Zimmer Biomet Holdings Inc (ZBH) 2005 Q4 法說會逐字稿

Good morning. I would like to welcome everyone to the Zimmer fourth-quarter 2005 financial results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. (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 that could cause actual outcomes and results to differ materially from those in forward-looking statements. For a list and description of the risks and uncertainties, see the disclosure materials filed by Zimmer with the Securities and Exchange Commission.

Zimmer disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. This presentation also contains certain non-GAAP financial measures. A reconciliation of such information to the most directly comparable GAAP financial measures along with other financial and statistical information for the period to be presented on the conference call was included in the press release announcing our earnings, which may be accessed from the Zimmer website at www.zimmer.com, under the section entitled Investor Relation.

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

Thank you, LouAnn. Good morning, everyone, and welcome to Zimmer fourth-quarter 2005 conference call. We are pleased to be hosting this call to discuss a very good earnings quarter and a continuation of solid underlying revenue growth. Record margins, record Europe & Company operating profits and ratios as well as strong cash flow production highlighted the quarter.

Joining me on the call today are Sam Leno, our Executive Vice President of Finance and Corporate Services and Chief Financial Officer; and Jim Crines, our Senior Vice President of Finance, Operations and Controller. We will begin today's call with comments related to our fourth quarter 2005 including an update on operations followed by a Q&A session. All comments and comparisons are on an adjusted basis. Further, all adjusted discussion excludes acquisition integration expenses and inventory step-up.

We will provide reported sales figures in most cases but really focus more of our attention on constant currency, given the expanded foreign exchange headwind.

As always, I wish to thank our Zimmer team for the continued hard work with a special congratulations again this quarter to our spine team with a 25% constant currency sales growth, and to our large European business with double-digit constant currency sales growth and record operating profits.

As our press release indicated as always, we take very seriously our commitment to deliver on our earnings expectations. Zimmer in the quarter was the only major orthopedic company to date to meet and exceed original First Call EPS expectations.

Let's take a look at the fundamentals of our fourth quarter P&L and balance sheet performance. Consolidated sales for the quarter were 848 million, an increase of 6% reported to prior year, towards the upper end of our range and essentially equal to street expectations. However since we provided our original guidance at the end of the third quarter, we have a loss of about $3 million in anticipated sales solely due to foreign exchange.

On a constant currency basis, our three geographic segments, Americas, Europe, and Asia-Pacific grew at 8%, 11%, and 9% respectively. On the same basis, total Company sales to prior year improved by 9%, exactly the same as last quarter and a number that is consistent with our expectations for the first two years of the Centerpulse integration. We believe on a weighted basis for our combined Zimmer served markets, this 9% will prove to be market growth for the quarter.

Reconstructive sales grew 6% reported in the quarter and 9% constant currency, again, exactly the same growth as prior quarter. For the year, reported total sales were 3.29 billion, an increase of 10% both reported and constant currency. Reconstructive products grew 11% reported and 10% constant currency. This quarter we believe the global constant currency recon market based on over 80% of the market already reporting grew at 9%, composed of 8% volume and mix and 1% price. We do see for us some improved Hip revenue and slightly less Knee revenue creating more balance. But we can find no significant underlying future surgery demand decline any different from the trends over several prior years.

Zimmer Hips in the quarter increased notably by 7% constant currency versus a prior quarter of 4% and our first half results of 5%. We believe for the first time in a year we have returned to solid marketshare growth in Hips.

Zimmer Knees grew at 10% constant currency, down from more recent results at 12% growth and again, a global market we believe this quarter growing at about 11%. We fully realize that Knees are driven a great deal by U.S. results and the Zimmer Americas business in the quarter was measured against the toughest comp in almost three years at 26% in the prior year fourth quarter.

Zimmer global reconstructive numbers grew by 9% in the quarter against a 2004 comp of 13% composed of 18% Knees and 7% Hips. For the year, Zimmer Hips and Knees grew in constant currency at 5 and 14% respectively versus 2004 full-year comps of 10% and 15% respectively.

Let's return to looking at the quarter in total. Zimmer's 8.9% constant currency sales increase globally was composed of volume and mix growth of 8.6%, not dissimilar from the 9% we saw from all of 2004 or for that matter a little over 9% we saw in volume and mix for the first three quarters of 2005. To be precise, and an important statistic for Zimmer, volume and mix grew at 9.3% for 2005 over 2004 and actually faster than the 9.1% recorded in 2004 over 2003. However implicit in our 2006 guidance is volume and mix growth of 10 to 11%.

When we grew at 14% in a very strong fourth quarter of 2004, price and foreign exchange were almost 5% of the growth and therefore volume and mix was 9%. For Zimmer, our year-over-year volume and mix growth is exactly the same, while we experienced moderation in price and foreign exchange. We believe for the quarter our 9% global recon volume mix is equal to the market growth while our leverage of sales to earnings continues to be substantially higher than every other competitive business.

Our Spine operation delivered an outstanding 25% constant currency growth and well above market. Trauma's 7% constant currency growth was one of the best quarters in almost two years and should prove to be within a couple of points of the market, while Dental delivered a respectable 13% constant currency growth despite some modest disruption from changes to our Italian distribution plan and the expected short-term effects of the Tutogen recall.

Worldwide price improvement for Zimmer was positive 0.3% versus positive 0.5% reported in the last quarter. In fact if you look at price for Zimmer in the last three quarters of 2004, it was plus 2, plus 2, and plus 2. If you look at all four quarters of 2005, price is plus 1, plus 0.6, plus 0.5, plus 0.3. In a total of two years, the real decline in global price for Zimmer has been 1.5%. For us there has been no catastrophic or cliff affect drop in price. There has been a gradual decline based upon our mix of countries and products, easily offset by corresponding and continuing increases in gross margins.

While the numbers are roughly the same, it has clearly been up until fairly recently a moderating price market. We will continue to provide more granularity on our view of 2006 pure price forecasts. In any event as we have said and proved so many times, it is already in the guidance for us. Our strength in volume, mix and margins, combined with the model in which we operate the company make it far less of an earnings factor for Zimmer than people ever seem to realize. We know that is true because we have proved it each quarter for over four years.

Here’s some interesting price news for the quarter. Specifically our Americas reconstructive market was price positive again at 0.7%, which we continue to believe is not below the market but slightly above it. Perhaps more important, our Americas business has actually increased price by 10 basis points sequentially from the third quarter. Keep in mind this is real fourth-quarter data since Zimmer's 2006 new prices are effective January 1 and not during the October to December period. In fairness, the current 1% U.S. price improvement for Zimmer does in part reflect an earlier conscious decision to negotiate with key accounts which we believe will prove to serve us well now and in the future.

