expenses and I think what you would see is SG&A tracking inline with the top line growth.

Michael Jungling - Merrill Lynch

Great. Thank you.

David Dvorak

Thank you.

Operator

Your next question will be from the line of Bob Hopkins with Lehman Brothers.

Bob Hopkins - Lehman Brothers

Hi. Thank you and congratulations on the good results.

David Dvorak

Hello Bob.

Bob Hopkins - Lehman Brothers

Hey, first question to speak would you guys be willing to quantify the extraordinary spending on a pretax basis it's going on in 2008. When you include the monitoring expense, the compliance initiative, the IT systems, and all that's running through the P&L, is there any way that you are going to give us that number?

David Dvorak

I think you can get there Bob, if you follow the guidance that we have provided on the expense ratios, and you can do the math. And I think once you get to somewhere in the order of about $100 million of incremental spending including that monitor fees and related compliance expenses.

Bob Hopkins - Lehman Brothers

Okay.

David Dvorak

And as we have indicated some of those will carry over in 2009, and a good portion of them we would expect to go away in 2009.

Bob Hopkins - Lehman Brothers

Okay. So in terms of thinking about what flows through to 2009, the monitoring expense we know, but away from the monitoring expense what percentage carries over in to '09?

David Dvorak

Yeah. It's a little hard to say at this point, but probably safe is to assume that roughly in the order half of that.

Bob Hopkins - Lehman Brothers

Okay. And then one of the question on the [consulting arrangements] and the doctors spend, is it? Would it be a fair assumption, as we model longer term for your company, that those expenses relative to what we saw publicly announced a couple months ago, we'd come down meaningfully as we think about maybe '08 and '09 and 2010, or do you expect the same kind of numbers that we saw publicly announced would be maintained?

David Dvorak

I would think that you could anticipate that there would be adjustments. Business needs would dictate those adjustments to a large part Bob, but we may also find ways of supporting medical education for instance in a manner that puts those dollars into the hands of a neutral third party, so there is no appearance at all of an impropriety. So, I wouldn't discount all of those dollars down. Our needs will dictate them. But they may take a bit of different form as we go forward.

Bob Hopkins - Lehman Brothers

Okay and then one other from me is. It's clear when we have seen J&J and Stryker and Biomet, and now you guys report that there has been an apparent up tick in the orthopedic markets in hips and knees. Are there one or two things that you could point to that it's going to attribute the strength to or is it just surprising you guys as well?

David Dvorak

Well I think that it was broad based in our case. We saw an up tick in procedures, not only across the various product lines, but also across our various geographic segments. So, that's really the response. It is a broad based acceleration.

Bob Hopkins - Lehman Brothers

But is there one or two reasons why you think or just seeing an acceleration and happy to see it?

David Dvorak

Well an acceleration in procedure growth.

Bob Hopkins - Lehman Brothers

Okay so procedure growth.

David Dvorak

Yes, yeah I would tell you Bob in our case although again, we have seen what our competitors have purported. We are seeing within our own business to some degree, the effect of having put out, more instruments and more inventory into the field, and that's putting our sales and distribution networks in a position, to service the increase in demand that we are seeing across the market, and to go after new business opportunities as well.

Bob Hopkins - Lehman Brothers

Okay and finally just to be clear on the philosophy around guidance. I think you are pretty clear on this. But these are not aspirational goals, these are things that you expect to meet or exceed. Is that correct?

David Dvorak

That is correct.

Bob Hopkins - Lehman Brothers

Okay, thanks very much guys.

David Dvorak

Thank you Bob.

Jim Crines

You are welcome, thank you.

Operator

Your next question will be from the line of Matt Miksic, Morgan Stanley.

Matt Miksic - Morgan Stanley

Good morning.

David Dvorak

Good morning, Matt.

Jim Crines

Hello, Matt.

Matt Miksic - Morgan Stanley

Thanks for taking the questions. One point of clarification on guidance, is this $0.08 that's a difference between your $4.20, $4.25 adjusted and $4.12 to $4.17 I guess ex the $0.08. That $0.08 includes what's exactly in there and what's not in there?

David Dvorak

Yeah. What's in there, are in the integration costs associated with the acquisitions we've completed in 2007, and costs associated with the centralization of our European distribution.

Matt Miksic - Morgan Stanley

Okay.

David Dvorak

And we have multiple distribution centers in Europe, and we're moving towards a central hub, building out a new facility and with that, we'll incur some restructuring costs to either relocate people, or for those people that you see do not relocate to pay severance to those employees.

Matt Miksic - Morgan Stanley

Okay. Monitoring expenses are in the fore or in that other number, though they're not in that $0.08?

David Dvorak

That's correct.

Matt Miksic - Morgan Stanley

And then, another just clarification on guidance, I know you're moving away from quarterly guidance. But just to help us, maybe put together the pace of the year, and the first quarter, I mean in one way to look at this. If you are looking back on the first quarter, based on what you know now, what kinds of things should we be mindful of as we put together our numbers, nuances in the quarter like differences of selling days, price cuts, year-over-year-year comps or new launches that might affect Q1?

