Zimmer Biomet Holdings Inc (ZBH) 2005 Q1 法說會逐字稿

Welcome everyone to the Zimmer first quarter 2005 financial results conference call.

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

After the speaker's remarks, there will be a question-and-answer period. [Operator instructions]

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 including but not limited to our ability to successfully integrate Centerpulse AG and Implex Corp. that could cause actual outcomes and results to differ materially from those in the forward-looking statements.

For a list and description of these 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 most directly comparable GAAP financial measures, along with other financial and statistical information for the period to be presented on this conference call, was included in the press release announcing our earnings which may be accessed from the Zimmer Web site at www.zimmer.com under the section entitled, "Investor Relations".

Now I would like to turn the call over to Mr. Ray Elliott, Chairman, President, and Chief Executive Officer of Zimmer Holdings, Inc.

Sir, you may begin.

Great.

Thank you, Judy.

Good morning, everyone.

Welcome to Zimmer first quarter 2005 conference call.

We're pleased to be hosting this call to discuss a good start to the new year.

We continue to make excellent progress particularly as it relates to the Centerpulse and Implex acquisitions.

Joining me on the call today are Sam Leno, our Executive Vice President and Chief Financial Officer.

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

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

Alternatively, please feel free to contact us.

We'll begin today's call with comments related to our first quarter 2005 including an update on operations followed by a Q&A discussion.

All comments and comparisons are on an adjusted basis.

Further, all adjusted discussion excludes acquisition and integration expenses and inventory stepup.

We will include sequential analysis where it can provide insight although fourth quarter to first quarter comparisons are typically less useful.

We will only communicate in the quarter combined Zimmer and Centerpulse performances with legacy references other than individual brands now eliminated.

We will try to maximize the use of your time in the busy earnings season but maintain a high quality disclosure.

As always I wish to thank our new Zimmer team, legacy's Centerpulse, Implex, and Zimmer employees for the exceptional work.

No one would have realistically expected the completeness of the integrations or the strength of our combination financially.

As our press release indicated we take very seriously our commitment to deliver on expectations.

We indicated that we would hope to deliver a minimum of 10% growth on the top line for the first two full years, 2004 and 2005, and 20% or more growth in the EPS for 2004, 20 to 25% for 2005, and the potential to exceed 25% for 2006.

So far we've kept our pledge and we plan to do so in the future.

During the quarter, I'd also note we were pleased to be named to "Business Week's" top 50 performing companies.

Let's take a look at the fundamentals of our first quarter P&L and balance sheet performance.

Consolidated sales for the first quarter were 829 million, an increase of 12% to prior year.

The 829 million was about $17 million above First Call consensus expectations.

On a constant currency basis sales to prior year grew 10%.

In reconstructive products, reported sales grew 13% in the first quarter, an increased day rate growth from the average of the prior three consecutive quarters, and more than the total 2004 day rate growth of 11%.

We certainly are cognizant of both German and Japanese price weakness that from our perspective was planned and forecasted.

We do see less hip revenue and more knee revenue growth but we can find no underlying hip surgery demand decline.

However, mixed price have negatively impacted hips more than knees, and while hip primary surgery bookings appear normal, actual operating room block time continues the pattern of accelerated knee surgeries.

From our perspective there are clearly less hip revisions, a product of our primary surgery success.

As with most of the competition, the pattern of new product releases in hips appears on the surface to be more back end loaded for the year.

In fact, it's interesting to note with most major competitors having reported, similar to prior quarter on both a worldwide basis and U.S. basis, knee market growth has gone up about 1% and hip market growth gone down about 1% in two product categories of relatively comparable size.

The resulting affect is a worldwide reconstructive market still growing about 13to 14% ex-dental reported, but with a decidedly heavier trend shift to knees as predicted.

Zimmer America's bellwether reconstructive numbers on a day ray rate basis grew about 20% in the quarter against really tough comps.

On an adjusted day rate basis, Zimmer America reconstructive sales increased 17% in the first quarter of 2004, 20% in the second quarter, 20% in the third quarter, and 19% in the fourth quarter, for an adjusted 2004 day rate growth of 19% versus 2003, or slightly less than the day rate growth in the first quarter of 2005.

As this happens so often in the last few years, rumors of our demise are simply premature and don't really reflect the data.

The analysis to date would rather suggest that our orthopaedic healthcare segment is settling in at growth rates of low double digit, with somewhat less price and technology mix but more patient volume and more knees.

[Brand] and some recent unpredictable declined it's more likely validating everyone's existing future models, including ours.

Let's return to looking at the quarter in total.

Zimmer's 12% sales increase globally was composed of volume mix growth of 9%.

This number is important.

It's the same 9% we saw for 2004 including the strong fourth quarter and despite less billing days.

It also suggests that in the quarter Zimmer has held fundamental volume mix share despite the continued pressures of the acquisition.

We have tough competitors so we're happy about that.

To my earlier comments, and also an important point for Zimmer, global reconstructive underlying volume and mix grew 10% in the quarter versus 10% growth in first quarter 2004, and 10% growth on a day rate basis in all of 2004.

In short, no change.

No change in this case is good.

It's tough to hold share and gain share in the midst of a major integration.

Our real combined global reconstructive procedure and mixed growth has been sequentially solid despite some shift in knee versus hip surgeries, and despite some $50 million in gross sales to synergies that grew progressively through 2004.

That's why we feel good about our quarter, the next few years facing us, and our acquisitions of Centerpulse and Implex.

Worldwide price improvement for the quarter for Zimmer was 1% reported, but on an unrounded basis was only a half a percent less than prior quarter.

With Japan and Germany appropriately annualized, it becomes 2% and within a forecasted range of 2 to 3%.

The U.S. reconstructive market was positive 3% price, which we believe is still a little higher than the 2.5% we have ultimately forecasted internally.

Global price had a reported 1% and an annualized positive 2%, now includes the full impact of Japan at negative 4%, Germany at negative 5%, and due to these governments distribution of price reductions, hips more negatively impacted than knees, with a global differential between the two product categories on price of 2%.

But in the end for Zimmer, we are where we guided our external audiences and businesses to be.

As a reminder, on an important contractual note, we have completed most of our large hospital buying agreements for hips and knees, with pricing conditions consistent with prior years, but technology upgrades and carve outs improved, along with compliance.

These agreements are not price increase speculation but are completed negotiations for several hundred institutions for the next two to three years.

Our ability to carve out unique Zimmer products and techniques such as Trabecular Metal and MIS, as well as a reduction in the number of suppliers will be long-term beneficial.

Our efforts to quantity MIS economic benefits into improve hospital per patient profits and increased market share gain for those hospitals participating should help create an ongoing balance to more mutually beneficial relationship.

HCA and gain sharing have become topics of continued discussion.

Our comments will be limited.

With respect to HCA, we expect to conclude officially and jointly announce a mutually satisfactory agreement with HCA that should improve both our profitability and theirs in exchange for increased compliance.

By definition, outsiders assume win-win is not possible.

HCA's conference call comments with respect to both parties being pleased with the outcome is reasonable and accurate for this point in time.

Either way, Zimmer expects to do well.

View One seems to be a logical starting point.

The opportunity to chase several millions of dollars in new business with a less crowded field of competitors is always welcome provided real compliance is delivered.

We believe our downside risk is minimal and immaterial.

Our Zimmer HCA compliance goals are undisclosed but lofty, stringent, and reflect the need to be demonstrated in a relatively short time frame.

Zimmer's low cost manufacturer, low cost distributor, and low cost acquirer of new sales designations thrive very well in multiple market environments, including higher volume, less price, higher compliance.

Our strategy to profit and win in any environment remains intact.

Our skill at running financial models and return scenarios I believe is second to none in the industry.

Perhaps we differ with HCA on the [profit] sharing.

We believe for so many, many reasons already stated that gain sharing will be present in a limited way, creates more issues than solutions, will have an immaterial affect on orthopaedic profitability and failing that, virtually no real impact beyond the first year in any institution.

Most, but not all surgeons, will be lessen enthusiastic with the complete understanding of the risk reward analysis.

Conversely the hospital cost consultants and software sellers appear to be particularly enthusiastic.

Returning to our quarterly performance, our plan when we announced the Centerpulse deal, was to try to remain at approximately 10% sales growth for the first years despite sales of synergies, distributor realignments, and a larger, slower growth Centerpulse Europe.

For 2004 and the beginnings of 2005, we are clearly delivering to that committed pace.

Our Americas business delivered another strong growth in the quarter at 14% with volume and mix up 11% in total, and a stellar 22% in knees.

Europe delivered at 9% reported and 4% constant currency as with prior quarters.

However, on a constant currency day rate basis, Europe sales are up some 6 plus percent demonstrating sequential improvement again for the third consecutive quarter.

Adjusted for one-time distributor realignments our Europe business remains solid in the face of considerable change and we believe in the aggregate, equal to or perhaps even slightly above local competitive constant currency growth rates.

For your reference, all final changes in our European distribution network are now complete including this quarter's minority buy out of a key Italian distributor.

In Asia-Pacific, sales also grew by 9% reported, with the 5% constant currency growth was a significant improvement, geographic mix was the story.

Japan continued to grow at only 2% with the combination of minus 4% price due to government reductions, and additional 2 to 4% negative due to a key distributor change, already referred to in the prior quarter's remarks and included in our forecast of sales to synergies.

The anticipated Japan changes were offset by an exceptionally strong growth in the balance of Asia at positive 24% reported, and 19% constant currency.

Led by greater China at 21%, Australia up 16%, and Korea and Southeast Asia up a very strong 42%.

On a worldwide basis for the total Company, we expected to lag both geographic segments and product categories for the first two years post the Centerpulse deal.

At 13% reported growth in recon for the quarter, we are at least holding our own despite integration to synergies and primarily recon oriented distributor changes.

At 17% reported reconstructive growth for the quarter in the Americas, we are definitely taking share.

We anticipated losing some $50 million by year-end 2004 in sales to synergies.

We are planning a reasonable run rate recovery of 50% of those lost sales from cross training benefits, distribution changes, and other strategies that should accrue to our favor mostly beginning late in 2005 and extending through 2006 and 2007.

I'll return to some detailed geographic and product sales analysis in a few moments, but for all of us, the heart of the Centerpulse deal, at least for the first two years, was devoted to early accretive and long-term sustainable earnings per share.

On that note, as with our underlying sales, we continue to both reap the current benefits while simultaneously getting excited about the future possibilities.

In our second real apples-to-apples comparative quarter, including the Centerpulse acquisition, adjusted diluted earnings per share for the first quarter 2005 were extremely strong at $0.75 adjusted on 249.2 million average outstanding diluted shares, or an expansion of approximately 3 million shares from first quarter 2004.

For the quarter, we delivered a diluted EPS increase 30% over prior year and $0.08 better than the First Call consensus EPS estimate of $0.67.

The story remains clear.

The acquisition of Centerpulse was not only accretive on an adjusted basis the very first day after closing, but as we've commented at year-end, helped contribute to final 2004 EPS result that were $0.50 greater than the stand alone street 2004 estimate.

This pattern of significant and rapid financial return from the dealer is reflected by both EPS and cash flow continues in 2005.

We're obviously very pleased with the new Company's efforts to drive each line of the P&L, deliver integration strategy targets early, and of course create operating cash flow.

We will continue to emphasize our trademark focus on profit margins and incremental earnings contribution from new sales.

The once very meaningful legacy Zimmer metrics combination of 75% gross, 30% operating, and 20% net margin results are but a memory.

Zimmer's gross profit margin in the quarter exceeded our own expectations again and broke an all time record of 77.3%, up a whopping 270 basis points from the first quarter 2004, directly related to geographic mix, product mix, manufacturing management, and continued vertical integration in the U.S., Switzerland, and Puerto Rico.

For Zimmer it validates what we've been saying for a long time.

Our model can thrive in both a strong price or lesser price environment.