The positive 0.3% price globally for us also now includes positive 1% in Japan while Germany improved nicely from -5.5% for the year to only -2.6% in the fourth quarter. Iberia or Spain and Portugal combined and France both registered positive price, as did Belgium, Holland and Switzerland. Only the UK and Italy faced stiffer price in the quarter at -5% and -2% respectively. Europe price in total for Zimmer in the quarter was -1% or the same as prior quarter, but with a little different country mix. If the current trends had continued into 2006 but with Japan, France, and Germany at mid single digit price reductions and the U.S. slightly negative, price for Zimmer given our geographic weightings would be flat to slightly negative in 2006.

As previously mentioned in last quarter's conference call and at several investor sessions, this latter scenario has already been accounted for in our guidance at -1.2%. These are fairly complex calculations given the variables, but we have refined information technology systems for price and we pay relentless attention to the data points.

The expected trends in price have improved for Zimmer, but nowhere more so than in Japan. We have moved from a very real earlier in the year possibility of two to three years at -8% to more recently -7 to -8 for 2006 and -5 to -6% for 2007. The final result, although not yet fully confirmed, will be better than even the latest information. We now expect with confidence the combined effect of the FAP, or foreign average pricing, and the R-Zone, the annual Japan hospital price survey, for Zimmer to be specifically as follows.

Total read impact in 2006 is minus 6.4%, but an actual annual P&L impact of less than 5%. Total rate impact for 2007 equals -5.8% but an actual annual P&L impact of something just over - 5% and total rate impact in 2008 of -0.6% with an actual annual P&L impact of less than 2%.

Of particular note for Zimmer, we expect the 2007 Knee impact will only be a little over -2%. With our Japan Knee market share, this is an important improvement versus our expectations.

You may wonder why I keep repeating the words for Zimmer. Please do not regard our best efforts to communicate Japan price as representative of the orthopedic or medical device industry. The addition of Trauma products, the choice of the UK, France, and Germany for foreign average pricing comparisons, and the subcategorization to almost 300 different product codes will have very different affects on different companies. As a result, the changes are Zimmer only. Having said that, for us this is much better than expected news and very manageable within our model.

With respect to HCA, our ultimate timeframe during 2005 to validate compliance was relatively short and we have concluded additional discussions with HCA for the near term. We will continue to partner with HCA to provide support and where possible to help them prove that their hard work can provide a win-win. We also of course have a committed intention to receive the optimum value for our products and services. Just prior to the 2005 year end, we adjusted our prices accordingly.

As an interesting sidebar on U.S. price, according to the American Hospital Association, and I quote, "Profit margins for U.S. hospitals reached a six-year high in 2004, the last full year for which statistics are available, with an average of 5.2% USA Today reported. The increase in profit margins was due to strong bargaining power with insurers, slowing expenses, and an improving stock market that increased investments income. More high dollar services such as orthopedics and strong outpatient revenue also helped to boost profits. About 25% of hospitals are in the red, a decrease from about 33% in the past several years." Kind of makes you wonder about all the interesting rhetoric in 2005, doesn't it?

Returning to our quarterly performance, our plan when we announced the Centerpulse deal was as you know to try to remain at 9 to 10% sales growth for each quarter of the first two years post integration despite sales dissynergies, distributor realignments and historically a larger slower growth legacy Centerpulse Europe. For the full year 2004 and the full year 2005, we have fulfilled those expectations.

I will provide some detailed geographic and product sales analysis in a few moments, but the key to the Centerpulse deal was early, sustainable, and accretive earnings per share growth. We continue to reap the benefits of not only our integration work but intense focus on margin and mix management combined with prudent expense control. We have done so without the sacrifice of key future personnel additions or technology investments.

Adjusted diluted earnings per share for the fourth quarter 2005 were very strong at $0.86 on 249.8 million average outstanding diluted shares. For the quarter, we delivered a diluted EPS increase of 21% over prior year and about $0.03 better than the First Call consensus EPS estimate of $0.83. The pattern of significant financial return from the Centerpulse deal reflected by both EPS and cash flow combined with our own distinct earnings drop through model continues. Adjusted EPS for the year are $3.10 or a 29% increase to prior year.

We will continue to focus on profit margins and incremental earnings contribution from new sales. Zimmer's gross profit margin in the quarter was an all-time record 78.1%, up sequentially 90 basis points from the third quarter despite a stronger Europe at somewhat lower margins and more Hip and Knee revenue balance. The 78.1% margin is a 130 basis point improvement from prior year. With the vast majority of some 30 to $35 million in favorable integration synergies as well as a long list of mix and cost reduction opportunities still in front of us for 2006 and 2007, we are confident in the potential strength of our margin management.

Looking at gross profit from a price impact perspective only, the 78.1% margin in this current fourth quarter 2005 contained only 0.3% global positive price increase for a margin net of price of 78% while the 76.8% margin in the fourth quarter 2004 contained 2.1% positive price for a margin net of price of 76.3%. On a net of price basis, we have increased our gross margin by 170 basis points over last year. Said differently, the 170 basis point improvement in gross profit was achieved in spite of a 180 basis point moderation in price contribution.

We are the only major orthopedic company increasing margins meaningfully on a quarter-over-quarter, year-over-year basis in a period of reduced price contribution. We believe that at over 78%, our gross margin is easily once again at or near to the top of both the orthopedic industry and major medical devices.

Our gross profit margin for the year was 77.7%. SG&A expenses and total operating expenses for the quarter as a ratio to sales were very good at a post-acquisition record 37.0% and 42.4% respectively. At 37.0%, SG&A costs increased only 2% versus prior year despite a 6% reported sales increase and are comparable to last quarter's 3% growth as we continue to remove unwanted costs and consolidate programs and staff relative to our acquisitions.

It should be noted that during the fourth quarter, we closed the Austin operation two months early. The 37.0% SG&A ratio is a sequential improvement of 180 basis points from the 38.8% ratio recorded in the third quarter and a 150 basis point improvement from fourth quarter prior year. Although we do not disclose it separately, G&A expenses were at yet another post-acquisition record low as a ratio to sales.

The actual increase in SG&A absolute dollars from fourth quarter 2004 was a little under $5 million on a sales improvement of about 47 million indicating a fully loaded SG&A expense cost of only a little over $0.10 to acquire each new sales dollar. With the more recent expectation of less price, we continue to take specific expense actions to enhance our leading position as low-cost manufacturer and low-cost distributor while increasing long-term key investments in such areas as Orthobiologics. Over a two-year timeframe starting with fourth quarter 2003 at 40.9%, we have publicly targeted to reduce SG&A by at least 200 basis points with this quarter's performance reflecting not a 200 but nearly a 400 basis point improvement from that point in time.