David Dvorak

Yeah. I think, Matt, similar to what you have seen in prior years out of this business. The same issues around seasonality, obviously, with elected procedures slowing down in the summer months. I would tell you the spending on the infrastructure and operating initiatives as it turns out in the aggregate was likely to play out evenly over the course of the year.

There are some of those that will hit hard in the beginning of the year and others that would be more active I guess in the back half of the year. So in the aggregate we would expect that spending to take place somewhat evenly over the course of the year. On the pricing front, Japan price reductions April 1st as they typically are, so really no difference related to prior year seasonal patterns.

Matt Miksic - Morgan Stanley

Okay so new cuts as of Jan 1, no unusual comps in any of your business lines that we should be thinking about for Q1?

David Dvorak

I guess that the only other thing I would plan out is to the extent we are seeing the effects of acquisitions on our top line in the Spine and Dental businesses. At some point, the back half of the year next year we'll be up against some tougher comps there.

Matt Miksic - Morgan Stanley

It's helpful, one question just on the regulatory front. One of your competitors has been hit by a couple of warning letters from the FDA over the last year or so, just wondering if you can give us any sense of maybe where you are in the cycle of inspections over the past several months, where you stand with the FDA?

David Dvorak

We obviously have a variety of different facilities as you know Matt. And so those inspections are taking place on a rolling basis. Jim mentioned, that we have initiatives underway to enhance further our quality systems, that's a significant priority for us as one would imagine and we are going to continue to improve those systems as we go forward. So it's an ongoing commitment in our area, but one that we treat as a major premise to running our business.

Matt Miksic - Morgan Stanley

Okay. And then just finally, again to the question of strength in the fourth quarter, you saw broad based strength I think across all your businesses, buts Hips in particular I think across the market have been stronger than expected. This is something you guys are often unwilling to talk about it off label usage.

As we get more resurfacing products out into the market, many of these products are proved overseas in that sort of well characterized clinical data and results and safety profiles and so on. Is it possible that as these other products rollout from Stryker and Smith & Nephew, that we see just a broader off label use across other manufacturers who have approved OUS products?

David Dvorak

That is not part of our business strategy, whatsoever Matt. I mean, we respect the clearances that we have and treat that matter in a very carefully fashion. So we don't anticipate that we are going to participating in the resurfacing market until we have a product that's properly clear.

Jim Crines

Matt, this is Jim. I would tell that we don't think we are seeing that at all. In fact I think, I believe there are reimbursement challenges with respect to anyone who would choose to use our product off label and that is frankly, keeping that under tight control across the market.

I would tell you that in fact, as well examine our Hips results relative to our competitors, and particularly those that are reporting higher dollar growth, one of things that's contributing to our performance relative to their performance is the fact our large diameter head, metal offering has not reached the level of penetration that is at all near what those other companies have achieved with their alternate bearing offerings.

Matt Miksic - Morgan Stanley

Okay and just one last question, just in the past couple of quarters I think it's fair to say that it sounds and looks like you have learnt some lessons in terms of forecasting and providing guidance, and perhaps managing the business as well. I just wanted to ask if there is anything that you see yourself doing differently over the next, you know as you talk about your quarter and your guidance today or going forward based on what you have learnt say in the last nine months?

David Dvorak

Well Matt we obviously went through an extremely methodical process to put our 2008 plan together. We described that process broadly to people that we've met have with, and really all of that hard work puts us in a great position and provides us with nice momentum coming out of the fourth quarter. So we're anxious to execute on these plans and optimistic that we're going to have a good year in 2008.

Jim Crines

Matt this is Jim. I would just say as I have said before that we really appreciate all the feedback we get from you folks and hopefully you see that we're doing everything we can to respond to that.

Matt Miksic - Morgan Stanley

Great, well thanks I will jump out.

David Dvorak

Thank you

Operator

Your next question will be from the line of Kristen Stewart with Credit Suisse.

Kristen Stewart - Credit Suisse

Hi good morning.

David Dvorak

Good morning

Kristen Stewart - Credit Suisse

I was just wondering if we could just plan and take a step back to -- in October you guys have reduced your guidance and one of the things that you had cited was reduction of 33 to 38 I think it was in constant currency growth. What happened I guess relative to your expectations in the month of November and December, I would imagine December is generally a pretty slow month. To really drive the increase in your top line growth, was it just currency and if it was just currency are fully hedged to where it not dropping fairly and you mentioned the SG&A impact obviously but it does any at all fall through to the bottom line?

David Dvorak

Okay, I will pass the currency question back over to Jim, but let me just respond to the front end of your question Kristen. I think that what we saw, it was broad based procedure growth that drove across to our various geographies, as well as our business units. And candidly, I think that we also did a better job of exploiting those opportunities. We had better synchronization of our distribution, our manufacturing to take advantage of that, and I think that there were less missed opportunities on our part in the fourth quarter then there may have been in the second and third quarter.

Jim Crines

Yeah and on the currency front, Kristen this is Jim. That really contributed a fraction to the over achievement as we indicated in our prepared comments it was $11 million of the over achievement on the top line.