The 77.3% margin in first quarter 2005 contained only 1% global price reported, or 2% annualized for Japan and Germany, while the 74.6% margin in first quarter 2004 contained 2.7% positive price reported.

But perhaps as often missed relates to just what a huge arsenal of GP and cost of goods sold leverage we really have.

We frankly don't see a zero price or negative price environment, but apparently a few industry analysts may.

If so, based on our current trends, Zimmer could potentially maintain 77% plus gross margins with no price help at all.

That's a profit outcome we could easily live with.

In the quarter, gross profit dollars grew by 16% on a 12% sales increase.

Despite the legacy Centerpulse content, we believe that at 77.3%, our gross margin is certainly the best in the orthopaedic industry and close to the best in major medical devices.

As a matter of reference, the highest recorded gross profit for the legacy Zimmer business prior to Centerpulse was 76.1%, more than 100 basis points below where we are today, and those historical margins contain four points of price.

We believe strategically executed scale works.

For the second quarter in a row, we can provide some apples-to-apples individual comparisons on the P&L.

SG&A expenses and total operating expenses for the quarter, as a ration to sales were excellent at 38.8% and 43.9% respectively.

At 38.8%, SG&A costs increased only 8% versus prior year despite a 12% sales increase.

The 38.8% SG&A ratio is 130 basis points sequential improvement over the 40.1% ratio recorded in the first quarter of 2004.

The actual increase in SG&A absolute dollars from first quarter 2004, excluding the Implex acquisition was $22 million on a sales improvement of about 87 million, indicating not a variable, but rather a fully loaded expense cost of only $0.25 to acquire each new sales dollar.

As we mentioned earlier with respect to high volume, high compliance new business opportunities, this makes growth at these cost rates an attractive proposition.

While we are passionate about our innovation and marketing leadership, it reaffirms our belief that as the low cost producer, the low cost distributor, and the low cost acquirer of new sales, Zimmer's in the best position to capitalize on share growth profitably.

We believe that our focus on reconstructive is a strength in virtually any environment.

Significant diversity of product only tends to be a good argument when the compared segments have similar long-term profit contribution potential.

Over a two-year period starting with fourth quarter 2003 at 40.9%, we have targeted to reduce SG&A by at lease 200 basis points, with this quarter's performance completing that goal three quarters early and despite including Implex.

We'll now set out sights on reducing operating expenses in total below 40%.

That is a several year project and would denote operating profit ratios to sales in the high 30s.

We expect with the increase in total development projects to 177 from 146, and the expanding number of external technology-relationships that are R&D ratio to sales this quarter at only 5.1%, will increase back to its historical 5.5 to 6% range.

In the quarter, R&D represented a 6% increase in spending over prior year.

The conversion of neocartilage-related [istocost] to equity, open positions, expanded biological programs for the next several quarters, and 11 of 177 projects on a delayed start due to staffing resources explains the difference.

These upcoming expanded investments in R&D will prove to be essential if we are to continue the current pattern of delivering more than $500 million per year in new product sales.

Total operating expenses for the quarter at 364 million represent a real growth of only 7.7% to prior year despite a 12% sales growth, and include the addition of more than $3 million in quarterly Implex expenses not present in the prior year quarter.

For a reference in the first quarter, actual acquisition integration costs were 17 million versus 14 million the prior quarter, and compare very favorably to $31 million in first quarter 2004.

We continue to be very pleased and encouraged by the fundamental structural design that we have put in place for Zimmer and specifically our ability to create significant ongoing leverage, not just acquisition-related for one or two years, but a model that works for several years.

Operating profit in the quarter reached 277 million, an all time record by almost 20 million, and the second consecutive reporting period that we've produced more than a quarter of a billion dollars in operating profit.

We're equally pleased to reach a record 33% adjusted operating profit ratio to sales in the first quarter, up sequentially by more than 100 basis points in the fourth quarter 2004, but more important up more than 400 basis points from the 29.1% recorded in first quarter 2004.

As previously mentioned, Zimmer was modeled during the late 90s turn around and well before Centerpulse to target approximately $0.50 of operating profit for each new sales dollar.

In first quarter of 2005 we delivered $60 million more in operating profit on $87 million more in sales, or a $0.69 of operating profit on every new sales dollar.

That is a period-to-period incremental profit creation per sales dollar that we believe is unmatched anywhere else in major medical devices and really reflects the potential that strategic scale and execution can provide.

Zimmer has been a very limited user of EBITDA as a comparator due to its non-GAAP designation.

However, with the Centerpulse and Implex acquisitions, and the relevant implications of interest, depreciation and amortization, it should continue to be useful for our shareholders in the near-term.

EBITDA in the first quarter improved to 39% as a ratio to sales on an adjusted basis and as with operating profit a 400 basis point improvement from the first quarter 2004.

EBITDA is already running, excuse me, is already providing some 45 times interest coverage in the quarter after only 18 months of debt paydown post the Centerpulse closing.

Adjusted net earnings in the period were very strong at 187 million, and also new all time record in ratio to sales of 23%.

This represents a 60 basis points sequential improvement from fourth quarter 2004, and a 400 basis point plus improvement from the 18.5% recorded in the first quarter 2004.

Our first quarter tax rate improved from full-year 2004 by 100 basis points to 30.5%, and a whopping 560 basis point improvement since becoming a public company.

It's a good trend when you consider that we expect to reduce our sustainable tax rate to under 30% over the next two years.

We're obviously pleased with these first quarter 2005 results and the progress of the Zimmer Centerpulse Implex integration.

We like the trend and as for our latest guidance we're comfortable with our public 2005 commitments both low double digit sales growth and the original 20 to 25% adjusted diluted EPS growth targets, increased with last night's guidance to imply $3 a share adjusted, or a 24% growth for this year.

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

Cash flow generation has always been our story, is perhaps even more important now as the primary source of rapid debt paydown and where appropriate, acquisition capital.

Operating cash flow for the quarter was at the favorable [inaudible] expectations registering 153 million, despite the normal tax payment schedule and heavier medical education in sales meetings usually associated with the quarter.

The $75 million of cash and equivalents on hand, we have a new debt position of only 351 million.

The new net debt position is inclusive of both the 2004 Implex cash purchase price and earn out payment which together totaled a little over 150 million.

In the 18 months of combined operations with Centerpulse and 12 months with Implex, we have delivered $1.2 billion in cumulative operating cash flow.

Shareholders equity has increased from zero at the time of the spinout, to 745 million at the time of the Centerpulse acquisition, to well over $4 billion to date.

And therefore, net debt as a ratio to equity has already been reduced to single digits.

Our first quarter combined working capital statistics continue to perform within Zimmer's normal range for this time of year and consistent with the number of projects underway.

Our combined inventory days are 262, up four days from year-end, and down 15 to 20 days from the normally higher summer period.

We continue to believe with 177 projects, and in some cases national rollout strategies, somewhere between 245 and 265 days makes sense particularly in the low working capital carrying cost environment.

Our receivables collection will continue to provide support for strong cash flow production.

In the quarter, we delivered global receivables at a very respectable 62 days, a nice improvement of two days from prior year same quarter.

With hospitals as our customer and now a very large European business, the two day improvement is notable.

And by the Americas receivable results also improved to 39 days, down one day from prior year same quarter, again a notable achievement given the little tougher U.S. hospital financial environment.

Let's review the quarter sales in a little more detail.

Reconstructive sales for Zimmer is the revenue recognition of hips, knees, shoulders, elbows, and dental implanted into patients during the reporting period.

For the first quarter worldwide reconstructive sales increased to 690 million, a 13% increase over prior year, and as mentioned previously, a comparable day rate increase to prior quarters in 2004.

Globally, knees grew a solid 19% and hips 6%.

At this point in time for Zimmer, hips are a weaker market but knees the stronger one given almost endless historical [inaudible] knee growth counts in the 20s.

As discussed earlier for Zimmer, current Japan, Germany, and to a much lesser extent U.S. pricing effects hips more negatively than knees by a differential of some 2%.

We are pleased with our recon results both the total market and the three primary competitors who have already completed their public reports.

Without any additional information, we expect the global recon market to be up 13 to 14% in the first quarter, and therefore given the absorption of Centerpulse we are pleased with the result.

Zimmer America's recon growth of 17% should beat the market by about two points despite tough comps.

The combined Centerpulse Zimmer effort remains cumulatively ahead of plan and ahead of schedule.

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

In the knee category, on a worldwide basis in the quarter, knee sales for Zimmer increased by 19% versus prior year to 348 million on a 17% constant currency.

An important 6% sequential dollar growth versus fourth quarter of 2004, and strong year-over-year growth despite the impacts of Europe's annualized distributor changes, Japan's biannual pricing decrease, and historical 20% plus comps.

We can report that for the quarter all femorals increased by 19%, all articulating surfaces also grew 19%, all tibials grew 20%, all patellas grew 21%.

Good consistency suggesting strong primary surgical use.

From a brand point of view, our NexGen LPS-Flex remains the right place to start.

The world's original top selling high flex knee continued its 10 quarter trend to gain with an explosive 89% increase to prior year in the quarter, versus last quarter at 74% growth, the previous quarter at 71 percent growth, an average growth of 65% for all of 2004, and 50% plus growth for most of 2003.

Trend's a large percentage gross on this size of product based generally go the opposite way after two or three years.

It's no coincidence, therefore, that the LPS-Flex is the knee of choice for our new MIS mini and trademark Quad-Sparing total knees.

The LPS-Flex mobile U.S.

ID was completed in June 2004 with more than 200 investigational devices implanted.

We're also very pleased to announce the January release of the LPS-Prolong Highly Crosslinked Poly Articulating surfaces, with the first surgeries completed in December.

CR Prolong is already trending to annual sales of $25 million and represents 50% of all NexGen CR surgeries.

Zimmer sells twice as much PS as CR.

The new Zimmer CR-Flex knee also continues to be a special story with CR-Flex Femorals delivers sales of almost $15 million in the first quarter this year, a 25% sequential growth to the previous quarter, and a 113% increase to prior year.

The patented minus size femoral components in the CR-Flex system have ben utilized in 35% of surgeries as a unique soft tissue balancing process.

The new CR-Flex, in just seven quarters, represents more than 26% of total CR sales, and of course, the new CR-Flex mobile bearing is now in full development.

We believe in cruciate retaining units were still growing some 5 percentage points faster than the market.

PS and CR combined, Zimmer high flex femoral components of annualized sales of over $160 million despite still being only a little more than our 20% of our own Zimmer primary knee mix.

A few more highlights.

The legacy Centerpulse's NX knee had double digit growth primarily in Europe and has become a $20 million brand.

The new Zimmer Uni, the industry's first high flexation single compartment knee, with broad surgical philosophy options, quickly registered $3 million in quarterly sales literally from a zero start.

Mobile bearing and Trabecular metal versions will follow.

Annual sales for all Zimmer UNI products continues to be well over $50 million.

The patented Zimmer RHK rotating hinge, combined with legacy Centerpulse MOST system reached $10 million annualized brand status with a 30% increase in the quarter.

While hip revision sales may have been weaker, Zimmer's option LCCK knee revision offering jumped by 34% in the quarter.

Knee revision remains a great opportunity for us representing only 6% of total Zimmer femorals.

Trabecular Metal Mom Block Tibial trays have continued to take shares.

Surgeons not only recognize the value of the material but the inherent lack of micromotion, and therefore reduced probability of tibial osteolysis, leading potentially to revision.

Trabecular Metal tibial trays increased by another 30% in the quarter versus prior year, and along with TM patellar implants and TM knee augments, delivered an annualized Trabecular Metal run rate in knees alone of almost $50 million.

We have initiated the expansion of our New Jersey-based Trabecular Metal technologies manufacturing capacity to 30 reactor units operational in June from the current 18 units.

We expect to comfortably exceed $100 million in total Trabecular Metal sales in 2005.