For the year, SG&A and operating expenses are 38.3% and 43.7% respectively. We expect that with the increase in total development projects and the expanding number of external and internal biological relationships, our R&D ratio to sales would operate between 5 and 6%. For example, we have doubled our internal people and project-related biological investments during 2005 alone. In the recent prior months we signed an exclusive relationship with Revivicor Inc. for xenographic porcine tissue replacement products and even more recently committed $24 million to a new Warsaw-based R&D center.

Last month we announced and staffed three new emerging technologies departments devoted solely to orthopedic applications for our woven materials, sensor technology and drug device combinations.

During the fourth quarter, R&D totaled $46 million, a sequential increase of $2 million and almost $180 million for the year or in absolute terms almost a $10 million increase over prior year despite still eliminating projects with nonproductive overlap and less attractive future potential. We continue to shift R&D dollars to innovative investments and away from me-too product duplication. We spend more; we spend smarter; and we spend on programs that will make a real difference to patients, surgeons, and hospitals.

Total operating expenses for the quarter at 360 million represented an increase of only 1% to prior year quarter versus a 6% sales growth. For the year, operating expenses were $1.44 billion or a 6% increase versus a full year sales growth of 10%, and therefore consistent with our highly leveraged drop-through type model. For reference in the fourth quarter, actual acquisition and integration costs increased to 22 million versus an average of 12 million per quarter in the first nine months. During the fourth quarter we decided to execute and absorb now rather than later the European restructuring that moved us from integration structure to a go-forward structure; the underbooked value disposal of our acquisition related redundant Austin facility; and charges related to the planned discontinuance of some older productlines from the Centerpulse acquisition.

For the year, total acquisition and integration expenses were 57 million and about $10 million higher than the original 2005 plan, solely due to the fourth quarter items described. Correspondingly with the completion of these tasks already in 2005, we expect 2006 acquisition integration costs to drop off dramatically to only $15 million or so for the entire year.

Operating profit in the quarter also reached a record at $303 million, the first time ever over 300 million and the fifth consecutive reporting period that we have produced at or more than $0.25 billion in operating profit. We were really pleased to reach our best operating profit to sales ratio ever at 36% in the quarter, up sequentially over 300 basis points from the third quarter and up a whopping 340 basis points from a strong fourth quarter prior year. During the quarter we believe we have recorded the highest operating margin in all of major medical devices.

As previously mentioned, the Zimmer construct that we have today was modeled during the late '90s turnaround and well before Centerpulse to register approximately $0.50 of operating profit for each new sales dollar. In the fourth quarter of 2005, we have delivered $44 million more operating profit on $47 million more in sales, or about $0.90 of operating profit on every new dollar of sales, in part because fourth quarters for us enhance leverage and also drive record gross profit ratios and continued progress in G&A. $0.90 on the dollar is not long-term sustainable, but $0.50 should be.

EBITDA in the fourth quarter improved as you might imagine on an adjusted basis to a record 41.6% as a ratio to sales, up sequentially 300 basis points from the third quarter and up 340 basis points from the same quarter prior year.

Adjusted net earnings in the period continued very strong at almost $215 million with an industry-leading 25% net margin ratio to sales up over 300 basis points from the same quarter prior year.

Our fourth quarter 2005 tax rate improved from the prior year quarter by 130 basis points to 28.9% and therefore our annual ETR basis as we begin 2006 moved to 29.6%, under 30% and consistent with where we hope to be. We are pleased with these fourth-quarter 2005 P&L results and believe that we continue to make substantial progress while simultaneously raising the performance bar.

Despite endless 2005 orthopedic industry black clouds, essentially a new black cloud per quarter, the orthopedic sector appears to be generally performing quite well. Zimmer's actual financial results continued to exceed expectations with $3.10 adjusted EPS for the year and a 29% EPS growth. However based upon the stock market for most of 2005, we can assume that no good deed shall go unpunished.

At this point, I will provide some brief introductory fourth-quarter cash flow and balance sheet highlights. Cash generation remains fundamental to both our story and our strategy. We had another excellent operating cash flow quarter. Operating cash flow was above the favorable end of expectations, registering $251 million. For the year, operating cash flow was 878 million. In only two years of combined operations with Centerpulse, we have delivered a little under $2 billion in cumulative operating cash flow.

Free cash flow in the quarter was 190 million and for the year reached 623 million. The Company at year-end has $245 million of cash and equivalents on hand and only 82 million in debt, primarily maintained in Japan due to favorable spreads.

During the quarter, our Board of Directors authorized a $1 billion common stock repurchase program through year-end 2007, giving Zimmer another option to increase shareholder value. Speaking of shareholders, shareholder equity has increased from zero at the time of the spin-out to a little under $5 billion today.

Our fourth-quarter combined working capital statistics continue to perform well and consistent with the number of projects under way. Combined inventory days are 283, down 20 days from the third quarter as expected, however 283 days is a 25-day increase from prior year. Yes, we brought in titanium, tantalum, and other metal raw material metals at favorable prices and we've increased our overlap inventories knowing we would close our Austin, Texas plant two months early. A large part of the story though is in the standard DOH formula itself. We had 258 days on hand at year end last year, but that was with a 76.8% margin. If you apply the same gross profit margin as last year, the year-end days would be approximately 267 or a drop of 36 days from the third quarter and well below the industry averages for our mix of products.

Conversely in other businesses where margins are declining and inventory reserves increasing, don't assume working capital is well-managed just because the DOH is coming down.

Our receivables collection continues to provide support for strong cash flow production. In the fourth quarter we delivered excellent global receivables at 56 days, an eight-day improvement sequentially and three days better than the 59 days in prior year same quarter. In fact 56 days is the best global AR number since the first quarter of 2003 almost three years ago.

Combine America's receivables results were very solid at 37 days, an improvement of two days sequentially and one day better than prior year same quarter, again a notable achievement in the U.S. hospital environment. We are very excited about our European group delivering 81 days AR in the quarter, an outstanding improvement of 37 days from the time of the Centerpulse acquisition and at least 20 days better than the broader European hospital market receivables performance.

Let's review the quarter's sales in a little more detail. For the fourth quarter worldwide reconstructive sales increased to 702 million reported, a 6% increase over prior year and 9% constant currency. Knees grew at 7% reported but 10% constant currency. Hips grew 3% reported to prior year but 7% in constant currency. We expect the global recon market, ex Dental, to be up about 9% constant currency in the fourth quarter and we are delivering around the 9 to 10% growth we committed to at the beginning of the Centerpulse integration process, despite price being about two points less. In short, the combined Centerpulse/Zimmer effort remains cumulatively ahead of our expectations. For the year, as previously indicated, global recon growth for Zimmer is 11% reported and 10% constant currency.