Kristen Stewart - Credit Suisse

Can you give us a sense just in terms of where currency has been impacting you in the previous three quarters. I know it wasn't obviously as much of a hit but just where that was on the gross margin line?

David Dvorak

Yeah, again I guess you would have, I don't have it here in front on me, you'll have to go back over the year and look at what currency has contributed to the top line in total. I think in total, if you look back over the year you will come somewhere to the order of $100 million benefit to the top line, and as I indicated you can get a sense of what's going on with hedge losses, when you consider that we've disclosed that the hedging program effectively neutralizes that top-line benefit by the time you get down to the operating profit line. So you can do the math and get a sense of how that's playing out in the margin.

Kristen Stewart - Credit Suisse

Wouldn't some of your SG&A and R&D also be impacted obviously by higher foreign exchange rate because the expenses will also be a little higher?

Jim Crines

Yes.

Kristen Stewart - Credit Suisse

And the last question, just going back to the acquisition, integration and other expenses that you broke out is just about $0.08. What's your general philosophy on kind of how you would exclude this into, I guess outside of the adjusted numbers? What type of expenses are these specifically, and to what degree will they continue going forward?

Jim Crines

Yeah. We would look to put into that line any unusual expenses that are sort of one-time in nature and we've done that -- we have done it consistently. And then we would also look to provide very transparent disclosure. You'll see in our periodic filings as to what's included in that line and we will continue to report on that basis.

Kristen Stewart - Credit Suisse

And the added distribution, I guess the investments there, will those be similar to what you did in previous quarters with the purchases of distributorship or is this something different?

Jim Crines

There we're talking about our own distribution centers, our own logistics, and operations in Europe. We're not talking about not referencing acquisitions made to third-party distributors.

Kristen Stewart - Credit Suisse

But aren't those included in the acquisition, integration and other or those within the SG&A line?

Jim Crines

Well, just referencing what we were talking about on the call with respect to centralization of our distribution operations in Europe in 2008, that is, as I said that is an effort that involves our own internal logistics operations in Europe.

Kristen Stewart - Credit Suisse

Maybe I will follow-up in line. Thank you.

Jim Crines

Sure.

David Dvorak

Thank you.

Operator

Your next question will be from Joanne Wuensch of BMO Capital Markets.

Joanne Wuensch - BMO Capital Markets

Thank you very much. A couple of questions, the first, have you seen any changes in your business practices with the physicians, now that the DOJ settlement is behind you?

David Dvorak

Our business practices are obviously geared towards being completely incompliance with the terms of those resolution agreements. And I would not describe the business practices as it has been changed in material sense.

Joanne Wuensch - BMO Capital Markets

And I still need to ask the question in different way, but I am sorry -- which is that, do you feel like there has been some speculation that now that the settlement is behind Zimmer, that the doctors would not be a averse to using Zimmer products, could you sort of comment on that?

David Dvorak

Well, I think that as a general matter, all these healthcare professionals are making decisions with respect to products in the best interest of their patients. And we feel very comfortable with the quality of our products and believe that is going to be the basis for competition on a go-forward basis and we're going to be well served in that marketplace.

Joanne Wuensch - BMO Capital Markets

Okay. In your guidance, do you have a share repurchases plans?

David Dvorak

We do. If you look at the average share number that we've provided, you'd probably be able to figure out that. What we've assumed in is a bit more modest than what we experienced in 2007, but as I indicated in our prepared comments to the extent that we don't have other needs for the cash over the course of the year, what we have assumed into our guidance may prove to be a bit conservative.

Joanne Wuensch - BMO Capital Markets

Okay. And this question has been sort of ask the couple of different ways but I want to really get my arms around that what you said, in the second quarter the company met expectations then guided lower and the third quarter they met expectations and guided lower, and now in the fourth quarter you beat expectations and guided in line with the street. If you had to say what happened between the last conference call and this conference call, could you just put couple of items that may give you some increase confidence in the way the financial guidance is being provided? Thank you.

Jim Crines

As David explains, we've had the opportunity to go through, a very detailed review of our business unit and corporate operating plans. We're very pleased frankly with the performance in the fourth quarter relative to our earlier expectations.

We see our supply chain in our sales and distribution networks. We're responding to the increase that we're seeing in demand across the quarter, that together with the process that we went through give us the confidence that we have going into 2008 that we will meet or exceed the financial targets that we've set for ourselves.

Joanne Wuensch - BMO Capital Markets

Okay. Thanks.

Jim Crines

Sure

David Dvorak

Thank you.

Operator

Your next question will be from Mike Weinstein with J P Morgan.

Mike Weinstein - JP Morgan

Thank you. Good morning, guys.

David Dvorak

Good morning, Mike.

Mike Weinstein - JP Morgan

I think a lot of the questions have already been asked. But, I do want to circle back on some of the questions that were being raised, and the theme that Joanne was pushing you guys on. Are you surprised by the performance in the fourth quarter? The market obviously is healthy. You're not necessarily growing above market, neither hips nor knees, but you're pretty close, looks like inline with the market in knees and maybe slightly below in hips.

Are you surprised though by your performance could certainly the tone you guys gave one the third quarter call was much more cautious than your tone since then with investors at meeting and so forth was cautious. So, am I right in assuming you're a bit surprised, or how should we characterize your own response for the quarter?