Our comfort is for good reason wit the first quarter 2005 easily surpassing $25 million.

For those of you following the FDA down classification of mobile bearing knees, in June 2004 you may recall the panel made a positive recommendation, but in October the FDA turned down Osmond's petition indicating that they would accept an amended petition to include some special controls.

This work has begun.

The Osmond Group presentation was made April 1 and graft test protocols will be issued to the FDA to keep this process moving forward.

With Zimmer's LPS-Flex mobile ID complete we expect to be on the market in 2007 regardless, or sooner of the FDA approves the amended petition.

Zimmer plans to have the world's largest mobile bearing offering including the Uni-Flex mobile, the LPS-Flex mobile, the CR-Flex mobile, the NX mobile and the Natural Knee mobile all supported by advanced prolong polycrossing polys and ultimately the new [SEMA], as well as Trabecular Metal and fast low cost MIS navigation techniques.

There continues to be excellent progress and new data points on the Zimmer minimally invasive knee front, particularly in training, utilization, computer assisted developments, new products and instrument deployment.

I'll update those activities later.

Let's switch now to hips.

We continued to observe country-specific government pricing decisions, later year new product cycles by both our competitors and ourselves, a surgical capacity limitation that appears on the surface to be increasing knees at a corresponding rate to the decline in hips, and a material reduction, at least in Zimmer's case of hip fracture and revisions stems.

Mixed penetration that is favored hips now shifting a little bit more to knees.

Conversely for us, MIS hip stems are still definitely driving market share.

While foreign exchange, price, and mix can always be variable, we have not seen a decline in future underlying patient demand for primary total hip replacement.

On a worldwide basis in the first quarter, hip sales increased 6% to 292 million and 3% in constant currency.

The 6% growth this quarter, as with some of our competitors, was up against the toughest Zimmer prior comp in three years at 21% growth in first quarter 2004.

Zimmer hips in the Americas grew a solid 9%.

Importantly, with underlying basic hip units of surgery and mix up 7%, we believe Zimmer's domestic hip unit and mix growth exceed the Americas first quarter total hip market performance of 4 to 5% ex- price.

Despite what seems to be a currently weaker reported sales period for hips as opposed to underlying demand change, we continue to be very encouraged with hips in our new company after our first year together.

Our enthusiasm is based on the potential breadth of MIS, hip resurfacing, Trabecular Metal, advanced polys, the positive outcomes for compatibility testing between the legacy brands, and the potential for per patient profit improvement we believe we can help deliver to hospitals.

Zimmer fiber metal tapers, along with the new M/L taper are the stems of choice for Zimmer's MIS mini and two incision hip surgery.

In the first quarter, these two stem families grew a gain by 28% bringing the combination of fiber, metal and M/Ls to over $27 million in the quarter.

Neither the hip stem market nor the porous stem market are growing at anywhere near 28%.

As we've noted so many times in our press releases, for Zimmer, MIS brings in new business.

It did last year and it is this year.

Legacy Centerpulse's CLS [paternal] taper, with a 40 million plus per sales sales base, mostly in Europe grew exceptionally well at 18% in the quarter.

This is with only a few MIS instrumentation sets now available.

CLS paternal, you will recall was honored with the best to metalists results in the latest publishing of the highly regarded Swedish Ship registry where results were 100% survival rate after ten years.

Along with the original alloy classic, they sound like great European MIS hip stems to us.

During the second half, we expect to launch the very first Trabecular Metal surface stem, expand the offering of our highly successful MIS stem, the M/L, this time with the popular HATCP coating, and introduce the VerSys format of our unique EPOCH composite stem in FullCoat.

Zimmer porous hip stems approximate an annual run rate of nearly $400 million.

Zimmer primary Acetabular shells increased from prior year by 14%, porous primary cups increased 15% with strong showings from legacy Centerpulse's Allofit shell, up 18%.

Trabecular Metal cups continued to thrill us with sales of more than $11 million in the quarter, an increase of almost double prior year.

During the quarter Trilogy brand cups, including HAs, ceramic and Trabecular, have grown to an annual rate of more than 100,000 units implanted.

The [Duron] cup and stem, including our resurfacing option available only ex-U.S., grew by more than 100% to almost $5 million in sales in the quarter and quickly became on an annualized basis a new $20 million product line very early in its life.

Here's one of our favorites, of course, despite extremely tough comps for almost five years significant internal penetration, new competitors, and U.S. ceramic-on-ceramic presence, premium priced longevity and Durasul highly crossing polyliners increased by yet another 14%.

Not only is the growth rate solid but the base of sales is very different.

Our two Highly Crosslinked brands, when annualized deliver more than a million dollars per year.

After five years, we are still generating almost $1 million a month in new business globally.

During the quarter, we announced an exclusive deal with Massachusetts General Hospital and Cambridge Polymers for [actual] next generation advanced polymers and hydrogels, CIMA or cold irradiated mechanically annealed poly, will potentially revolutionize the industry just as Zimmer and Centerpulse did with the longevity in Durasul brands.

As you know, our ceramic-on-ceramic PMA has been accepted by the FDA as fileable and we have received a list of compliance questions for our response which we are busy doing.

We do not have any additional updates or better guidance versus the second half of 2005 indications already provided.

We have been pleased with our 2005 U.S. co-exclusive and 2006 forward U.S. exclusive on Palacos bone cement products including antibiotics.

The agreement with Zimmer was reached in late 2004 with Heraeus Kulzer GMBh.

Sales training is being completed in April with the first product on the shelf before summer.

We have mutually agreed to broaden our discussions with Kulzer to selected European and Asian countries, but as yet with contractual conclusions.

As with prior quarters, there is much new activity with MIS hip and I'll cover these stories as well as a few amazing recent MIS scientific publications.

We'll also discuss 2005 hip new products and new projects in the development section.

New products, new techniques, MIS for Europe, and our bone cement should liven things up in hips, not to mention a break through in AVN hips we'll discuss later.

In upper extremity joints, Zimmer's Bigliani/Flatow shoulder has continued to grow worldwide with a 15% plus increase in the first quarter, despite an array of competitive new products.

We are pleased to announce the release of our new collagen repair patch with the first surgeries completed by Dr. Greg Nicholson of Chicago.

The initial successful utilization was for a severe rotator cuff tear.

Once the [teno] was repaired, the patch reinforcement took only 15 minutes.

We expect the [inaudible] clearly demonstrate reduced inflammatory response versus competitive offerings and with expanded indications to follow.

To complete reconstructive discussions, our dental business furnished the first quarter with sales of 33 million, up 19% reported and 17% constant currency.

In the quarter prosthetic implants increased 23% led by the Tap Screw Vent up 29% with almost $10 million in sales.

Dental biological sales of collagen graft and membrane grew by almost 50% and Puros block Allograft, just released, showed strong early acceptance.

While the rebranding to Zimmer continues within the dental group, major marketing initiatives for unibody implants to California-based Zimmer Dental Institute, soft tissue graft strategies, assessment of our potential to use Trabecular Metal and minimally invasive surgeries supported by image guidance are underway, along with the completion of our West Coast plant consolidation and new high speed machinery and equipment.

Domestic dental sales growth at 17% has been somewhat hampered by back orders but are expected to moderate significantly during the second quarter.

On a worldwide basis in the first quarter trauma sales grew pretty much as expected at only 1% to 45 million.

Given some competitive high teens or better growth for the quarter, we should continue to lose share until we deliver new products for mid 2005.

With only a limited field release of our unique volar radial and distal femoral [Periarticular] locking plates some other new products have been carrying the load.

The ITST Nail went from modest sales to more than 13 million plus annualized and grew in the quarter by more than 30%.

For reference, ITST-type nails continue to be reimbursed in the U.S. market at higher rates than compression hip screws, however our total offering of Zimmer brand diameter Intramedullary nails grew only 5%.

The former Centerpulse's Sirus titanium lateral starting point femoral nail was a great addition to our lineup.

Sirus nails in the quarter were up 19%.

Our large compression hip screw category, though, remained weak at minus 11% growth while Periarticular plates increased by 19% with new releases and geographic expansion.

Better than all of that, by far, though is potentially exciting news for us in trauma and I haven't said that for a while.

Two reasons.

First, our new Trabecular Metal osteonecrosis intervention implant, better known as the ON Rod, just received a positive and totally unexpected regulatory surprise from the FDA.

Despite being in an [IVU] study, the FDA has granted Zimmer a 510K approval on our Trabecular Metal ON Rod effective immediately.

Here's the significance.

There is no hip [Avas] or necrosis solution available on the market like it.

It is well understood through the literature that of the million or so total hips done each year, about a hundred thousand or 10% are osteonecrotic.

Of those, while it's difficult to tell, 50,000 are likely to be Stage 1 or Stage 2 and targeted in many cases for core decompression even though MRIs are still admittedly not completely reliable in this area.

Vascularized fibulargraphs are also a solution but they carry the additional morbidity and cost of the secondary surgery related to bone grafting.

At $2,000 or better per solution, that makes early stage ON a hundred million dollar market and we are potentially sitting here at Zimmer with the best of the best of the magic bullets.

We believe that we can be ramped up with instruments and Trabecular Metal ON rods by the fourth quarter.

Between the new products lineup, perilocking plates, restore our new risk fixator, [supercondor] of femoral nailing, and the pleasant surprise on our ON Rod 510K, we can now expect to see improvements to our flat projections for trauma throughout the late second half of 2005.

Secondly, for the future, we acquired exclusive global rights during the quarter for an advanced locking plate design developed by SOS for Swiss Orthopaedic Solutions.

The systems ability to create unique fixed angle constructs will provide an innovative opportunity to address high energy fractures as well as bone of compromised quality such as osteoporosis and is therefore consistent with our focus on implant solutions for diseases that today more than ever afflict women.

Our Zimmer's spine division sales increased by 14% reported in the quarter to 38 million and consecutive sequential increases of 3 million.

We are very pleased with the significant improvement.

Cage sales remain firm at 8 to 9 million as with the prior two quarters and now represent only 23% of spine sales versus 50 to 70% in recent years.

The big story, though, is Dynesys, our Dynamic Stabilization System.

Sales jumped to more than 8 million in the quarter, almost triple the prior year's clinical field work, and when combined with some $2 million of spinal Trabecular Metal, these two technologies delivered almost $10 million.

In short, Dynesys and Trabecular Metal combined are outselling cages.

While we've hardly reached juggernaut status, the signs of life are unmistakable with new products finally overtaking cages in quarterly sales.

As we've noted several times, until we combine Trabecular Metal, Dynamic Stabilization, and MIS with the new pipeline and a few small technology and biological acquisitions, spine will be competitive in some areas but still languish below current market growth rates, although competitive rates do seem to be moderating and after 18 months of hard work, we're getting closer.

We would now high hope to raise the bar and keep this double digit spine run rate growth alive for the whole year, not just the latter part as previously indicated.

On a separate note in the spine category, we believe that the recent settlement and acquisition of intellectual property between Medtronic and Dr. Gary Michaelson will not cause any negative effects for Zimmer.

In our orthopaedic surgical products division, sales increased 5% for the quarter to 54 million.

OrthoPAT, our Perioperative Autotransfusion System again lead the way and increased sales by 22% to annualize at almost $30 million.

Wound management showed excellent performance with 18% growth.

Our Lumatec Arthroscopy business, along with Hall Power Tools made specific had a soft quarter with minus 2% and really detracted from an otherwise solid performance in our orthopaedic surgical products group.

Let's switch to a quick look at our new product developments and performance.

As I mentioned in my earlier remarks, we've redesigned the new combined Zimmer pipeline to 177 projects with, in most cases, over $1 million of development each.

This is an increase of some 30 new product, projects, or techniques.

Of the 177 projects in total, we are diverse. 59 are in hips, 37 in knees, 10 in extremities, 31 in trauma, 7 in ortho guidance, 10 in OSP, 14 in spine, 9 in dental and 6 in biologics.