Let's take a look at each global product category and geographic segment more closely. First, products. In the Knee category, again on a worldwide basis in the quarter, Knee sales for Zimmer increased by 10% constant currency versus prior year to 351 million. For the year Knees grew 14% both reported and constant currency.

From a brand point of view, our NexGen LPS-Flex continues a three-year trend of gain with a very strong 42% increase to prior year in the quarter. It is no coincidence that the LPS-Flex is the knee of choice for our new MIS Mini, subvastus, and trademarked MIS Quad-Sparing QS total knees. After the best part of the year, we have still seen almost no impact from the two new competitive knee systems on the market. The new Zimmer CR-Flex knee also continues to be a special story. The CR-Flex femorals delivered sales of some $18 million in the fourth quarter this year, a 45% increase to prior year and a sequential quarterly increase of over $2 million.

LPS-Flex and CR-Flex femoral component sales alone reached over $45 million in the quarter, but are still less than 30% of our own Zimmer Knee femoral mix. The legacy Centerpulse Innex Knee delivered excellent unit growth of 24%. Our new Uni, the industry's first high-flex single compartment knee, combined with other Zimmer unicondylar offerings registered a run rate of over $50 million in annualized sales.

Zimmer's LCCK knee revision offering jumped by 20% in the quarter, a good sign. Knee revision remains an important future opportunity representing historically only 5 to 6% of total Zimmer femoral units. In fact, our penetration of the hinge market has grown substantially with the combined legacy Zimmer and Centerpulse brands delivering 31% growth in the quarter while our unique Trabecular Metal revision knee cones are solving complex and more difficult cases.

Trabecular Metal monoblock tibial trays have continued to take share. TM tibial tray units increased by almost 20% again this quarter. We overachieved our guidance of $100 million in total Trabecular Metal sales for 2005 substantially. How much so? We tallied almost $30 million of TM in the fourth quarter alone.

There continues to be excellent progress and new data points on the Zimmer minimally invasive knee front, particularly with the early success of our new MIS stem tubular component, progress with computer-assisted surgery systems and a new peer reviewed study on improved per patient profitability even in a high Medicare mix environment. I will update those activities later.

Here is an interesting knee factoid. A couple of years ago we announced that Zimmer since inception was the first company to cumulatively implant one million knees in the U.S. This period we were the first company ever to exceed 100,000 knee arthroplasties globally in a single business quarter. Whether it is 10% growth against a very difficult 18% global comp or not, 100,000 knees in a quarter is a lot of knees.

Let's switch to hips. Zimmer Hip sales were sharply stronger in the fourth quarter. For us MIS hip stems are still definitely driving market share. It's clear based upon current and future anticipated company reports that we took market share and constant currency hips this quarter both globally and in the U.S. On a worldwide basis in the fourth quarter, hip sales increased 3% reported to 294 million but a 13% sequential increase and up 7% in constant currency versus only a 4% increase last quarter and substantially above the 5% for the year.

For us, porous stems continue to have double-digit unit growth. We are very encouraged with our targeted hip brands in the new combined company. Our enthusiasm is based on the potential breadth and impact of both MIS and hip resurfacing, Trabecular Metal, advanced (technical difficulty) polys I should say and EVA consulting potential for MIS. Zimmer fiber metal tapers along with the new M/L taper are the stems of choice for our MIS-Mini, anterior lateral, and 2-Incision hip surgery. In the fourth quarter these two-stem families grew by 20%, bringing the combination of fiber, Metal, and M/Ls this quarter to almost $30 million in sales.

Obviously neither the hip stem market nor even the porous stem market are growing at anywhere near 20%. We recognize there is always some cannibalization of other stems, but day in and day out our MIS leadership brings in business.

Speaking of MIS, new instruments for legacy Centerpulse brands in Europe are already having an impact. The CLS Spotorno with a long-standing $40 million per year sales base mostly in Europe had unit growth in the quarter of over 13% or at least two times the current European market growth in units. We would suspect that our growth versus the market must be frustrating to competitors putting so much effort into marketing knockoffs while legacy Centerpulse Alloclassic and CLS brands reached more than $22 million in quarterly sales and were sequentially up on a unit basis by 20% over the third quarter.

At the end of the year and throughout 2006, we expect to launch two new platform technology stems, the very first Trabecular Metal stem and the EPOCH composite full coat, a great addition for MIS and the only successful composite stem on the market. Look for both of these new MIS hip products at the AAOS.

And acetabular cups, Trabecular Metal modular and Durom hip resurfacing continue to thrill us. Primary Trabecular Metal cup sales increased over $13 million in the quarter, an increase of almost 30% from prior year. New revision TM shells and augments added another 1.6 million in the quarter. The Durom cup and stem including our fast-growing resurfacing product available selectively ex-U.S., grew more than 70% to some $7 million in sales for the quarter or a sequential increase of almost 30% from the third quarter alone.

Speaking of metal-on-metal articulations, our U.S. Metasul large-head filings were completed in December.

Here is one of our favorites of course, premium priced longevity in Durasul, highly cross-linked polyethylene liner units increased by yet another 14%. Not only is the growth rate way above market but the base of our sales is very different to our competitors. Our two highly cross-linked brands when annualized deliver over $100 million per year in sales and despite competitive releases sequentially increased their growth rate from prior quarter. We believe that in the future colder, radiated, mechanically annealed or other poly technologies exclusive to us will potentially revolutionize the industry just as Zimmer and Centerpulse did several years ago with the Longevity and Durasul brand polys.

As you know, our Trilogy AB ceramic-on-ceramic PMA has been accepted by the FDA as fileable and we have received our plant review dates for February and CeramTec's for early March. Assuming no relevant 483s, we expect to be selling ceramic-on-ceramic first thing in the second quarter.

We have been really pleased with our U.S. performance on Palacos bone cement products. During the quarter, bone cement and accessory sales increased by 50% to prior year. The new platform products including the Trabecular Metal hip and the EPOCH composite, new techniques like the Zimmer anterior lateral, MIS for Europe, new polys, bigger metal-on-metal heads, a little ceramic-on-ceramic and the new antibiotic bone cement should continue to improve hip sales.

As with prior quarters, there is much new activity on MIS hip including a recent factual press release on more than 2500 MIS 2-Incision surgeries from over 200 surgeons that provides for a change real data on our technique. In upper extremity joints, legacy Zimmer's Bigliani/Flatow and legacy Centerpulse's Anatomical Shoulders amongst others continue to grow worldwide with a solid 14% unit increase in the fourth quarter despite a continuing array of competitive new products.

Good news from the FDA. We just received a very rapid 510-K approval for our new Zimmer anatomical inverse shoulder, another great new product that you will see at the AAOS. Total Zimmer extremity sales are now annualizing at almost $70 million.