David Dvorak

I think that we were surprised by the extent of the procedure growth, and that's obviously a positive surprise. I think that, as I said earlier, Mike that a lot of things have come in the sink. We were able to take full advantage of that up-tick in procedure growth, and we were able to do that across a variety of different business units that were coming in below our expectations in the prior two quarters.

And so, things came together in a more significant way, and I think that we also saw an earlier payback to some of the investments that we made in the distribution cannel that's Jim has mentioned including inventory and instrument deployments.

Mike Weinstein - JP Morgan

And when you say pick-up in procedure growth, do you -- are you talking about Hips and Knees or you are talking across your business? Do you think that there was a fourth quarter pick up in volumes?

David Dvorak

Well, primarily in reconstructive procedures that's, because it's three quarters of our business it dictates so much to us. But I'm referencing really the reconstructive business, when I say that.

Mike Weinstein - JP Morgan

And you seem to be suggesting that you've got enough of a read on the market to say that you think the market actually picked up in the quarter. Is that, I mean rather than just the Zimmer's own business picked up a quarter, is that right?

David Dvorak

It's true, Mike. I think that it's our perspective from our running our own operations, as well as what's been reported publicly.

Mike Weinstein - JP Morgan

Based on -- it's being based on the other numbers that have come through so far?

David Dvorak

That’s right. It corroborates our view from our own perspective.

Mike Weinstein - JP Morgan

Okay. Jim, just one financial cleanup question. The drop in the tax-rate in the quarter, maybe help me understand better what was the one-time benefit there and then you have been suggesting that the tax rate would move up in 2008, but here you are pretty much -- you are actually guiding to below what we had, and you're pretty much guiding to a flat year-over-year. Can you just maybe walk us through both of those?

Jim Crines

Sure. What led us to the tax rate down to where we landed at 27.5% for the year was really the strength of our earnings and profits and of our non-US operations. That happened to be particularly strong in the back half for the year, and why it wasn’t factored earlier in the year. That and the fact that frankly, we go through the more detailed robust process at the end of the year that gives us a more precise indication of what our legal entity earnings and profits are on a consolidated basis, and make the adjustments as we did at the end of the year.

Mike Weinstein - JP Morgan

So that's why there was catch up for the year?

Jim Crines

That's right, that's sort of the story of 2007 and with respect to 2008 at 28.5% again above where we landed in 2007 and we are forecasting that given the fact that some of the newer products that we have launched that will drive the mix of earnings and profits, or getting sourced out of our US facilities. The net as we indicated that does tend to put some upward pressure on the tax rate.

Mike Weinstein - JP Morgan

Lastly, a couple of quick questions here. How much of your cash is in the US right now?

Jim Crines

It's roughly about a third of what we have reported on the balance sheet as of December 31, '07.

Mike Weinstein - JP Morgan

Okay, and philosophically Jim, your thoughts on taking on either working that down, or taking on debt to increased share repurchase, the company is still against that?

David Dvorak

Well Mike, I don't know that we've ever said we are against that. That's something that we would consider. It's clearly not something that we have reflected in the guidance that we provided for 2008.

Mike Weinstein - JP Morgan

Okay great thank you.

Jim Crines

Thank you, Mike.

David Dvorak

See you, Mike.

Operator

Your next question will be from Mark Mullikin of Piper Jaffray.

Mark Mullikin - Piper Jaffray

Just a couple of questions on the competitive environment here with one of your competitors having some very well known issues at this point with quality and manufacturing issues. Are you seeing anything in this field indicating that you might begin some share on the large joint side of the business?

David Dvorak

Nothing of significance in that respect.

Mark Mullikin - Piper Jaffray

Okay. And then on some of the smaller component extremities, dental, and spine within the extremities business you put up a string of really strong quarters here. Are there any specific products or geographic expansion, what's driving that?

Jim Crines

Mark, this is Jim. I think some of what is driving that is certainly benefiting our reports, and to some extent, I think with that the new products that we've introduced are even driving an increase in usage across the surgeon community. I think this new Inverse/Reverse Shoulder Systems, as I understand it are a bit less challenging with respect to surgical technique.

So, they are getting greater usage if you will across the surgeon community, and that's driven up market, driven the market higher with respect to the total procedures that are being done. And again, we've launched a couple of new products into that category that have been incorporated such as our Trabecular Metal Technology. And that's really helped to drive the kind of performance you are seeing out of our extremities line.

Mark Mullikin - Piper Jaffray

So, is it that this is a product group that Zimmer has that some of the competitors don't, because we've seen some pretty weak numbers out of some of the other shoulder companies, is it basically that you are gaining share because you have that product line?

Jim Crines

Well, I think that product is gaining share, and it's extending the market as Jim said, because it in a sense is addressing an unmet clinical need prior to the launch of their product. So, we would expect to continue to do well in that segment.

Mark Mullikin - Piper Jaffray

Okay. And then within Spine we're seeing a nice rebound in growth and you mentioned finishing the NDS acquisition, are there any specific products that are driving that growth have you now anniversaried some of the Interbody Fusion Cage, challenges at this point?