Of these projects, 86% are on or close to plan dates and requirements, 10% are on hold or not started, and 4% are either off schedule or likely to be terminated.

Of these projects, more than two-thirds involve new innovations, new platforms, and new technologies.

During the latter portion of the first quarter, we launched or limited released 28 new projects, including in hips 40mm longevity and 32mm metal-on-metal, plus six new Trabecular Metal Acetabular or revision augments and in Europe, the new ZMFR [pressfit] cuff.

In knees we released LTS Prolong fixed compatible for femorals, quad spring non-core instruments, Trabecular Metal femoral cones, and the MIS stem tibial.

We'll talk more about this significant MIS innovation later.

In extremities, the new Zimmer collagen repair patch as previously mentioned and the Trabecular Metal humeral, an anatomical kill [quinoid] and an anatomical removable head, all for our shoulders were all added.

In trauma, we launched more than a hundred field evaluation and limited release sets for our new femoral, tibial, and humeral perilocking plates in the in the U.S. and for the MBC non-contact bridging system in Europe.

Eleven new projects were improved and initiated in the quarter including line extensions to the popular MIS M/L taper, a cruciate design for the Trabecular Metal glenoid, [Duron] hip resurfacing expansion and two new MIS spine projects.

New product projects are expected to consistently deliver 15 to 20% of Zimmer sales each year from a rolling 36-month list of new products.

That's 500 to $600 million in sales organically each and every year.

We have never missed that target since it was instituted in 1998.

We have in fact averaged about 18% of sales cumulatively per year for those seven years.

New product sales for the first quarter 2005 totaled $167 million and represent a record 20.2% of sales up over 200 basis points from full-year 2004.

While 20% is not unusual in medical devices, it's pretty much unheard of in a $3 billion plus sales base in orthopaedics.

We consider our designers, developers, and innovative rapid new product delivery system known internally as "Focus" a material in-house competitive advantage.

Let's look briefly at geographic segments first in the Americas.

Zimmer Americas had another strong showing.

Revenue for the quarter was 480 million, up 14% over prior year and sequentially up $24 million over a strong fourth quarter of 2004.

11% of our growth in the Americas was driven by increases in unit volume and mix and 2% growth was derived from price increases with reconstructive as previously mentioned at 3%.

Our combined Americas reconstructive growth in the quarter was up 17% and delivered $385 million in sales.

This would imply that in the Americas, during the quarter, Zimmer had a 14% growth in pure reconstructive surgical procedure units and mix.

In our 17% Americas reconstructive growth knees delivered excellent results with a 22% increase to 222 million, or a sequential growth of 18 million from fourth quarter 2004, and significantly higher than the 14 million sequentially for fourth quarter 2004 versus third quarter 2004.

NexGen LPS and CR-Flex, the new high flex Uni, Trabecular Metal tibial components, Prolong articulating surfaces, legacy Centerpulse Natural-Knee, and NexGen LCCK revision knees all made substantial contributions to America's knee performance.

Hips in the Americas, increased 9% to 132 million, we believe above the market's growth figures and a sequential increase of $4 million over a very strong fourth quarter.

We are pleased Zimmer hip growth in the quarter of 9% given a 21% prior year comp, some decline in hip revision, U.S. operating room schedules relative to knees, and back end loaded 2005 hip new product releases.

Hip performance in the Americas benefited from market share taking growth in primary porous stems related to various MIS procedures, Trabecular Metal cups, and highly crossing poly both longevity and Durasul.

Our dental business in the Americas grew a solid 17% in the quarter to 19 million, and also above the market despite short-term back orders created by our California plant consolidation.

Based upon our results in the already released public reports of our three major competitors, as well as the remaining market players, we believe that the reported market growth and domestic reconstructive products for the quarter should be approximately 14 to 15% ex-dental.

Zimmer's combined America's reconstructive growth of 17% would appear to be outpacing domestic hip and knee market increases by about 2 to 3 points.

Our reconstructive growth has been broad-based.

In the quarter, 13 of 30 U.S. distributors grew hips at double the market rate or better, 18 of 30 distributors grew knees at 20% or better, and 7 of 30 distributors grew knees at a terrific 30% plus.

All increases are implants only and exclude instrument sales.

Here's a statistic we continue to be proud of.

The new combined Americas operating profit margin in the first quarter 2005 came in at 52%, or a record $250 million.

For the first time ever, Zimmer Americas generated a quarter of a billion dollars in operating profit in a single quarter.

The 52% operating profit ratio is up 100 basis points from the fourth quarter of 2004.

Take a look at Europe.

In the quarter, European revenues were 235 million, up 9% reported and 4% constant currency, but up a strong 6% on a day rate basis and a solid improvement to prior quarter.

The 235 million in sales was $7 million sequential gain in sales versus the fourth quarter, typically Europe's strongest.

In the quarter prices for Germany declined by 4.8%.

This correlates to our forecasted near-term flat to minus 1% for Europe in total during 2005.

While we do not expect it to improve, neither do we expect it to materially effect our global business results.

We have for a long time anticipated German DRGs and buying groups as well as flat to slightly negative pricing in Europe.

Reconstructive implants delivered sales of 214 million in the quarter, up to 8% reported.

Hips were by far the most negatively affected by German pricing changes and disynergies, up only slightly on a reported basis, but knees improved by a market share taking 16%.

With the cores competitive constant currency reconstructed numbers for Europe estimated, in the aggregate and single digits, it's clear that excluding last year's distributor reorganizations, we are lagging the European total reconstructive market a little in hips offset by taking some share in knees.

Positive gains in the quarter reflect the continuing acceptance of both Durasul and longevity highly crossing polys, some early impacted minimally invasive procedures, the growing acceptance of Duron and Trabecular Metal, as well as ongoing market share gains for the NexGen knee brand and Zimmer dental products at a very strong 20% growth.

Several of Europe's country businesses performed well on a sales growth basis versus the competition, Russia, Portugal, the Middle East, South Africa, and Eastern Europe all continued at 25% plus growth rates as expected, while the U.K., Belgium, Austria and Spain were all solidly mid to high teens growth.

Two of our largest countries and toughest competitive environments, Germany and France, both remained firmly in high single digit growth.

Italy is in perhaps the toughest competitive environment of all where we held our ground and gave nothing back remaining flat to prior year.

As mentioned previously, we did exercise our right to purchase the remaining minority position in our largest independent Italian distributor, Allo Systems.

For the quarter Europe improved operating profits to 87 million, a new record by 1 million and positive sequentially over a great fourth quarter 2004.

Profits improved by 15% to prior year on a 9% sales increase with an operating profit to sales ratio of 37%.

Zimmer's European gross profit margins have continued to operate well above 70%.

This ratio still has the opportunity to expand even further as marketing strategies and market-related synergies are implemented over the next year or two and provided that price reductions remain relatively contained.

In Asia Pacific, revenues in the first quarter were 114 million, an increase of 9% reported and 5% constant currency.

These results are respective since they reflect the 2 points of incremental growth over prior year sequentially, are inclusive of the Japan price cuts, and the partial effects of the previously mentioned change in a key Japan distributor.

Asia Pacific at flat to 1% positive price historically, and we informed you over the last quarters that Japan prolong was operating at minus 4%, driving Asia Pacific pricing in total to minus 3%.

This continues to be a very manageable outcome.

We believe that the Asia Pacific market is growing in mid single digits in and local currencies and as a result netted the synergies and as a distributor reorganizations, we appear to be holding our own at about plus 5% local currency growth.

In the first quarter, as with the prior quarter, our combined Asia Pacific business was led by reconstructive growth of 9%, up 3 points of growth from the prior quarter.

We expect Trabecular Metal tibial components, the recently released NexGen CR-Flex knee, the strength of the Centerpulse Natural-Knee to continue to improve Asia Pacific's knee performance in the quarter at an acceptable 10% growth.

The new Japanese natural hip and MIS driven expansion will help to escalate hip performance in the quarter, this time at 7% growth.

While our dental business is small in Asia Pacific, it did deliver another very strong 25% sales increase consistent with the prior quarter.

Korea, Southeast Asia, and China delivered excellent 25% plus growth performances in constant currency, while Australia, New Zealand showed strong mid teens growth.

Displaying solid earnings drop through from sales, the Zimmer Asia Pacific businesses delivered $52 million in first quarter operating earnings for a 45.7% operating profit to sales ratio, an increase of 160 basis points sequentially and up 300 basis points from the first quarter 2004.

Let's move from products and geographies to hot topics, and given time constraints I'd like to narrow that discussion down to three topics, a brief integration update, a mix update and a minimally invasive activities for the quarter.

Here's a brief update on integration.

Of the 3,410 scheduled milestones required to execute the entire Centerpulse integration, that's up from last quarter's 3364, we have completed 2,328.

Our target for year-end 2005 is 2,835 milestones, or 83% of the total project requirements.

Of the remaining thousand or so milestones for 2005 and 2006, approximately 80% are related solely to manufacturing cost reductions.

Net sales to synergies, excluding distributor restructurings fluctuate between 40 to 45 million annualized incurred or future anticipated.

As I indicated earlier we expect to regain about 50% of those sales losses through year-end 2005 with the benefits accruing primarily to 2006.

We believe annualized positive cost synergies will reach or slightly exceed our latest indication of $100 million.

We have changed distribution models in 13 countries and completed those tasks.

We have merged all medical education training and Zimmer Institute teaching organizations, we have completed about 90% of the Warsaw and Puerto plant and distribution expansions.

Forgings and castings for Warsaw and Winterthur are being built with all ten NexGen forgings from Winterthur tested early in the quarter.

Our new three-year global tax strategy is already contributed to a nicely improved ETR.

We have revamped and redesigned both dental manufacturing and the entire ops, distribution, and information technology systems for the spinal business.

We continue to have more than 70 full-time staff working on the integration.

With respect to mix, first in hips, [core] and stem units increased from 58% of total primaries in full-year 2004 to 60% at the end of the first quarter 2005.

Management believes that this continues to compare favorably as an opportunity with the market estimated in the low 70s%.

As per my earlier comments, revision hits as a percent to total hips actually declined to 4.7% in the quarter versus 5.1% in the full quarter 2004.

Highly Crosslinked Poly remained a significant opportunity with the addition of Centerpulse at 58% of global units penetration but composed of 94% penetration in the U.S. versus only 36% penetration in Europe.

The sales of Trabecular Metal in hips increased to 4.2% of sales, or more than 2.5 times what it was at the beginning of 2004.

And knees, the posterior stabilized to cruciate retaining use increased to a 66:34 ratio, an increase of 2 full points for PS at Zimmer, although both categories took share last year and by management's estimates some new share in the quarter.

Revision in knees was the opposite of hips with the revision in knees improving to 5.7% of sales in the first quarter versus 5.2% in the full- year 2004.

Revision hips and knees remain a huge opportunity for Zimmer.

In Highly Crosslinked Poly for knees, Prolong improved to become almost 50% of CR articulating surfaces, but still only 12% of total surfaces due to the predominance of PS in our portfolio.

As indicated, NexGen LPS Prolong was just released.

Lastly, Trabecular Metal in knees increased from 3.2% for full-year 2004 to 3.5% at the end of the first quarter.

Although growing exponentially, Trabecular Metal on a percent to sales basis still provides an almost endless future opportunity.

Now let's turn to minimally invasive solutions.

We're always excited about the progress and expansion of our six-year-old MIS program.

The Zimmer Institute remained very busy as we met our goal last year to train 1400 surgeons with their key OR staff while the momentum has doubled.

During the first quarter we trained 458 surgeons in 21 Zimmer Institute locations, including six wet lab contractors.

We've added the Celebration Hospital Group in Florida and recently announced a major agreement with the Ohio Orthopaedic Center of Excellence under the leadership of Dr. Michael McShane.

