2003 FORM 10-K ZIMMER HOLDINGS, INC. AND SUBSIDIARIES The following table sets forth the operating profit margin by segment for the years ended December 31, 2003, 2002 and 2001: Percent of net sales Year Ended December 31, 2003 2002 2001 Americas 51.2% 48.3% 47.4% Europe 26.3 24.4 19.5 Asia Pacific 45.3 46.1 45.4 Year Ended December 31, 2003 Compared to Year Ended December 31, 2002 Operating profit for the Americas as a percentage of net sales increased due to improved gross margins driven by higher average selling prices and increased sales of higher margin products, leveraged operating expenses and the favorable impact of the change in accounting principle for instruments. The change in accounting principle for instruments increased operating profit by 1.7 percentage points. With respect to sales growth, increased Zimmer standalone average selling prices of 4 percent in 2003 and favorable effects of volume and mix, 15 percent increase in 2003, represent the most significant factors in improved operating profit in the Americas. As reconstructive implant sales grow at a higher rate than trauma and orthopaedic surgical products, operating profit margins generally tend to improve since reconstructive product sales generally earn higher gross margins. This was the case in 2003, with Zimmer standalone reconstructive implant sales growth of 22 percent as compared with total Zimmer standalone sales growth of 19 percent. In the fourth quarter, the Company reported operating profit as a percent of net sales of 50.4 percent for the Americas. Operating profit for Europe as a percentage of net sales increased due to improved gross profit margins driven by higher Zimmer standalone average selling prices and favorable product and country mix, leveraged operating expenses and the favorable impact of the change in accounting principle for instruments. The change in accounting for instruments increased operating profit by 1.4 percentage points. Increases in Zimmer standalone average selling prices in Europe of 2 percent in 2003 and the effect of volume and mix, 19 percent increase in 2003, were the key factors in improved operating profit. Also contributing to the improvement was significantly lower growth in operating expenses. In the fourth quarter, the Company reported operating profit as a percent of net sales of 24.7 percent for Europe. Operating profit for Asia Pacific as a percentage of net sales decreased primarily due to less favorable rates on hedge contracts during the year compared to the prior year, partially offset by increased Zimmer standalone average selling prices and leveraged operating expenses. The change in accounting for instruments had an immaterial effect on operating profit for Asia Pacific. Increases in Zimmer standalone average selling prices in Asia Pacific of 1 percent and volume and mix improvements of 4 percent in 2003 contributed modest improvement but was offset by higher cost of products sold. Included in cost of product sold are losses on foreign exchange hedge contracts, which increased in 2003 relative to 2002. In the fourth quarter, the Company reported operating profit as a percent of net sales of 47.1 percent for Asia Pacific. Year Ended December 31, 2002 Compared to Year Ended December 31, 2001 Operating profit for the Americas as a percentage of net sales increased to 48.3 percent in 2002 from 47.4 percent in 2001, reflecting improved gross profit margins due to higher average selling prices and increased sales of higher margin products, and lower selling expenses as a percent of sales due to lower costs associated with the U.S. distributor network. The Americas continued to invest in strategic initiatives such as  MIS  Technologies, field sales personnel, medical education programs and new product launches. Operating profit for Asia Pacific as a percentage of net sales increased to 46.1 percent in 2002 from 45.4 percent in 2001. This increase reflects lower selling, general and administrative expenses as a percent of sales in Japan as a result of a sales force and dealer reorganization, partially offset by lower gross profit margins as a result of lower yen hedge gains compared to 2001. Operating profit for Europe as a percentage of net sales increased to 24.4 percent in 2002 from 19.5 percent in 2001, due to improved gross profit margins as a result of higher average selling prices and favorable product and country mix, the leveraging of sales growth in Europe on controlled increases in operating expenses and improved efficiency in the utilization of instruments (more frequent use of instruments resulted in fewer placements and less expense). LIQUIDITY AND CAPITAL RESOURCES Cash flows provided by operations were $494.8 million in 2003, compared with $220.2 million in 2002. The principal source of cash was net earnings before cumulative effect of change in accounting principle of $291.2 million. Non-cash expenses for the period included depreciation and amortization expense of $103.3 million, Centerpulse inventory step-up of $42.7 million and Centerpulse in-process research and development write-offs of $11.2 million. Working capital management, together with the collection of $20.0 million of cash related to Centerpulse tax loss carryforwards, contributed $80.4 million to operating cash flow. Working capital continues to be a key management focus. At December 31, 2003, the Company had 62 days of sales outstanding in accounts receivable, unfavorable to the prior year by 10 days. Acquired Centerpulse businesses had a negative impact of 10 days, due to Centerpulse’s business mix which has a greater proportion of European revenue with payment terms generally longer than those in the U.S. At December 31, 2003, the Company had 232 days of inventory on hand compared to 247 days reported at the end of 2002. The reduction was principally due to improved inventory management and the acquired dental and spinal businesses carrying fewer days of inventory. 26