Jim Crines

That is the truth. On the Spine side, we've anniversaried out some of the losses that we're experiencing on the cage side, and we're just reaching the traction point of adding the Thoracolumbar products that we picked up through the NDS acquisition, as well as the MIS offering with the [TAV E] that is opening doors for us and we're creating some opportunities in that area as well as ongoing expansion of our Denus product family.

Mark Mullikin - Piper Jaffray

And how much did acquisitions contribute to the quarter and how much are you factoring into '08 guidance?

Jim Crines

We haven't provided that detail Mark, and I'm not kind of provide to you on this call. I mean it clearly did contribute on the spine and dental numbers with the dental sales in Europe increasing 65% in the quarter, but in the aggregate it's modest.

David Dvorak

It's very modest, and in particular within Spine you would see that and our US numbers and then obviously on the dental side, it was the European distributor. So, you'll see an up tick in the numbers that Jim walked you through earlier in the call.

Mark Mullikin - Piper Jaffray

Okay. And then the ORTHOsoft acquisition, where does that fit in to the revenue build?

Jim Crines

Yeah, it would be in the, what we refer to us orthopedic surgical products and other sales. There are very modest revenues that come with that. The strategy there is really focused on having that technology available for across actually our entire reconstructive portfolio.

Mark Mullikin - Piper Jaffray

And then just one last one on the gross margin line, you are guiding that to be in a bit down in this quarter, it was down quite a bit sequentially. Can you just maybe breakout what are the pressures on the gross margin line is that the FX issue, is that the reinvestments exactly what's pressuring it?

Jim Crines

Yeah. Well the most significant issue, is the FX issue that's what contributed to the sequential decline in the fourth quarter, and that carries over into 2008. There are a couple of other things as well that we've mentioned, higher material cost being one specifically on cobalt chrome. We are seeing a significant increase in the price of that material.

And then there is two other things would be the investments, we are making in quality systems infrastructure that does impact to some degree on cost of goods and that's it..

David Dvorak

Startup costs.

Jim Crines

Well, I'm sorry there is one other thing that startup costs on the international manufacturing expansion. We'll also run through cost of goods in 2008.

Mark Mullikin - Piper Jaffray

Okay, very good. Nice quarter, thanks a lot.

Jim Crines

Thank you.

David Dvorak

Thanks Mark.

Operator

The next question will be from Tao Levy of Deutsche Bank.

Tao Levy - Deutsche Bank

Thanks, good morning.

David Dvorak

Good morning, Tao.

Tao Levy - Deutsche Bank

David, maybe on the dental business, can you give us a sense of how much that distributor added not necessarily in dollars, but you grew there 60% whether maybe half of that growth?

David Dvorak

It’s a small base business, so insignificant in the scheme of things. I think that the breakout of the different geographies that Jim walked through earlier in the call, provide you with good guidance in that area Tao.

Tao Levy - Deutsche Bank

Okay. And any thoughts on how we should view sort of the dental business in 2008, just given all the macro environment issues.

David Dvorak

Well, we are still optimistic about that segment. It's a business that we've invested in since the time we consummated the Centerpulse transaction in 2003 with good success performance wise, and we will continue to do so. It is one of the areas in the infrastructure expansions -- that of the infrastructure expansions that Jim described earlier, and principally on the sales and marketing side.

Tao Levy - Deutsche Bank

But overall in terms of end user trends, consumer trends, I mean, you feel comfortable that still maybe a good growth business this year?

David Dvorak

Yeah, we are bullish on it. It became hard because of such an under penetrated market at this point and time, relative to the potential patients that could benefit from those procedures.

Tao Levy - Deutsche Bank

Okay. And on the hip side, last quarter, you had mentioned that you are a bit nervous on how your hip business is going to perform, not so much by hip resurfacing taking over but by surgeons getting exposed to competitor products, etcetera, now that you've gone through some of that experience maybe in the last few months. Have you seen that take place, have you seen folks, who are trained in the Birmingham you see go away from the Zimmer products?

David Dvorak

Well, I think that as we stated earlier on the call as well, we don't believe that we are losing units here. We think that we are missing some mixed opportunities there and the Metal-on-Metal under penetration within the United States that Jim referenced is an example of that. So I think that we're quite comfortable that we're retaining the unit share on that side, but we want to sure up our ability to take full advantage of those mix opportunities. And so, some of the benefits of the product offering on the Taper product with connective technology this year will start to kick in. But then, we have some other programs in the pipeline that we think will help us even in advance of ultimately having a resurfacing product offer for the US marketplace.

Tao Levy - Deutsche Bank Securities

Okay. And you mentioned, you talked about investing in compliance and systems. Do you currently have any issues with the FDA? Any warning letters, that usually takes a few months for those to be posted, that may have been issued?

David Dvorak

We don't have any warning letters at this point.

Tao Levy - Deutsche Bank Securities

Got you. And then just lastly, on the shares outstanding that you are expecting for next year, it doesn’t look like you are assuming much of a repurchase. Any sense of where that interest income line should shake out then, given assuming limited share repurchases, which you are guiding to?