Europe has significantly expanded its Zimmer Institutes with our original Paris, Innsbruck, Budapest, and Estonia operations augmented now by Marseilles, Vienna, and Lins in Austria and Bokken in Germany.

Today we offer 13 different MIS Zimmer wet lab and didactic courses in our global curriculum.

A recent survey of a hundred surgeons with completed courses rated our bioskill teachings as well our facilitator educators exceptional and the best available anywhere.

We also utilized a broader survey to statistically, not anectdotally answer two questions that you have occasionally asked was the most important benefit provided and what are the adoption rates.

Survey says that the most important benefits of the clear belief that Zimmer Institute's providing enhanced surgical performance due to bioskills.

With respect to adoption rates of surgeon attendees, and knees about 50% adopt some form of Quad-Sparing, including true Quad-Sparing, mid vast to sub vasous, or medial [parapatella], while 20% reduce incision size and the remaining 30% return to their practice and main traditional knee surgery.

In hips, about 55% adopt one of the multiple offerings of mini hips, 25% utilize the two incision, and 20% return to their practice and maintain traditional hip procedures.

The two incision numbers may sound high, but we also know that it's difficult for surgeons to maintain the pace, precision, and pressure associated with the two incision technique day in and day out despite the tremendous patient benefits, thus accounting for some higher attrition later.

The two incision has settled in however at 8% of our business, is not declining but is consistent with the previous four quarter post Centerpulse.

There's no doubt though, our unique Zimmer anterolateral has taken off.

More on that in a minute.

I would point your attention to recent publications on two incision outcomes clinically and economically and offer the following thoughts.

Many of the reports did not use our procedure, they were trying a self-or competitor created version of the two incision, nor did they use our current instruments or our implants.

Virtually none of the surgeons were trained at Zimmer Institutes and the case of the economic outcomes being not improved, it's little wonder since it was mostly a competitors mini procedure within one case a 12-centimeter incision.

One study on catastrophic outcomes in MIS was a three-patient study, not 30 or 300, but three, and only one surgeon had actually used Zimmer products.

It's unclear as to whether they had received Zimmer Institute training.

Our own Zimmer economic study captures more than a thousand patients at more than 20 hospitals, and our complications and clinical follow-up is approaching 3,000 patients.

I'll also point out that coincidence or otherwise, these recent papers and profiles are written by surgeons who have a longstanding relationship with a single competitor, and to my knowledge, none of then have ever been inside a Zimmer Institute.

Our attempts and those of Zimmer's surgeons successfully practicing MIS to write op eds and letters to the editor have been denied.

We have hundreds and hundreds of two incision patients who would not trade their experience for the alternative.

Fantasy in the end does not overwhelm fact.

Just ask some of these patients since several are preparing testimonials.

There's just a few quarterly highlights from the Zimmer Institute.

We created the curriculum and delivered the first combined MIS flex Uni and MIS Flex mini course.

We completed the very first French language only MIS Quad-Sparing course in Marseilles, the first German language only MIS anterolateral hip course in Bokken, and the first MIS supine meeting for the famous Alloclassic stem in Austria with a similar course in Thailand.

Of the 57 full curriculum courses delivered in the first quarter, 37 were in the U.S., 14 in Europe, and 10 in Asia Pacific.

Here's just a few of the Zimmer Institute development projects underway.

Zimmer Institute facilitators advanced guide, a full faculty leadership development program, the design and release of interactive surgeon precourse training modules, an investment partnerships related to proprietary [tact] on man made teaching simulators.

In terms of course selection, of the 458 surgeons trained in the first quarter at Zimmer Institutes, 44 received training on MIS-2 incision, 214on quad spring knees, and 132 on the new Zimmer anterolateral.

With respect to our hardworking Zimmer consulting group, 65 U.S. and European speaking engagements are already booked early in 2005 at 105 events where the speaker is delivering a presentation outside their home country.

Surgeon-to-surgeon visitation demand continues to escalate with 212 completed in the first quarter and an open demand list of 339 requests.

Two incision requested visitations remain solid at 61 requests.

Our MIS proctorship consultant program continues to expand a little too slowly at only about two surgeons per month, as we try to keep up with in field surgeon-to-surgeon demand.

During the quarter we released a thousand patient two incision economic value added white papers supporting the potential opportunity for 30% better clinical outcomes at measured by SF36 for 30% less cost.

We're preparing this white paper [for a] full manuscript.

During the second quarter we hope to have some preliminary announcements on the infrastructure required to publicly market our MIS economic value added programs to hospitals and industry.

We are pleased to announce that Dr. Richard White, past President of the press prestigious Hip Society has agreed to lead and conduct a perspective ramdomized study on the new Zimmer MIS anterolateral hip versus traditional minis.

The study will include both clinical and economic data points.

Let's take a look the Zimmer MIS utilization in the quarter.

On the hip side, as previously noted, two incision remains solid at 8% with Europe up 1% utilization and the U.S. down 1%, and as noted earlier, unchanged as a percent of total hips in the past four quarters.

Overall Zimmer legacy MIS hip utilization is 53% versus 50% last quarter, due solely to the recent release of the anterolateral.

On the knee side, 42% of legacy Zimmer knee surgeries utilized MIS techniques, up from 36% last quarter and true Quad-Sparing has jumped to 8% consistent with increased Zimmer Institute course demand.

With respect to instrument deployment, we continue to roll out MIS multi-referenced [foreign one] and IM sets for NexGen, MIS Natural-Knee 2 implants were released in the quarter and MIS instruments for Europe's [NX] are under full development.

In total for knees during the quarter, we released another 657 sets of Zimmer MIS knee instruments and cumulatively surpassed more than a thousand sets of our trademark Quad-Sparing issued to the field since inception.

Zimmer has now released 2,853 sets of MIS knee instruments since we founded the MIS knee program.

Relative to hip instrument deployment, we issued more than 100 sets for the new anterolateral [loan] this [inaudible] quarter plus another hundred plus sets for the MIS M/L taper and MIS versions of Europe's Alloclassic and CLS paternal stems.

Our target at this point is to issue about 500 new instrument sets per quarter through year-end.

On February 22nd, we announced the first successfully performed electromagnetic image guided total knee performed by Dr. David Lionberger at Methodist Hospital in Houston, utilizing Zimmer's MIS high flex Quad-Sparing knee and Medtronics [stealth] station with axiom electromagnetics.

Since then we've performed on an evaluation basis 40 more surgeries in the U.S., Germany and Singapore, and we have achieved our initial goal of being first to market with no line of sight required proprietary EM technology to support MIS total joint surgeries.

Combined with our new instrumented linkage project, Zimmer can move forward as a leader in smart tools for orthopaedic joint replacement.

By the fall of this year, we hope to have a complete marketing and regulatory program in place to once again change the game.

We will begin a limited role at a proprietary portable electromagnetic-capable MIS guidance systems with an optional fee for service model, a strategy we believe is crucial in providing the latest nonoptical EM technology in a capital format that community hospitals can both benefit from and afford.

In a related matter on February 23rd, we signed a new extended U.S. agreement with our partner, Medtronic, covering fee for use, disposables, and a portable hardware platform consistent with the previously described strategy.

Lastly, we are announcing the commercialization of the first 510K approved MIS stem tibial component that can be assembled inside the patient.

This important new implant reaffirms and strengthens our leadership position in innovation within the MIS new segment than we founded.

The product is an industry first, totally tibial components designed to be assembled within the patient.

The new implant can be utilized will all Zimmer MIS knee offerings including the trademark Quad-Sparing.

The key elements that allow the implant to accommodate a smaller exposure are the low profile length of keel.

After the implant is placed on the proximal tibia, the stem extension can be dropped down through the plate as opposed to a threaded underside attachment.

This new drop down featured a stem, and the keel designed geometry itself are both strong, filed Zimmer intellectual property positions that will make this innovative effort both difficult and ultimately costly to try to duplicate.

A press release summarizing the unique break through will follow shortly.

As usual, we've gone and had lots to tell people.

It sounds like we're making good progress, Sam.

What are your thoughts and additional color on the business?

Thanks, Ray.

You're right.

We began 2005, our second year, including the results of the Centerpulse and Implex acquisitions with another record breaking quarter including improved margins, strong cash flow, and a lot of innovative new products to look forward to.

I'll add some detail to several key areas including breaking down sales a bit more, foreign currency, reported gross profit and operating expenses, interest expense and debt levels, acquisition and integration costs, our effective tax rate, cash flow, capital expenditures, amortization and depreciation, and finally guidance.

Again, several factors contributed to our excellent first quarter financial results including the underlying sales growth for knees, dental and spine, was better than expected, mixed together with continued improvements in manufacturing operations, continues to play an important role in improving risk profit margins.

We continued to overachieve the timing of realized expense synergies associated with the integration of Centerpulse into Zimmer, and while sales net the synergies did materialize, in total they were less than expected, and finally, careful expense management resulted in our continued ability to improve operating margins while leveraging sales growth.

For the first quarter of 2005, as Ray mentioned, sales increased 11.6% over prior year, and 9.5% in constant currency.

Now that we have a full-year of Centerpulse included in our historic sales numbers we thought it would be useful to communicate the sales growth contributed by price, volume mix, and foreign currency for our geographic segments similar in detail for our 10-K for 2004.

For the Americas, total reported sales was up 13.6%.

Of that 2.4% came from price, 11% from volume mix, three-tenths of a point for foreign currency, and a constant currency of the Americas was up 13.3%.

In Europe, total sales reported up 9.1%, of that, point two-tenths of a point was for price, 3.8% from volume mix, 5.0% from foreign currency, constant currency for Europe was up 4.1%.

In Asia Pacific, total reported sales up 8.7%, of that a negative 2.9% contribution by price, a positive 8.1% from volume mix, a positive 3.5% from foreign currency, constant currency growth for Asia Pacific was 5.2%.

Looking at geographic sales growth by key product categories, where we can add value, knees in total were reported to grow at 18.7%, that's 21.8% in the Americas, 15.5% in Europe, 9.7% Asia Pacific.

In hips, total sales were 6.0% growth, Americas was up 8.9%, Europe 2.5%, and Asia Pac 6.5%.

Dental in total reported sales growth of 18.7%, the Americas dental was up 17.2%, Europe 19.5%, Asia Pacific up 24.7%.

Total reconstructive, reported was up 12.8%, in the Americas it was up 16.5%, Europe up 8.4%, and Asia Pacific up 8.5%.

Trauma in total reported sales growth of 0.8%, in the Americas, it was down 6.2%, Europe was up 16.6%, Asia Pacific was up 8.6%.

And finally, spine, total reported sales growth of 14.3%, consisting of the Americas up 10.7%, Europe up 23.5%, and on a very small base, Asia Pacific up 140%.

In the area of foreign currency, the U.S. dollar on average remained relatively constant during the quarter since our last quarter earnings call.

And as a result, the foreign currency exchange rate contribution to sales growth of $16 million, or 2.1% for the first quarter was very close to what we contemplated in our first quarter guidance three months ago.

If foreign currency exchange rates remain unchanged for the balance of 2005 from first quarter levels, foreign currency movement should contribute approximately $70 million, or 2.4% to our 2005 full-year sales growth over 2004.

Reported gross profit margin for the quarter was 77.0% including $2 million pretax, or $1 million net of tax of inventory stepup expenses related primarily to the acquisition of Implex in the second quarter of 2004.

The balance of the acquisition-related inventory stepup of $3 million pretax will be expensed to the P&L over the next three quarters.

Inventory stepup related to the Centerpulse acquisition was completely expensed by the fourth quarter of 2004.

Excluding the effect of inventory stepup expense, the adjusted gross profit margin for the first quarter was 77.3%, which represents an all time record for Zimmer.

Reported operating expenses for the first quarter were 45.9% of sales.

Included in reported operating expenses for the quarter were acquisition and integration expenses totaling $17 million pretax, $12 million net of tax, or $0.05 in earnings per share.