To complete our reconstructive discussions, Zimmer Dental had a very successful fourth quarter with sales just under $40 million and up a solid 13% constant currency. These results reflect negotiations and infrastructure disruptions to change our Italian operations and the expected short-term effects of the Tutogen recall. Said differently, Americas and Asia-Pacific Dental sales in constant currency excluding Europe grew on a combined basis at a very solid 15%.

Dental implants and surgical products increased 12% while Atlantis rapid turnaround custom abutments continued to double again. Dental sales of our new biological graph, Puros, jumped by almost 34%.

Exciting news on the medical education front. Our global state-of-the-art Zimmer Dental Institute, designed as a university type setting, is open for business in Carlsbad, California. We will continue to move into Biologics, computer-assisted technology, and of course value-added education, a definite competitive edge that is difficult to match by famous Internet implant sellers.

On a worldwide basis in the fourth quarter Trauma sales grew 7% constant currency to $46 million. The Trauma market has had mixed results but we are clearly moving back into positive territory while we only (technical difficulty) begin to deliver new products. With expanded field releases of our new locking plates, periarticular unit sales in the quarter jumped by 46% and quickly reached an annualized rate of over $25 million. Compression screws remained weak and were actually negative in growth. Fortunately they are declining as an operating room solution instead of the mainstay they once were.

New NCB or noncontact bridging plates jumped 600% with major releases and external fixation improved by over 60%. ITST nails are still growing in units at more than 50% despite our relatively flat nail performance overall. Trabecular Metal osteonecrosis rod units were quickly up over double versus prior year again this quarter. As we convert new products from old, deliver innovative solutions, and make our recently announced Trauma division fully operational, results should continue to improve.

Our Zimmer Spine division sales increased by 23% reported and an outstanding 25% constant currency in the quarter to record $43 million in sales. We are really pleased with this continued sales improvement. Excluding spine market Orthobiologicals, it is clear that we took substantial market share gain for the third quarter in a row. Cage sales remain firm for the fifth consecutive quarter at just under $8 million and now represent only about 18% of spine division sales, versus 50 to 60% in the pre-acquisition years. The big story though is once again Dynesys. Our dynamic stabilization system. Sales jumped to $12.5 million in the quarter, up 1.5 million or 10% sequentially from last quarter and were three times prior year sales, in fact outselling cages by nearly 60%. Perhaps more interesting, Dynesys this quarter became a $50 million brand and we outsold the Charite artificial disk by $2 million in the quarter. A year ago from now, who would have guessed?

When combined with some $3 million of spinal Trabecular Metal, these two new technologies delivered $16 million in sales, or more than double the contribution of cages in the quarter. As we have noted several times, the combination of Trabecular Metal, dynamic stabilization, and MIS with our new pipeline and a few technology and biological acquisitions should create a globally competitive and formidable spine business. We would hope to keep this above market growth going. Congratulations to our spine division for their best quarter yet.

In our orthopedic surgical products division, sales improved sequentially by $1 million from prior quarter but grew versus last year by only 1% to 57 million on a constant currency basis. Obviously OrthoPAT now declining by 26% to prior year took its toll as we phase out the distribution agreement. We expect to see this decline to affect sales growth negatively by at least $4 million in the first quarter of 2006. This assumption is already implied in the latest guidance provided.

During the quarter, autotransfusion and wound debridement products continued their solid growth with increases of 8% and 11% respectively. Let's switch to a quick look at our new product development performance. During the first half of 2005 we launched 48 projects. During the third quarter we launched an additional 28 projects and during the recently completed fourth quarter we launched another 29 releases, including 14 full releases, 6 limited releases, and 9 developer clinical study releases. We continue to drive higher margin, higher mix new products to temporary overlap the older ones, but ultimately to replace them. During 2005, we had 106 different releases on 78 different projects while we continue to operate between 160 and 170 projects. Nearly two-thirds of our R&D investment spending relates to innovative products and platforms with a real bent towards improved patient quality life and potential EVA outcomes to increase average per patient profitability for hospitals.

Hip product launches in the fourth quarter include the developer release of the first Trabecular Metal stem, limited release of the Mayo stem plus sizes, the new [Avenier] stem for France, and new Durom hip resurfacing instruments. Coincident with the releases, seven new hip projects were initiated.

In knees, we delivered releases on both the Natural brands knee MIS instruments along with new lateral Quad-Sparing for NexGen and the first of the MIS modular precoat stemmed tibial plates. We initiated the new Natural-Knee II flex with a Trabecular Metal monobloc tibial, much to the delight of legacy Centerpulse surgeons.

The news in extremities is the full launch of the Trabecular Metal humeral for shoulders. Clearly in volume though, the bigger news continues to be in Trauma, where four peri locking plates move to full market release and the new femoral and humeral NCB plates also went to full release along with legacy Centerpulse's [seras] [nail] in the U.S. market.

Here is an important statement for us. In Biologics after almost five years we filed along with our partner ISTO, our IND for Neocartilage to the FDA for approval to conduct Phase I human clinical trials for the repair of articular cartilage. If and if in medical devices development is always the operative word, nonetheless if this one is a winner for Zimmer, it will forever change reconstructive orthopedics. We have known for years how to grow bone, but the Holy Grail is not growing bone, it's growing integratable, sustainable, and safe articular cartilage.

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 has historically been 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% to sales cumulatively per year for those seven years.

New product sales for the fourth quarter 2005 were excellent and totaled $185 million or 21.9% of sales. For the year, new product sales were $695 million or 21.1% of sales, our best year ever.

Let's look briefly at the geographic segments. First in the Americas, Zimmer Americas had a bit more challenging quarter but holding the line and in fact increasing reconstructive pure price was both psychologically important and very successful. The minor affect of hurricanes along with some residual DTC pressure frankly did not help knees much, but hips returned to market share taking numbers with both MIS and revision hips moving up nicely.

Americas revenue for the quarter was $493 million, just under the 0.5 billion mark and up 8% over prior year. 7% of our Americas growth was driven by increases in unit volume and mix and 1% growth was derived from price. The Americas reconstructive growth in the quarter was up 8% and delivered 394 million in sales. This would imply that in the Americas during the quarter Zimmer had a little under 8% growth in pure reconstructive surgical procedure volume mix or based on reports to date a slight share gain.

In our Americas reconstructive growth knees had decent growth with an 8% increase to $220 million, still up 4% sequentially and despite the worst possible prior year same quarter comp of 26%.

NexGen LPS and CR-Flex, the new high flex UNI, Trabecular Metal tibial components, the new MIS stemmed modular tibial, and NexGen LCCK revision knees all made substantial contributions to the Americas' knee performance, a solid performance given the comp.