Jim Crines

Well, we've given an off a lot detail guidance and I think the one thing we…

Tao Levy - Deutsche Bank Securities

I appreciate that.

Jim Crines

So I am going to leave it to you to figure out what it needs to be to get within that 420 to 425.

Tao Levy - Deutsche Bank Securities

But that is factored into…

Jim Crines

Sure, sure.

Tao Levy - Deutsche Bank Securities

Okay, great. Thanks a lot. Great quarter.

Jim Crines

Okay. Thank you.

Operator

Your next question will be from Steven Lichtman of Banc of America Security.

Steven Lichtman - Banc of America Securities

Thank you. Good morning.

David Dvorak

Good morning, Steven.

Steven Lichtman - Banc of America Securities

Guys, I don't think you mentioned gender hip, maybe I missed it, but is that still a plan launch in 2008?

David Dvorak

It is. We've been talking about two different product launches in that category, the M/L Taper with connective technology, which is the one that is beginning to ramp now. In the back half for the year, we would go to potentially a limited release and then extend beyond that with respect to the EPOCH stem that also fits into the gender category.

Steven Lichtman - Banc of America Securities

Okay. And then in the terms of the gender knee, any change in the tone out there. On the last quarter call you had mentioned that you need to kind of, sense go back to the drawing board in terms of the message out there DTC etcetera.

What's the general tone out there on the gender knee?

David Dvorak

We've refocused our sales force and I think that we saw some of the benefits of having done so and we have productive fourth quarter in that area. So, we continue to be very optimistic about the performance of our Gender offering on a go forward basis.

Steven Lichtman - Banc of America Securities

Okay. You talked, David during your prepared comments about expanding the corporate compliance program, and you said as you initiate change, we anticipate may face some challenges. Can you expand on that, what types of things you will be looking for and what potential challenges were you referring to?

David Dvorak

Sure. I think that any time where you are dealing with a dynamic circumstance, different parties that are involved in those changes come at them at different speeds. Principally in our case, I think that we are committing significant resources to ensure that we are in absolute compliance with the resolution agreements, and so that includes, our senior management team and myself on that list.

So, that is part of what we are referring to, as we are very focused on that. But, it's a key priority, and we are absolutely confident that we are going to work through this transition period, and be able to generate first grade products in a manner that brings about trust and confidence in all the stakeholders involved in that process. We are very optimistic that we are doing the right things, and it's going to serve the company well in the long-term.

Steven Lichtman - Banc of America Securities

Okay. And in terms of the gross margin looking forward, it may be qualitative, as we look past '08, can we think about gross margin getting back to the levels that we've seen previously, or some of the issues that you mentioned in terms of cost infrastructure issues that perhaps will last little bit longer than 2008, understanding there are certain one-timers with FX. How should we think about gross margin a little bit longer-term?

David Dvorak

Sure. Well, Steve there are so many factors that impact our margins, including price, product mix, and geographic mix. There are clearly some things you could forecast out that would lead you to believe there, we would see improvement in gross margin. Not the least of which is, sort of anniversaring out of the hedged losses, that we've been experiencing and then, leveraging some of these investments that we're making.

So, one other things that has contributed to even in the phase of very modest price increases, and improvement in gross margin overtime, is our ability to leverage unit growth. And we are making investments as we said, that will put us in a position to leverage unit growth in time. Whether or not we see that in a significant way in '09, as I said here today, I can't really project that.

Steven Lichtman - Banc of America Securities

And then one quick thing on the fourth quarter, nothing unusual in terms of selling days in the quarter, the fourth quarter?

David Dvorak

No.

Steven Lichtman - Banc of America Securities

Okay. And then, I think that's it from me. Thanks a lot.

David Dvorak

Good. Thanks, Steve.

Jim Crines

Thank you.

Operator

Your next question will be from Doug Schenkel of Cowen and Company.

Doug Schenkel - Cowen and Company

Hi. Good morning, and thanks for taking my questions.

David Dvorak

Hello, Doug.

Doug Schenkel - Cowen &Company

Just a couple of quick clean up questions. I think you talked about integration of Endius distribution last quarter being a bit of a drag on spine. Are we past this dynamic at this point or where do we stand on that integration?

David Dvorak

Yeah, we out past that dynamic. That was an acquisition Dough that was really geared towards picking up some products that represented holes in our offering prior to the Endius acquisition, Atabe and the title systems in particular. And there were distributors that came along with that, but as you can imagine it was a small company with an independent distributor network, and so there's going to be some displacement. I think we've also picked up some good people through that, but that process is complete at this stage and so what you saw in the fourth quarter should be representative of the benefits that we see in the go-forward time period.

Doug Schenkel - Cowen & Company

Great, thanks for that. We talked a lot about GSK today already, but I was wondering if it was possible to provide any metrics in terms of whether or not that would demonstrate whether or not you becoming more or not becoming more successful and actually using the product as a way to capture additional surgeons?