These expenses include distributor termination costs, integration-related consulting and professional fees, retention and other integration-related expenses.

Excluding the impact of the acquisition and integration expenses, adjusted operating expenses as a percentage of sales where 43.9%.

Reported operating profit margin was 31.1% for the quarter.

Excluding the impact of the inventory stepup and acquisition and integration expenses, adjusted operating profit margin was 33.4%, and that's a 110 basis points better than the fourth quarter, and 430 basis points better than the first quarter of 2004, again, an all time record for Zimmer.

With our continued strong operating and free cash flow we reduced net debt, that's total debt less cash, by $127 million in the first quarter to a new total of $351 million.

Interest expense in the quarter was $7.2 million, compared to $5.9 million last quarter.

In the first quarter, the Company amended its credit facilities.

We combined the five-year term facility into our revolver and extended the term of our revolver to five years from March 31, 2005.

This is a $1.350 billion multicurrency facility with an accordion feature that provides for the opportunity to increase size by another $400 million to a total of $1.750 billion.

It can also be used as a backup for any future commercial paper program that we may choose to put in place.

By doing so, we accelerated the expensing of approximately $800 million of previously capitalized credit facility origination fees.

Higher LIBOR rates during the quarter increased interest expense slightly on our remaining debt outstanding.

Since the acquisition of Centerpulse, in October, 2003, and Implex in April of 2004, we have paid down over $1 billion of debt.

Given our current debt level and our cash flow forecast for the remainder of the year, and excluding any new acquisitions, we have a new forecast to be net debt free by the end of 2005.

Let me go back and talk about the expensing of the previously capitalized credit facility origination fees.

It was $800,000, not $800 million.

Since the acquisition, we have spent $276 million on integration and acquisition costs.

Since the acquisition of Centerpulse, $178 million of those costs have been expensed to the P&L, with $17 million being expensed in the first quarter of 2005.

We expect to expense $45 million during the full-year 2005 as the majority of the remaining integration activities are completed.

For the full-year 2004, we achieved an effective tax rate of 31.5% on our adjusted P&L.

Our effective tax rate for the first quarter of this year was 30.5%, which is on the favorable end of the range provided in our 2005 guidance three months ago.

Major contributing factors to our improved effective tax rate for 2005 include the full-year effect of the reduction in the ongoing Swiss tax rate from 24% to 12.5%, which took place last year, continued benefits from the increased production and profits generated in Puerto Rico, and an improved mix of earnings from jurisdictions with lower tax rates.

The first quarter reported diluted earnings per share is $0.70 and includes the $0.05 negative impact of inventory stepup expenses and acquisition and integration costs.

First quarter adjusted diluted earnings per share is $0.75, exceeding our previous guidance and First Call consensus estimates by $0.08.

Operating cash flow was $153 million for the quarter, approximately $42 million less than the first quarter of 2004.

In the first quarter of last year, we made no estimated U.S. federal tax payment due to Centerpulse net operating losses and we also were able to realize a cash refund in that quarter of $55 million.

Again, due to the acquired tax attributes of Centerpulse.

By comparison, we did make a $33 million estimated federal tax payment in the first quarter of this year.

Adjusting for these events, operating cash flow in the first quarter of 2005, versus the first quarter of 2004, increased by more than $45 million.

Free cash flow, which is operating cash flow less capital expenditures, was $92 million for the quarter.

Capital expenditures for the quarter were $61 million, consisting of $43 million for instruments and $18 million for all other property, plant, and equipment fixed asset additions.

For the full-year, capital expenditures are expected to be approximately 270 to $280 million consisting of approximately $145 million for instruments, and a range of 125 to $135 million for all other fixed asset additions.

These additions are being driven by new products, insourcing, the closure of Austin, and continuous productibility improvements.

As we have disclosed previously we are tripling manufacturing capacity of our New Jersey-based Trabecular Metal technologies division in an attempt to get out in front of rapidly increasing demand for this product.

We expect to have this increased capacity on line by the end of this current quarter, two-thirds of which is already in production.

We're also increasing our distribution capacity in Warsaw with the doubling of our distribution center footprint to 260,000 square feet due to be completed early in the third quarter of this year.

We are increasing our manufacturing capacity in Warsaw and Winterthur with investments in new high speed automated equipment to keep up with our increased demand in cost reduction plans for knees.

Finally, we are doubling the manufacturing facility capacity and footprint of our Puerto Rico operation by adding 110,000 square feet to accommodate the closure of Austin, growing unit demand, and future manufacturing optimization projects.

Our Puerto Rico expansion should be completed within the next several weeks.

Since the closure of Austin was not included in our original acquisition capital expenditure plans, these incremental projects increased our earlier expectations for capital expenditures in 2006 and 2007.

As a result of the Centerpulse and Implex acquisitions, and the related $608 million of amortizable and tangibles recorded, amortization expense was $11.6 million for the quarter, and depreciation expense was $33.5 million in the quarter.

As a result of postponement of the effective date for the required implementation of FAS 123R, the expensing of stock options, we will not expense options in 2005, and we anticipate adopting the new standard in the first quarter of 2006.

As we mentioned, during our fourth quarter earnings call, using our historic methods of determining the effect of equity-based compensation and earnings per share, the expected effect on 2005, that we will continue to disclose in our public filings, should be approximately $0.17 per share.

Turning to guidance.

As we mentioned in our press release last night, we have updated our guidance.

The Company has reaffirming its full-year 2005 sales guidance which we estimate to be in the range of 3.325 billion to $3.345 billion, representing approximately 12% growth over prior year.

Additionally, we reaffirmed our second quarter sales guidance estimate of approximately 15% growth over the prior year period.

As a result of a better than expected first quarter, we are also increasing our earnings per share guidance for the full-year to approximately $2.86 reported and $3 even adjusted representing 24% adjusted growth over prior year.

We are also increasing our earnings per share guidance for the second quarter to approximately $0.71reported and $0.75 adjusted, representing a 29% adjusted increase over prior year.

Assumed in our second quarter guidance are increases and direct-to-consumer advertising spending related to MIS procedures and technologies, incremental legal and IT costs, and increased R&D spending primarily related to but not limited to biologics.

As a reminder, our second quarter 2005 earnings call will be held at 8:00 a.m.

Eastern Daylight Time on Thursday, July 28, 2005.

And now we'd be happy to take you questions.

Judy, we'll turn the call back to you.

Thank you. [Operator instructions] Your first question comes from the line of Joanne Wuensch with Harris Nesbitt.

Thank you very much and nice way to squeak out a quarter.

If we dig down a little bit on your hip products, you talked about the hip sales being slightly week this quarter.

I can attribute it to tough year-over-year comps, I can attribute to OR time.

But you also mentioned second half of the year launches.

Could you give us a little detail on what we should be looking for there?

Thanks, Joanne.

The big launches are the, there's quite a number, actually, it's about a dozen or so.

But the things of noted interest are the first Trabecular Metal primary stem which we're excited about.

The M/L taper, HATCP, which is going to become the number one MIS stem, at least in North America, a new Epic composite stem and then something that's hidden because it's not necessarily an implant is we have only rolled out less than a hundred sets related to Alloclassic and CLS Paterno, which are the two big legacy Centerpulse stems in Europe and those instrument sets, as we believe it does in the U.S., will drive market share back to us in Europe.

So those would at least be some of them.

Add to that a whole new Trabecular Metal Acetabular hip revision system, and you've got a big chunk of it covered.

Your next question comes from the line of Katherine Martinelli with Merrill Lynch.

Thank you.

A couple questions, if I may.

First of all, in terms of the Trabecular Metal and the increase in the reactor capacity that's expected mid year, are you currently capacity constrained for Trabecular Metal products?

We're just coming out of that.

We had been, Katherine.

But as I mentioned, while we're planning to have the tripling of capacity done by the end of this current quarter, we're already two-thirds of the way on line.

So we're probably pretty close to being out of capacity constraint right now.

And then with respect to gross margin, any way you can give a breakdown in terms of what drove the 270 basis points quantifying it?

I know you cited number of factors but just to give us a little better visibility on what the specific components were?

We certainty can't quantify it, but clearly we continue to drive improvements in manufacturing costs.

As you recall, I mentioned several times that the vast majority of the synergy benefits that come to us manufacturing costs won't accrue to us until late this year and then in the next year.

But having said that, we still continue on an operational basis to invest heavily in automation of our, as we would do normally to drive product costs down.

When we set our operating plants every year, we plan operationally to drive 1 to 2 percentage points out of product costs every year.

So some of what we're seeing is that, some of what we're seeing is mix.

As you know, knees is the strongest gross profit margin that we have out of the recon side and mixed outpaced hips, we're seeing spine kick in, spine has a high gross profit margins and dental gross profit margin are also pretty solid.

Add to that Trabecular Metal and I think you've got many of the components.

So even as Ray mentioned, even though overall price is only 1%, we have a lot more leverage that help us drive gross profit margins than just price

Your next question comes from the line of Mike Weinstein with JP Morgan.

Hi.

Taylor Harris here for Mike.

Good morning.

Your comments on your hip revision and fracture business, can you extend that to the market and if so why are we seeing revision rates come down?

I think I can probably on fracture stems because it's been a trend that's been chipping away for a while and those fractures are still there, obviously, because those are random events.

But it's changing to alternate solutions within the fraction or within the fracture line up and we're not as strong there, perhaps, as a couple of the other players, so I think that's one thing.

I don't know on hip revision whether this is a Zimmer only.

We do know the results of primary stems continue to dramatically improve, but we also know that our hip revision line is being added to now, as we speak, and with Trabecular Metal and on the Acetabular side to become much stronger.

We probably weren't the strongest there.

I'd also note, I don't know if it's going to come up in the questioning, but I also note I didn't get a chance to really look at it because it came out in the middle of preparation for the call, but I did note that DRG, we've been lobbying for a split to revision to help the hospitals out.

I've noted they've done that.

I think that may help us in attracting.

But I can't honestly tell you whether on the revision whether it's Zimmer factor or whether there's more of that out there.

Your next question comes from the line of Milton Hsu with Bear, Stearns and Company.

Hi.

Good morning, guys.

I have two questions.

First, just turning to hip business in Europe, obviously the surgeons there prefer older implants as the [Zywamilla]-type implants but going forward, how are you going to drive mix there off of a base that prefers the older products?

Oh, I think MIS will help that because we're not planning on changing our strategy, we will move more towards porous.

There's a bunch of things going on in Europe, I think, that we got to be, we have to be cognizant of, it's more than just that.

Price in Europe, there's a 2% differential.

I mean the governments there are pretty smart.

It's a high hip, lower knee world over there, at least historically and now in volumes so they've got a higher price hit on hips than they do on knees by about 2%.

Germany, our largest business, is being really affected by that.

German pricing at minus 5 and hips is very aggressive.

We've got some knock off products which occasionally happens in Europe going on, primarily in Italy.

We're changing to more global products in France.

We've got a strong export market over there, but it's knee weighted.

We're heavily weighted in knees in export and we haven't got all the MIS instrumentation out yet.

Therefore, you're not only taking the share you'd like but you're not getting that uptick that porous gives you when you get MIS.

So we're not, you know, I mean I know people want to focus on that, but we're neither excited about negatively or surprised by Europe.

We understand where we're at at this point in time.

And, you know, we're comfortable with the future, obviously.

And then just second question on as the Department of Justice investigation gets underway, do you think the industry's going to be less aggressive in signing new [inaudible] consultants on this and will this have a beneficial impact on SG&A across the board?

Thanks.

I don't know the answer.

I guess in our case, if you believe you're doing the right things and obviously we do, you'll continue to do those things to grow the business.

We're not doing anything special in that area.

I don't think there's any special effect on our operating expenses or on that situation.

I think it's a case of planning for needed services and going out and acquiring those services.

So, you know, I'm not going to speak for everybody, but I don't think that's a big factor.

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

Hi.

Good morning, thank you.