Hips in the Americas increased 8% to 138 million and clearly better than the domestic hip growth figures that now appear to be likely 3% or perhaps at best 4%. We are pleased with the Zimmer Hip growth in the quarter especially considering a prior year same quarter comp of 15%. Hip performance in the Americas benefited from market share taking growth and primary porous stems related to various MIS procedures, Trabecular Metal cups, and highly crossing poly, both Longevity and Durasul.

Our Dental business in the America grew at 13% in the quarter to $24 million, up sequentially 10% and we believe not far off market. Based upon our results and the already released public reports of our three major competitors as well as the remaining market players, we believe the market growth in domestic reconstructive products in the quarter will be approximately 7 to 8% ex Dental. Zimmer's combined Americas reconstructive growth of 8% with a more balanced performance from hips and knees would appear to be at or slightly above market.

Here is a statistic we're always proud of. The new combined Americas operating profit margin in the fourth quarter of 2005 came in at 260 million or a 52.8% ratio to sales up 180 basis points from the same quarter prior year. That's a 12% operating profit increase on an 8% sales growth.

Let's take a look at Europe. We are very pleased with the underlying constant currency sales growth and the traction being gained. In the quarter European revenues were 234 million, up 3% reported but most important up 11% constant currency. Double-digit growth is well above the European market and well above our own first three quarters constant currency growth of 7%. As mentioned previously, price decline in the quarter for Germany improved to -2.6% and this along with Italy and the UK contributed significantly to our -1% price for Europe during both the quarter and the full year.

We do not expect it to improve too much, but neither do we expect it to seriously impact our global business results. We can still foresee a new DRG-like tariff system in France, probably mid single digit negative very late in 2006, some price improvements in Iberia, and a new German government with a preliminary focus thankfully on labor, not healthcare. Reconstructive implants in Europe delivered sales of $212 million in the quarter, an excellent increase of 9% constant currency.

Hips were negatively affected by German, Italian, UK pricing changes, some aggressive competitor knockoffs, and surge in dissynergies but despite the circumstances responded very well by delivering 6% constant currency growth. These were consistent with prior quarter at 4% reported but more important a solid 12% constant currency. With the quarter's competitive reconstructive numbers for Europe estimated in the aggregate at low double-digit, we are after a great deal of hard work back near the market.

Positive gains in the quarter reflect the continued acceptance of both Durasul and longevity highly cross-linked Polys, some early impact of minimally invasive instrument deployments, the growing acceptance of Durom and Trabecular Metal, as well as ongoing market share gains for the NexGen knee brand.

Many of Europe's country businesses performed well on a sales growth basis versus the competition. The UK and South Africa, Sweden, Norway, Finland, Belgium, the Netherlands, Russia, Portugal, the Middle East, and export all grew sales for the quarter in mid to high teens or better constant currency. Spain, France, Switzerland, Germany despite the price declines and tough competition remain solidly in mid to upper single digit growth. For the quarter, Europe delivered an all-time record operating profits of $93 million and an all-time record operating profit to sales ratio of 40%. Congratulations to our European team.

In Asia-Pacific, revenues in the fourth quarter were $121 million, up sequentially by 9% and an increase of 4% reported but 9% constant currency. These are good constant currency growth results given our Japan mix. Asia-Pacific continued a positive 1% price in the quarter. We believe that the Asia-Pacific reconstructive market is growing at high single digits in local currencies and as a result, net of dissynergies in the distributor reorganization we appear to be at or above market.

In the fourth quarter, our combined Asia-Pacific businesses were led by very strong constant currency reconstructive growth, up 11% to almost $100 million in sales. We expect Trabecular Metal tibial components, the NexGen CR-Flex Knee, and the strength of the Centerpulse Natural-Knee to continue to improve Asia-Pacific's knee performance this quarter at an outstanding 15% growth.

A new Japanese natural hip, some hope for Trabecular Metal regulatory approvals, and MIS-driven expansion will help escalate sales hip performance this quarter as with last quarter at 7% constant currency growth.

While our Dental business is small in Asia-Pacific, it did deliver another strong 25% sales increase. The constant currency country growth rates were good with Australia and New Zealand at 7%, Korea and Southeast Asia at 23% and Greater China delivering an excellent 16%. Japan had a much improved 7% growth in a market that doesn't grow much more than 5%. Displaying their usual strong earnings drop through from sales, the Zimmer Asia-Pacific businesses delivered $57 million in fourth quarter operating earnings and a near record 47% operating profit to sales ratio, up 330 basis points from the fourth quarter 2004.

Let's move from products and geographies to hot topics. Since we have already covered price, I will focus that discussion down to briefly updating you on minimally invasive activities and providing a few hints on what to look for from Zimmer at the AAOS in Chicago.

The Zimmer Institute remains busy and we reached our primary goal of training 2500 surgeons during 2005. We actually trained 2489, but close enough. That by the way is a 70% increase over last year's 1477. The new MIS anterior lateral hip and the MIS Quad-Sparing TKA account for almost 60% of the courses. We have reached a total of 25 Zimmer Institute partnerships composed of 10 in North America, 10 in Europe, and five in Asia-Pacific. We would like to welcome our latest Institute on board, the Mount Sinai Hospital and Teaching Center in Toronto, Canada.

We have added to the curriculum in the second half of the year with MIS Knees offered in local languages in Thailand and Germany, several brand-new courses including Dynesys Spine in Australia, mini hip and knee in London and revision hip and knee in Toronto and Baltimore, to name only a few.

During 2006 computer-assisted training for iNav and electromagnetics will be added in both Warsaw and several satellites along with we hope five beta sites for operating room and clinical pathways efficiencies for MIS. The latter associated with the new EVA consulting business that we are developing. You can expect a separate press release covering this exciting new Zimmer orthopedic services opportunity.

With respect to MIS knees, two interesting publications were issued in the quarter. The first article by Dr. Richard Berger et al published in the Journal of Arthroplasty stated results of 50 patients that had undergone Zimmer MIS Quad-Sparing surgery solely on an outpatient basis, 48 or 96% of whom were discharged directly to their homes the same day of surgery.

The second study by Drs. Coon and Tria, et al published in Seminars in Arthroplasty concluded that Zimmer MIS Quad-Sparing knees even in an environment that is primarily Medicare may provide average hospital improved profitability of almost $3000 per patient. The study comparison protocol utilized a 50-50 patient cohort mix retrospectively on over 400 total knees versus traditional open techniques. Separately on a prospective basis, clinically and statistically significant improvements were demonstrated in such categories as range of motion and walking distance, all at three days post-op.

During the past year, 876 surgeons completed Zimmer MIS Quad-Sparing training at our Institutes globally and we now estimate that 7% of legacy Zimmer TKAs in the U.S. utilize our MIS Quad-Sparing technique. During the last three years we have issued 4455 MIS Knee instrument sets, of which 1289 are Quad-Sparing.