Jim Crines

Well that the metric that we have provided in the past, and continue to provide, is High-Flex penetration, within that primary knee portfolio. As we reported we saw that sort of level out in the fourth quarter at 47%, consistent with where we had seen in the third quarter. Now, we also saw fairly significant up tick in procedure volumes, within the fourth quarter and when we look at growth of that product line relative to some of the other products that was really one of the products that led that growth, and particularly when you look at, if you focus on the growth rate in knee sales in the fourth quarter on Europe relative to the third quarter, we are moving ahead with putting more instruments, more inventory out into the field in Europe, but it is definitely contributing to the up tick and growth we saw in knees.

David Dvorak

It also contributed, as Jim mentioned to reversing some negative trends that we have previously been seen in the Natural-Knee product line.

Doug Schenkel - Cowen &Company

Right. Okay. That's very helpful. And just one last follow-up on the investment you talked about in the instrumentation in the sales force. Is it fair to assume that these investments will result in some sort of multiyear acceleration that would begin in sales in I guess spine, trauma and dental as soon as 2009 or does that usually take a bit longer to actually get a return on that investment?

Jim Crines

Well with instrument you actually get to see and as we did in the fourth quarter, you get to see a pretty immediate return. If there are unmet surgery demands, those things will be put to use pretty quickly, and I think we did see some of that in the fourth quarter. So as we move ahead we would expect to see a pretty immediate return on the placement of more instruments and inventory into the field.

There are other investments that we're making around systems that will help us more efficiently manage those assets in the field, but I think it will be a little longer before we are able to leverage those investments.

Doug Schenkel - Cowen &Company

Okay, great. Thanks a lot and congrats on a great quarter.

Jim Crines

Thank you

David Dvorak

Thanks Dough.

Operator

Your next question will be from Bill Plovanic of Canaccord Adams.

Bill Plovanic - Canaccord Adams

Great, thank you. Just a few questions, clarification questions for me here. First of all just in terms of the double-digit earnings growth '09 off of '08 is that off of the 420 to 425 guidance?

David Dvorak

That's correct.

Bill Plovanic - Canaccord Adams

Okay. And then the point of clarification, and I think Bob asked the question of a 100 million in incremental spend for 08, if I actually take that $100 million as your current tax rate that’s about a $0.30, am I in the ballpark and thinking about what the GAAP earnings would be?

Jim Crines

Well I wouldn’t use that, the $100 million is not something we referenced in reconciling between GAAP and non-GAAP earnings.

Bill Plovanic - Canaccord Adams

Okay. What is that number in terms of that we should reference for non-GAAP and GAAP earnings?

Jim Crines

Yeah, the $27 million or $0.08 in 2008 is what we have forecasted for the acquisition, integration and other costs.

Bill Plovanic - Canaccord Adams

And that includes monitoring and everything?

Jim Crines

No, it does not, the monitor the $100 million embedded within the $420 million to $425 million. It’s embedded in the adjusted earnings per share.

Bill Plovanic - Canaccord Adams

Okay. Alright, that’s all I have. Thank you

Jim Crines

Okay.

Operator

Your next question will be from Michael Matson of Wachovia Capital Markets

Michael Matson - Wachovia Capital Markets

Hi. Thanks for taking my question. I haven’t heard a lot of questions about your acquisitions strategy, so I thought I would revisit that. I just wanted to see looking out at 2008, if you are still targeting the sort of $100 million to $400 million range that you've talked about in the past?

Jim Crines

You shouldn’t start that as a reference point I think going forward Michael. I think with respect to our merger and acquisitions strategy, we again think that we have a great portfolio of businesses, and one of the reasons that we like to mix the businesses that we have now is, many of the acquisitions that we do such as an ORTHOsoft we feel like we can leverage that to the advantage of all those different business units. So that’s going to be beneficial to hips, knees, to spine and we'll take it to other business units over the time as well.

Our priorities going forward will continue to be in a category of fill-in acquisitions, for spine, dental we like that space as we talked about on this call and we would like to expand critical mass within the dental marketplace. And of course, biologics we believe that these solutions will be wave of the future, and so we continue to be interested in exploring opportunities there. It's not limited to those three categories, but those are principle categories that organize our proactive efforts at this point in time.

Our criteria really hasn't changed from our past discussions, strategic fit is of the up most importance to us. We've an organization that I think has done enough, especially through the Centerpulse integration, to understand how much work these transactions take. We want to make sure that through all those efforts in spending the capital, that we are going to get a good return for our shareholders, and so we are very financially disciplined in the approach that we take to these acquisitions.

Michael Matson - Wachovia Capital Markets

Alright. And then, with regards to the monitoring in the enhanced compliance practices, the changes that you are making in your hip and knee business, you said you are also doing that in the spine and trauma, and dental and other businesses. Is that because the settlement requires you to do that, or is that something you are just taking upon yourselves to go ahead and do. And it sounds like some of your competitors may or may not be doing that, I just wondered what your thoughts are?

David Dvorak

It's really the latter Michael, the resolution agreements don't compel us to take those steps. But, we are embracing this process, we want to ensure that we are developing the very best practices in this area, and obviously as we make principle decisions around how these collaborative relationships are structured and organized, those principles are going to be equally applicable across our various business lines and across our various geographic segments. So it's our initiative in that respect.