Good morning, Bob.

A couple quick things.

A couple comments you made that really piqued my interest.

One was on the trauma side and the ON Rods.

Could you explain a little bit about how that technology works and is this something that could be potentially be a replacement for hip resurfacing products?

The first part of the question on the technology of it, it's not dissimilar from a lot of other Trabecular Metal solutions, Bob.

What you end up, it very much looks like a rod that you would imagine with a threading on one end.

And when the dead bone is removed and the threaded rod is placed in, you're actually attempting to thread the rod in where there's good bone on either side and ultimately have the bone, we hope, grow through and interlock itself multiple directionally through the rod.

So the potential for that, there's very early literature on it because this is such a new product.

But the early literature after 48 months shows a material improvement in the patients to the tune of, I think, 5 or 10 or 15% of patients.

I can't remember the exact numbers now but it is significant material from a clinical point of view.

On leader stage issues with hip resurfacing, I don't think it detracts form the potential hip resurfacing market.

I think in the early stage, this is a Stage 1, Stage 2 kind of product based on MRIs, so I guess to the extent that surgeons would make a decision to go to hip resurfacing at a very early stage, this certainly could provide an alternative.

I don't think it necessarily does in later stages because it's not indicated for that.

And then two other quick ones.

One, could you just explain why there's a tougher situation on pricing with hips than it is with knees?

And then secondly, you mentioned that in the out years, you could potentially see a high 30% operating margin if I heard you correctly.

I'm just wondering if you could elaborate on that a little bit and how that's possible?

Yeah.

I think, well, first, on the first one, it's very Japan Germany indicated because those markets are strong hip markets.

And what the governments do, is they go there, they're looking to recover revenues as you might imagine.

So what they do is they structure, the way they structure their pricing, and layer it, is more negatively affected to hips than it is to knees because that gives them the highest income, you know, recovery.

Bob, you tailed off at the end.

I missed the second part, just the end of the second part of your question, just give me the ending again.

Sure.

You had mentioned, I think, in your prepared remarks that over the next couple of years --

Yeah.

We get to high 30s.

I just missed the end of your, I didn't hear the end of your question.

Oh, I was just kind of curious as to if you could elaborate on that and what are the components of that and how that might actually be realized because those are margins that have not really been seen in larger med tech companies before.

Yeah.

Well, before you write us up in your model for that, my reference point was that we believe with the things we're putting in place, that Sam just described, the manufacturing cost structures, the long-term leverage and the fact that we are clearly capable of doing, you know, 77% margins without any price or even with some negative price and that we believe we can drive over a few years our operating expenses below 40, the math gets you to high 30s.

I mean it's just a simple math calculation.

All right.

Thanks for your time.

The next question comes from the line of William Plovanic with First Albany Corporation.

Hi.

It's actually Brian Wong for Bill Plovanic.

I have two questions.

First, in regards to the number of U.S. sales force that you let go, could you give us a quantity how many of those were let go due to the merger?

Very, very few unless they wanted to leave because they weren't happy with us.

We didn't have, we didn't go out and let hardly any go.

Do you mean distributors or do you mean sales reps because sales reps, very few.

We reconstructed our distributors and kept five of the Centerpulse distributors and reconstructed and married those in with our own and then merged spinal products into six or seven of our distributors.

But actual sales reps, I don't know the answer to the question but it wouldn't be very many unless they wanted to leave and weren't happy with us.

Actually, the vast majority of the head count reduction that we have continually referenced in our public filings come from the administrative areas, not SG&A, but G&A, and also in manufacturing as we wind down and shut down the Austin manufacturing facility and transfer those jobs elsewhere.

Okay.

Following up real quickly on that, will most of those non-compete agreements for the small number of reps that did leave, I mean, is that going to wind up expiring this quarter?

No.

The non-compete, the vast majority, I don't know about all of them, but the vast majority of the non-compete agreements that were put in place were put in place and ended last December.

There may be some a little different.

So we're already past that stage.

Okay.

And last question, the Duron seems to be doing pretty well in Europe.

Any chance that we could see that in the U.S. anytime soon?

No.

Not in a, it depends what you mean by anytime soon.

But not in a, not in a full femoral NS tibial hip resurfacing because it's got to go through the all the regular processes so it's going to a few years out.

Independently of course, as pieces or separate components you will see it and of course, it's operating in a hip resurfacing format in Europe, in Canada, and Australia and a few other countries.

But no, I wish, but not in the near-term.

Okay.

Great.

Thanks.

Great quarter.

Your next question comes from the line of Raj Denhoy with Piper Jaffray.

Thanks.

I just had a quick question.

You mentioned, I think, in the press release and also in your prepared remarks about the focus of R&D and acquisitions in the biologics area.

I'm curious if maybe you can flush out some of the areas that you're looking at and maybe even more so just the areas you find interesting?

I think we're referring more, I think it did say small acquisitions but I think we're referring more to external relationships.

And I don't think too much has changed there.

Raj, the fundamental thing we're always focused on is cartilage because it's the real game changer.

And then anything we can take into the future that would be application that today are Allograft-type applications so you get into things that are not just biological but even synthetics, obviously Trabecular Metal is one of those of sorts.

So anything that we think is a game changer or a peripheral addition to what we have today, and then I would add to that anything we think that can ultimately do one of two things, augment our existing spine business, where we're not overly strong in biologicals, and/or take us into sports medicine.

Okay.

And then just one other one.

You mentioned also that we could start to see some increased spending in advertising related to MIS and some other things.

Can you maybe flush out the scope of what that might look like going forward?

Oh, yeah.

I mean I don't know, you mean scope in dollars?

It's sort of, I would put that as single digit millions annualized.

It's not a huge difference in what we're doing today.

I think we've been, we haven't done any for a while and I think it's more a case of timing and getting those going and in place over the next six months.

We don't do them every month all the time.

So it has more to do with putting a push back on as opposed to any kind of dramatic change.

Okay.

Thank you.

Okay.

Your next question comes from the line of Bill Quirk with RBC Capital Markets.

Hey, good morning.

Couple questions if I may.

On a blended basis it looks like the proposed new hip and knee DRGs appear to be up over the past couple of fiscal years.

I'd love to hear your take here on these adjustments and then also your sense as to what the impact of splitting 209 into component parts, how this will affect your ability to adjust pricing?

I'll give you a very qualified answer because my take is based on what I read about midnight last night, because they came out, our health economics people here right now are busy analyzing it.

So I only know what I took home and quickly read because we didn't have the time to analyze it when it came out because we were busy preparing for this.

My take is, I'm very pleased for the hospitals.

We have been lobbying for this both at the [Avamed] level and elsewhere, including surgeons, for a long time.

So I'm happy with the breakout.

It looks rationale it me.

On the revision side, the slight cut to help fund that, on the primary side looks very sensible.

I was actually expecting, to be honest with you, a little more of a cut in that area.

I did some rough numbers last night.

If you use anywhere from 8 to 12% revision, and I played around with all four numbers, eventually used 10, I kind of got to somewhere between 2 and 3% overall net positive effect if the weighting between revision and primaries don't change too much, but I'll be honest with you, I did it in 15 minutes last night.

The people who should be doing it properly are doing it right now.

So my take is all positive, all good, assuming my numbers aren't too far off I think that's good news.

That seems fairly consistent with our math as well.

Also, if we could just spend a little more time on the HCA deal, I know Ray you don't want to talk about it too much, but I assume from your comments that Zimmer has an out on the pricing side if, to use your words, the stringent compliance it is not met.

Well, I mean, it's a compliance-based deal and it's a very high level of compliance which HCA is committed to.

And they are making every effort based on anything I know to try and deliver on that.

But it is a compliance-based deal, not a resetting of price structure.

If they're able to deliver the compliance, which, I mean, I hope they do because I think we fare well in that environment but it's not been the case in the past.

But I hope they do and if they do, that's fine.

If not, the pricing is not valid because you don't have the compliance.

So it's in their hands and it's in our hands to make work and we're going to try very hard to make it work.

Fair enough.

And I assume, Ray, just a quick follow-up to that, that should we not see this compliance, it will be fairly quickly recognized and hence, the adjustments made?

Well, it's a risk to reward ratio.

You know, one of the things we do when we run the models is we say what is the risk in us, or for us in this, how long is that risk likely to last, and, you know, what do we do afterwards?

And we've done the models that way.

But I'm not going to start out, you know, thinking they're not going to do it.

They're our partners, we want to work with them and you know, frankly, I think what's been publicized is 50 or $60 million.

I just love the idea of going after that, along with Stryker and J&J and see who gets what.

So I hope they deliver on it.

Thanks a lot, guys.

Your next question comes from the line of Glenn Reicin with Morgan Stanley.

Good morning, folks.

Good morning, Glenn.

A few questions, one for Sam and one for Ray.

Sam, given the gross margins in the quarter can you give us any sense of the progression in gross margins is the quarters, as we progress throughout the year, you know, given the upside this quarter I'm surprised you didn't raise your gross margin assumptions for the year.

And then maybe, Ray, you gave us a lot of granularity on the product side.

Can you just maybe simplify this and just give us a sense of what Trabecular Metal penetration is in knees and hips for you on a worldwide basis or maybe just in the U.S. and the same thing with respect to maybe just pressfit versus cemented penetration on hips and maybe the same thing with Highly Crosslinked Polyethylene penetration?

Let me answer that gross profit margin question first which will be a quick answer.

As you know, we don't give guidance below, or between sales and earnings per share, Glenn.

So when you say you're surprised that we didn't change our gross profit assumptions, we never communicated gross profit assumptions.

I'm sorry, give the upside in gross margins, I'm surprised you didn't go higher for the year on earnings.

We still have a long way to go.

But we did raise our earnings over the mid point of the guidance that we had out there by $0.10.

We think that's a pretty respectable jump.

Yeah.

I mean I would agree.

You know, we still got cross-training and new products back end loaded, hips are kind of an anomaly right now that we all have to figure out.

Spine sustainability, I mean we're pleased, we don't, you know, we don't know completely that it's sustainable global pricing.

So there's enough variables in there that we feel good about where things are going.

But you know, I don't like champagne parties at the end of the first quarter, either.

Would you expect gross margins to stay at current levels for the remainder of the year?

That would be like asking for gross profit line items.

Okay.

We don't do that.

Okay.

Fair enough.

Trabecular Metal, I'll answer it a couple different ways.

I thought I tried to in the material there so I want to make sure that you want something different than that.

Trabecular Metal in hips and knees is about $50 million or so each, and that represents, though, only around 3 or 4% penetration on something, ultimately, it couldn't be 100% because you just can't make fully loaded stems or femorals.

But you can get up to very high penetration we think and we still have 13 or 14 projects underway at this stage in Trabecular Metal alone.

We've popped up a couple of points, I haven't got my speech notes are turned over here, but I think this is correct.

We've popped up a couple of points in porous from 58 to 60.

I think the market's still in the 70s, we still have a long ways to go on that with both our product line and relative to MIS.

And then on Crosslinked Polys, it's all how you cut the numbers.

We call our penetration 56% because we have such a huge opportunity in Europe at about 36%, and Asia in the 50s.

We haven't even put SEMA on the marketplace yet which is going to be a tremendous product, but we are 94% penetrated in the U.S.

So without SEMA and without future products it's unlikely you're going to get too much more out of the U.S.

I don't know if you want more than that, Glenn.

Let me press you a little bit on Trabecular Metal.

On knees, I think you said up 30, and we have been seeing 50 to 55% increases over the last few quarters.

I'm just wondering if there was anything to that?

No.

Part of that is what Sam talked about earlier with Katherine, that we've not been able to expand new customers and expand perhaps as much as we might like just because we got so overburdened in manufacturing.

So, no, there's nothing at all to that.

The demand for the product is incredible.

I would also tell you, back to the earlier question on the DRG, the splitting out, I mean, Trabecular Metal's expensive, it has tremendous results but it is not cheap.