The MIS stem tibial plate, the first to be designed for assembly inside the patient and released only in June, is receiving rave reviews for its oval taper and independent trial of the [keyhole], amongst other positives. We have already billed almost $9 million during the latter part of 2005 alone.

Switching to MIS hips, a December press release on our first 2500 MIS 2-Incisions indicated not only considerable patient clinical success and testimonials but complications consistent with published ranges for traditional open hip surgery. Improved physical and economic outcomes were seen not by one surgeon but by many. These papers are a part of more than 15 total studies under way at Zimmer on MIS alone. Our new MIS anterior lateral has jumped in popularity with full training classes and now represents 4% of Zimmer's total U.S. hip and 6% of Europe's.

In the fourth quarter alone, we delivered three different MIS anterior lateral live surgeries globally with a session by Dr. Richard White attended by 694 surgeons and staff at 321 different sites around the world. Surgery has since been replayed for clinical training and sales staff with a total of more than 1000 additional viewings. Our MIS programs are supported by significant investments in computer-assisted surgery including intelligent tools.

We have already deployed 25 portable electromagnetic iNav systems with over 300 global cases completed at this early stage of release. We are developing Durom hip resurfacing programs, electromagnetics for the hip, and our very first disposable instruments, a potential game changer along with other intelligent tools that might very well make a vast array of cutting jigs and instruments disappear altogether.

Lastly what to look for from Zimmer at the AAOS in Chicago. You will certainly see lots of MIS not just in hips and knees though. Hint -- look out for Trauma. You'll see lots of Trabecular Metal. Don't believe the friendly knockoffs. They haven't got what it takes. Besides our expansion of TM into the more challenging revision surgeries will be extensive and differentiating.

Our infrastructure advancements to market EVA in the hospital for patient profitability consulting will really pick up the pace. You know what Zimmer has today in biologicals, but expect a new triple threat. Bridget, my new girlfriend, is an accurate and resourceful orthopedic intelligent surgery tool. You might even say that she responds to the very sound of my voice, but I can assure you she won't be the only lady present. If you're wondering about the second half of 2006 sales acceleration versus the first half, the answer in part is in Chicago.

Sam, I think I told them a lot about Zimmer at the AAOS but they may very well believe that there is nothing here but riddles. Time will tell. What are your thoughts on the quarter?

Thanks, Ray. Similar to the format of past earnings calls, I will add some detail to several key areas including foreign currency, gross profit, interest expense and debt levels, acquisition and integration costs, our effective tax rate, capital expenditures, amortization and depreciation, the impact of FAS 123 R, and finally, I'll cover some details in guidance.

Ray has already extensively discussed our sales results and in our Form 10-K, which will be filed no later than March 15, we will include a detailed breakdown of the price, volume mix and foreign exchange growth factors for each of our three primary geographic segments and each of our key product categories. So in the interests of time I will not address those details here.

In the fourth quarter the negative contribution of foreign currency to sales growth was the most significant of the year, reducing sales growth by $24 million or 3%. As a reminder, foreign currency contributed positive 2.1% to sales growth in each of the first two quarters of this year, positive 0.3 points in the third quarter and positive 0.3 points for the entire year 2005. If the U.S. dollar holds from current levels for the balance of 2006, the contribution of foreign currency to sales growth should be -$27 million or about negative 1% for all of 2006, although more importantly, -3% in the first quarter; while only -1.5% in the second quarter; flat in the third quarter 2006; and positive 1.1% in the fourth quarter.

Reported and adjusted gross profit margins for the fourth quarter were 78.1% because the inventory step up expenses were minimal. The acquisition related inventory step up expense from both Centerpulse and Implex have now been fully expensed and will not affect future reporting periods.

Excluding the affect of inventory step up expense, the adjusted gross profit margin for the fourth quarter was a record 78.1%, which is 90 basis points higher than the third quarter and 130 basis points over the fourth quarter of 2004.

For the full year, reported gross profit margin was 77.5% including inventory step up expenses of $5 million pretax or $3.1 million net of tax or $0.01 per share. Excluding the affect of inventory step up expense, the adjusted gross profit margin was a full year record of 77.7%.

The only debt we have on the books is Japanese debt because it carries a very low interest rate and with our continued strong operating and free cash flow, we have accumulated $245 million of cash on the balance sheet. Subtracting out the $82 million of Japanese debt, we have a positive net cash position of $163 million. Interest expense in the quarter was $800,000 and that compares to $2.1 million last quarter.

Since the acquisition of Centerpulse and Implex we have spent $316 million on acquisition and integration costs, $217 million of those costs have been expensed to the P&L with $22 million being expensed in the fourth quarter of 2005 and $57 million being expensed for the full year 2005. Included in the $22 million expense for the quarter is an estimated loss in the forthcoming sale of the Austin manufacturing facility that was shut down in the fourth quarter and the planned discontinuance of some older product lines from the Centerpulse acquisition.

Although the vast majority of the integration activities are behind us, a few items still remain and will be completed throughout 2006. Some of those items include additional IT systems conversions, the residual costs of decommissioning Austin and disposing of this asset, continued in-sourcing and a few other miscellaneous items. These items should result in about 12 to $15 million of integration expenses in 2006 and there should be no additional integration costs beyond 2006 for the Centerpulse and Implex integrations.

All references to our effective tax rate will be on an adjusted basis. We reported at the end of our third quarter that our year-to-date ETR was 29.9%. With 2005 complete, our full-year ETR is 29.6%, therefore our fourth quarter was 28.9%. 29.6% for the year is 90 basis points favorable to our full-year guidance of 30.5% and 190 basis points favorable to 2004.

As I mentioned during our third quarter earnings call, we may have the opportunity to drive the ETR down even lower in each of the next few years, however, this is very dependent on at least three critical areas including the first of an improved mix of earnings from jurisdictions with lower tax rates; the second being continued benefits for increasing production and profits generated in Puerto Rico while at the same time moving from the 9/36 election environment to a CFC structure; and finally, increasing Swiss production and distribution activity to take full advantage of our low Swiss tax rate.

You may also be wondering why our fourth quarter net income and earnings per share is flat in the fourth quarter 2005 versus the fourth quarter of 2004. As a reminder, in the fourth quarter 2004 we did identify that we revalued our deferred taxes as a result of negotiating a very favorable Swiss tax rate. The affect on our reported taxes and net income was an increase of $34.5 million or $0.14 per share in the fourth quarter of 2004 that we said would not repeat in the fourth quarter of 2005. We have excluded this item when discussing adjusted EPS at the end of 2004 and again at the end of 2005.