Michael Matson - Wachovia Capital Markets

Okay. And then you mentioned in the prior question that the flex penetration globally was 47% I assume. Can you give us what the breakdown is between the US and international markets?

David Dvorak

I will tell you that it's lowest in Europe; it's pretty high already in Asia Pacific, because that goes back to the development and launch of our very first High-Flex knees. They were designed initially for the Japanese markets. So our levels of penetration are higher in Asia-Pacific -- much higher in Asia-Pacific than they are in Europe and they are higher in the US than they are in Europe. And I will leave it at that.

Michael Matson - Wachovia Capital Markets

Okay. But there is -- you still think that there is room to drive increased penetration in the US?

David Dvorak

I think there is room in the US and I think there is even more room in Europe.

Michael Matson - Wachovia Capital Markets

Okay. That's all I have got. Thanks a lot.

David Dvorak

Okay. Thank you.

Operator

Your next question will be from Bruce Nudell from UBS.

Bruce Nudell - UBS

Good morning. Thank you. Could you guys provide a little more granularity with regards to your market expectations for units in US hips, US knees – O-US hips and O-US knees, just what kind of range you might see for hips and knees in those geographies?

David Dvorak

Yeah, right. Bruce, we have talked about the market in global terms, and unit growth being at around mid-single digits. We have not really broken it down by geography. It's probably a bit higher in US than it is in Europe. But again, on a global basis we see the market continuing to grow in mid-single digits and then we would have mix to modest price improvements accounting for the balance of growth to get to a market that we see growing an 8% to 10%, and understanding as well that at least with respect to the US we do see Hip resurfacing, accelerating growth in the US Hip market.

Bruce Nudell - UBS.

So, if I were to just kind of as for planning purposes say like US Hip is around 5% units OUS Knees around 7% or 6% units. Would that be in the kind of ballpark that you guys are thinking about?

David Dvorak

I would say it's in the ballpark, yes.

Bruce Nudell - UBS.

Okay. And then just a follow-up with regards to the consultant fees, when we spoke to the consultants as you I think alluded to on your call today. Some of the payments have kind of been held up due to monitoring review. Would it be safe to say that the accrued expenses for US consultant fees one way another were around $120 million, $130 million for the year in the US?

David Dvorak

I will tell you what you can do, is you saw the posting, the website posting that was made, the initial posting that put our total payments at round $85 million. And then as I indicated on the call, we had fourth quarter payments of $23 million that have been delayed. That math doesn’t quite get to your number Bruce.

Bruce Nudell - UBS.

Okay. So the full year was closer to overall 110 or so.

David Dvorak

And again we are talking specifically about US Hip to Knee.

Bruce Nudell - UBS.

Correct.

David Dvorak

Payments, right.

Bruce Nudell - UBS.

Alright. Thanks so much.

David Dvorak

Sure. Thanks Bruce.

Operator

Your next question will be from Jeff Johnson of Robert W. Baird.

Jeff Johnson - Robert W. Baird

Good morning guys. All my questions have really been asked. At this point the only follow-up I guess I would have is just at the upcoming AAOS meeting anything we should be looking for there. It appears you guys might not be having an analyst meeting at this point. Is that correct and maybe what was the rational in holding one this year?

David Dvorak

Yeah that is correct. We are excited about the AAOS and would love to have you come through the booth and we can show you some exciting things. As far as the analyst meeting goes, just because of scheduling we thought that the best thing to do was to maintain our circuit on this conference and to make ourselves available to all of you as best we can in both in person and by phone. So we didn't see the necessity of having that meeting.

Jeff Johnson - Robert W. Baird

Fair enough, David. I guess one more question on that to any change in tone of the AAOS meeting or do you plan on changing anything at all. How you reach out to surgeons there, dialing things back maybe a little from where they have been in the past or pretty much status quo go forward?

David Dvorak

Well we are excited about what we how to demonstrate in the way of the efficacy of our products. Obviously, our ongoing service efforts are compelling to these surgeons and making their decisions and the other healthcare professionals.

I think that everything you are going to see that the booth is going being indicative of the tone that we are establishing and continuing to collaborate with the surgeons, but making sure that our practices are perfectly compliant, so standby.

Jeff Johnson - Robert W. Baird

Fair enough, thanks guys.

David Dvorak

Okay. Thank you.

Operator

Your last question will be from David Toung of Argus Research.

David Toung - Argus Research

Yes, thank you.

David Dvorak

Hello.

David Toung - Argus Research

Yes, thank you for taking the call.

David Dvorak

David are you still there? Okay we seem to have lost him.

Sean O'Hara

Yeah, Virginia maybe we lost the caller.

Operator

Yes, sir. He is disconnected.

David Dvorak

Anyone else in the queue?

Operator

Not at this time. I will now turn the call back to David Dvorak for closing remarks.

David Dvorak

Thanks, Virginia and thank you everyone for joining us today and for your patience, continuing on through this call. We very much appreciate your interest in Zimmer and we're excited about 2008. We look forward to speaking to you again on our first quarter conference call which will be held Thursday April 24, at 8 am. Have a great day.

Operator

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

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Source: Zimmer Holdings Inc. Q4 2007 Earnings Call Transcript
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