And I think one of the things that's going to happen with the splitting out of the revision code up to what looked to me like about $12,000 last night, I think that's going to help people in hospitals and surgeons really be able to expand Trabecular Metal for us because of its applications and revision.

And then when you talk about porous hip stems, are you including Trabecular Metal so it's really just [depressed]?

No.

No.

It's not.

So it's not a pressfit number that's strictly just.

It's porous stems, as you know, it excluding Trabecular Metal.

Okay.

And then finally, metal-on-metal, any thoughts there and what kind of growth have you been seeing?

We've been seeing at this point, I don't have it in front of me, but I'm going to guess and say high single digit.

We have not had the product line with the larger 32s and 36mm heads for one issue.

And we just put the 32s out which is going to really help us a lot.

So I don't think, I think our performance will improve.

I don't think we're representative of what is a pretty good market because we haven't had the offering.

But that's been remedied or will be remedied.

One last note.

This will be my last question, just a clarification.

On your introductory comments you said for the corporation, you're in for 12% growth, 9% volume mix, 1% price, 2% FX and then I think for recon we had the same 2% FX, we had the 3% price, but the volume mix number you originally gave Ken but it looks like it's got to be more, it's got to be less than that given the totals here.

Sam's got the number, the chart he just read off.

But I think what you meant, I said U.S. reconstructive was 3, maybe what's confusing things.

So what was worldwide recon in price?

I don't know.

I don't have that in front of me.

Sam, should I just call you later?

Yeah.

We haven't got that chart in front of us, Glenn, so sorry.

We'll look that one up for you.

Thank you.

Let me go back to the first part of your question.

Again, won't talk about gross profit margins, but as we wind down the Austin facility, one of the things that we're aware of that investors might not focus on is that's an expensive process and the cost of having less and less production in Austin creates unabsorbed overhead and the cost of bringing production into different facilities has some start-up costs associated with it.

So all those factors are taken in consideration as we provide our guidance for the year.

Very helpful.

And just to be absolutely clear, those costs under GAAP accounting are not allowed to be applied to integration acquisition expenses but are reflected in our period statements.

Thank you.

Okay.

Your next question comes from the line of Ted Huber with Wachovia.

Good morning.

Thanks for taking my question.

Good morning, Ted.

Actually I had two things.

First off, on the '05 revenue guidance, you've completed a solid first quarter here with upside, you've got some new products relative to the ON Rod and it looks like dental capacity increases, yet you aren't increasing the revenue guidance for the year.

Are there other things that are holding back potential growth or is this just conservativism on your part?

I don't know if it's conservativism, I think it's just variables.

There's a lot of pluses that some of which you just pointed out we're obviously thrilled with the first quarter.

But, you know, the new products are back ended, everything has to stay on schedule.

Our cross-training will be complete.

We should start to see some of the recovery of lost sales, we hope.

The spine is a very pleasant situation.

We need to understand how sustainable that is and how we can add to that.

You know, you read like I do every day on price, it's a variable.

We don't think price, as I tried to point out analytically, has much impact, if at all, down to zero on an earnings basis.

But obviously it has a very immediate impact on sales.

So I think it's just a bunch of good stuff offset by a bunch of I don't knows.

And in our culture here, we view that cautiously.

That's helpful color.

Could you give us currency number assumed in that 12% growth, Sam?

Yeah.

As I mentioned, it's about a little over 2 points, about $70 million would be the full-year effect of currency contribution to sales growth in '05 if the rates that we saw towards the end of first quarter continue for the balance of the year.

Great.

And then final question.

Could you remind us when you begin to lap some of the current negative pricing in Japan, in Germany, and perhaps give us a little bit longer term view on what you expect there?

Yeah.

Japan is technically April 1, but it never works that way in Japan because it takes them about four to six weeks to get through at any given point the changes.

So I would say oh, coming up in the next couple of weeks or so in Japan, and then Germany, I believe, is June, but I've got to double check that.

Longer term, I don't see anything much different than what we've been saying for two to three years, I think it's two to three price.

I tell everybody, I'm not trying to be funny or flippant about it, but I don't think anybody's 1% smart.

We just can't be that sure, but I think it's somewhere in there in that range.

We run our models to look at ourselves and see what we look like and what we might have to do down to and including actually negative price but we don't believe that that's the story.

We believe the story's going to be somewhere in that twoish range.

So, Ray, just to be clear, these negative 4 to 5 numbers you've been suffering through in Japan and Germany effectively go away for the second half and should turn a little bit positive?

Is that fair?

Yeah, mathematically, that's correct.

What should happen, unless they change their policies, is that these are biannual increases and, therefore, what you need to do is take their real value that you see up front and divide by two.

So what we're getting hit with today as 4.8 is really going to be an effective 2.4 per year.

And, therefore, when I talk with people, I try to annualize them to give them a better feel for what's going to happen.

Conversely, France was supposed to come in at minus 3 or 4 in April, postponed it to June, and now has postponed it to January '06.

So as Germany and Japan annualize, anniversary, and hopefully go away, we will pick up some negative on France, albeit it won't be negative enough to offset the positive coming from the other two.

So there's a lot of variables here.

But again, that France is 2006 now.

That's correct.

That's helpful.

Thanks, fellas.

Okay.

Your next question from the line of Adam Galeon with CSFB.

Good morning.

Just one question about guidance.

I know you guys don't want to talk too much about '06, but you guys continue to talk about 25 plus percent earnings growth next year, and 25% growth on this $3 number for this year gets you to 375 which looks a good 15, $0.20 higher than consensus.

And so, Sam, you've seen our models, what's your sense of where, what the street is missing next year?

Sam just jumped out the window so would you like me to answer that question?

Please.

I don't know that the street's missing anything.

Clearly, we get questions every quarter as we have historically improved our guidance for the future.

We haven't changed our expectations for '06 even with the stronger expect to finish for '05 because the contributions to what caused us to provide that guidance are still out in front of us.

The third year, which was is big year for expense synergies kicks in, and that's primarily in the manufacturing arena.

Will have had a little over two years of cross-training our sales force.

We've had over two years of getting both product lines ready to be sold by those, by both those organizations together.

For example, all the Centerpulse product lines, they didn't have a MIS approach because they never had any MIS instrumentations and those are beginning to roll out now.

'06 based on current project forecasts and timing is likely to be a considerably bigger new product year than even '04 or '05 I think is another factor.

So we get asked this occasionally.

We remain comfortable with the up and guidance in '05, but in no way is this moving things forward that will detract from '06.

We feel very strongly that '06 on the percentage basis that we've given people remains as is at 25 potential plus.

Even if you fast forward, you know, past the big expense savings that will come to us with the balance of our integration plans, we still believe that the model we had prior to the acquisition of Centerpulse holds true, it will hold true in the future so we ought to be able to plan on for every dollar worth of sales growth it continues to drop down something to close to $0.50 of operating profit.

We get additional leverage helping us in tax rate, we've got an improvement in tax rate every year by about 50 basis points for the next several years at some point in time in the not too distant future will drop below 30% effective tax rate.

So all those things contributed to an optimistic outlook.

Thanks, guys.

Okay.

Your next question comes from the line of Steve Lichtman with Banc of America Securities.

Thank you.

Good morning.

Just one follow-up, Ray.

Can you remind us of the benefits of SEMA and the expected timing of rollout of that product?

Yeah.

The benefits of SEMA are really multidirectional, cross-directional mechanical strength that gets rid of those free radicals that have been the story in longevity completely but causes the material to retain virtually all of its mechanical strength characteristics, and in so doing, allows the application of it to be better and broader.

In terms of timing, you know, that's a good question.

We're at the stage now where we know how, let me tell you where the stage we're at because I don't want to at this point I don't want to disclose too definitive a date.

We're at the stage now where scaling, or looking at the scaleup characteristics that we, in other words, we know how to make it, we know how it works, we know it works great, we signed all the agreements, we've got to figure out how to scale it up more in volume than we know how to do today and then we have to produce and then we have to market it.

So there's some time left.

I don't want to put a definitive date on it.

Okay.

Great.

Thanks, guys.

You're welcome.

Your next question comes from the line of Ben Andrew with William Blair.

Good morning.

Just a brief follow-up question on the HCA discussion.

Ray, can you characterize whether or not that arrangement is going to be set up as a gain sharing deal for the physicians?

We have nothing to do with gain sharing, and I think people kind of sometimes confuse things a bit.

First of all, we don't obviously think gain sharing's going to have much of an impact.

But to the extent that HCA is able to apply for it with the right data base and to the extent they're able to get it, that would simply be a distribution methodology of the savings, not just that maybe incurred from their overall impound program but from a bunch of other things they're doing and they would have a structure they would apply for and have it approved by the government should that be the case.

It's not a double dip, it's not incremental to the savings, it's simply a method of distribution for the savings.

Whether they'll get it and where they're at in that process, A, I don't know, and you would obviously have to ask them that question.

Okay.

I mean I understand the basic arrangement in terms of it would be them implementing.

I'm just curious if they have mentioned that in the negotiations as one of their intents because it could have implications for mix as people think about which particular implant to use even within the Zimmer line.

Well, I've heard that argument.

But I will tell you, having, you know, spent a lifetime talking to a lot of surgeons, surgeons are not going to change what they believe is right for a patient relative to some minimal amount of dollars incoming to them, particularly when those dollars would be associated with potential risk and liability.

I mean I'm not saying every surgeon in the world will think the way I just described it because people are different.

But I know thousands of surgeons, and they're not going to move in that direction given the patient decisions they have to make.

They're going to do what's right for the patient.

What we have to do is be more effective working with hospitals to ensure that the system allows them to take benefit for that or we find ways to be more productive with them in the operating room and that's the direction and strategy we're going to take.

But I don't buy this theory that product patient decisions change massively and I really believe you will not see a repeat of sort of the earlier managed care area which was a disaster in orthopaedics anyway and those surgeons that were around at the time still remember that.

Can you give us an update on the process with the DOJ subpoenas?

Have you made a first filing or are you in negotiations with them about what you're going to file?

And what would you expect to be the next public announcement from that process?

Can't do, won't do, and don't know.

Fair enough.

Thanks.

And our final question is a follow-up from the line of Mike Weinstein with JP Morgan.

Hey there, it's Taylor Harris again.

Two quick follow-ups.

First of all, the Italian distributor that you bough in, I'm assuming that was already consolidated in sales so no impact on the top line.

Is that right?

Yeah, that's right.

It was a remaining put take that was built in the original agreement that had a balance of 49% minority ownership available.

We took our put option up on that and you're right, with no change in sales or consolidation.

Okay.

Great.

And then just one last question on HCA.

Can you talk about the carve out a little bit and were there any changes in the carve out policy for you guys or for the [three] broadly?

Our policy, as you know, is to try to maximize carve outs of things that are solely and specifically Zimmer or things we feel we can market as a leadership role.

So MIS, Trabecular Metal, high flex knees, longevity, Durasul and so on, so on.

We try to maximize those carve outs because that's our best opportunity to differentiate.

They're highly profitable and we also believe strongly they give the best patient benefits and we think we can prove that.

So there's no change in what we've tried to accomplish with HCA than any other group.

The other point is we obviously always try to negotiate a lower discount or more favorable pricing position on the carve outs, and we continue to have that as a Company policy.

Ladies and gentlemen, we have reached the end of the allotted time for questions and answers.

I will now turn the call back over for any closing remarks.

No closing remarks.

As usual, we've taken enough of people's time.

Just one quick thing for everybody and for Glenn, I guess, recon was 1% global in price and the Americas was up 2.5%.

So it's 1% global recon.

That may save Glenn and everybody else a nickel on their phone call.

Thanks, everybody.

Appreciate it.

I hope you got the kind of level of disclosure that you're looking for, as usual, and a pleasure working with you on the quarter.

Talk to you soon.

This concludes today's conference call.

You may disconnect at this time.