Capital expenditures for the quarter were $60 million consisting of $20 million for instruments and $40 million for all other property plant and equipment fixed asset additions. For the full year, capital expenditures were $255 million consisting of $150 million for instruments and $105 million for all other property plant and equipment fixed asset additions. These additions were driven by new products, the closure of the Austin manufacturing facility, information systems, continuous automation, vertical integration, and other productivity improvements as well as some facility related expenditures.

In 2006, the integration of systems in Europe and Asia-Pacific will continue. Additionally we are continuing to execute on our strategic initiatives including the expansion of the depth and breadth of our R&D platform so we are adding a new R&D facility to our Warsaw West Campus in 2006. Even with these added projects in 2006, our estimated capital expenditures for both instruments and traditional property plant and equipment should be the same approximate $250 million spending level that we experienced in 2005.

Depreciation expense was $37 million and as a result of the Centerpulse and Implex acquisitions and the related $596 million of amortizable intangibles recorded, the amortization expense in the fourth quarter of 2005 was $12 million.

Zimmer adopted FAS 123R share based payments effective January 1, 2006. Using our historic methods of determining the affect of equity-based compensation on earnings per share, the expected affect on 2005 that we intend to disclose in our Form 10-K should be approximately $0.18 per share. We estimate the affect of this new accounting standard on 2006 earnings per share to be $0.23 to $0.25 for the year. For modeling purposes the first quarter and each quarter thereafter is expected to be approximately $0.06 per share unless we advise you differently.

On December 15, we announced that our Board had approved a share repurchase program authorizing us to repurchase up to $1 billion of Zimmer common stock through December 31, 2007. With only a short period of time remaining in the year after that announcement, we did repurchase 59,200 shares of Zimmer common stock at an average price of $68.73 for a total cash outlay of $4.1 million.

Turning to the guidance, as we mentioned in our press release last night, we are reaffirming our 2006 guidance for sales growth of 8 to 9% over 2005. As a reminder, sales guidance for 2006 assumes a 1% reduction due to foreign currency for the full year; a 1% reduction due to the loss of the Company's OrthoPAT blood management system distribution agreement; and a 1% reduction in global pricing. We are also reaffirming our guidance for 2006 full-year growth of adjusted earnings per share to be 17 to 19%, which is a range of $3.62 to the $3.68 before incorporating the affect of FAS 123R four share based payments, which we estimate to be again $0.23 to $0.25 per share.

Reported earnings per share is expected to be $3.58 to $3.64 and this includes approximately 12 to $15 million pretax or $0.04 per share of residual acquisition and integration costs in 2006 and we will not be restating 2005 for share-based payments.

Now I'd like to make a few comments on our quarterly expectations for 2006. Looking first at sales, the estimated -1% drag on full-year sales growth from foreign currency should be dramatically different in each of the four quarters of 2006. Assuming no significant movement from today's exchange rates, the first quarter should be about 3% negative from foreign currency, the second quarter should be about 1.5% negative, and as a result, sales growth for the first quarter and the second quarter 2006 is expected to be 5 to 6% and sales growth for the second six months is expected the 10 to 11%. Our guidance implies 2006 annual volume and mix growth for Zimmer of 10 to 11%.

Adjusted earnings per share for the first quarter of 2006 are expected to be $0.86 to $0.87 or about 15 to 16% over prior year. Adjusted earnings per share for the second quarter are expected to be $0.88 to $0.89 or about 13 to 14% over prior year if we exclude the onetime favorable $0.02 earnings per share benefit that occurred in the second quarter of 2005 associated with the resolution of certain legal and other matters that we previously disclosed. If we do not exclude this $0.02, the second quarter adjusted EPS is expected to grow 10 to 11%.

Earnings per share is expected to increase 21 to 23% for the second six months of 2006. As I mentioned previously, the quarterly impact of the new accounting standard on share-based payments is estimated to be approximately $0.06 per quarter.

In summary, we further demonstrated our ability to generate excellent earnings per share growth under a variety of different business conditions including a somewhat flatter pricing environment and we exceeded First Call consensus by $0.03. In addition for the quarter, we are rapidly building cash in the balance sheet that may become a primary source of acquisition capital. We began to execute our newly authorized share repurchase program.

As Ray indicated earlier, we received an approvable letter from the FDA for Trilogy AB ceramic-on-ceramic and we expect to pass our FDA plant inspections which are scheduled to begin within the next few weeks and we anticipate receiving FDA approval shortly afterwards so that we can begin selling product in the U.S. market late this quarter or early in the second quarter. We also expect to receive FDA 510-K clearance to begin selling large diameter Metasul metal-on-metal components this quarter.

Spine sales as Ray mentioned, grew a record 23% reported and 25% constant currency in the quarter. Europe achieved a record 40% operating profit margin and in 2001 our first year as a public company, the Europe operating profit margin was only 15.6%. If we go back as far as 1997, it was negative.

We closed the Austin manufacturing facility in October, two months ahead of schedule. The organizational restructuring that we announced in the fourth quarter positions us to more effectively drive profitable internal sales growth while also pursuing and assimilating acquisitions. We also made significant progress with our systems integration throughout Europe. ISTO filed an IND for neocartilage and cartilage regeneration therapy and we hope to begin human clinical trials shortly. Surgeons published two papers that document and highlight the clinical and economic benefits of our MIS procedures. And continued strong margins coupled with sound asset management contributed to very healthy operating and free cash flow.

Our effective tax rate for the year is at an all-time low of 29.6%; and finally in the fourth quarter, Zimmer was the only major orthopedic company to date to substantially exceed original First Call EPS expectations.

We are proud of what we were able to accomplish throughout 2005 including surpassing First Call consensus EPS expectations in all four quarters and as we enter 2006, we continue to believe that our commitments to operating excellence, candor with our investors, highly leveraged profit contributions and strong cash flow remained intact.

Our first quarter 2006 earnings call will be held at 8:00 a.m. Eastern standard time on Thursday, April 27, 2006 and we also look forward to seeing you at our AAOS investor conference on Wednesday, March 22 beginning at 4:45 p.m. at the Sheraton Hotel and Towers in Chicago.

Now we would be happy to take your questions. So LouAnn, we will turn it back to you.

(OPERATOR INSTRUCTIONS) Mike Weinstein, JPMorgan.

Ray and Sam, can we spend a few minutes diving into the 2006 guidance and the staging of growth between the first and second half? Ray, you made the comment about we're going to see a lot of new product flow at the academy meeting and that might be part of why we see the pickup in sales growth in the first half and second half and as well on the bottom line. Maybe we could just flush out a little bit more behind that. Obviously you'll have on a reported basis an easier currency environment in second half and there's potentially easier comparisons from hurricanes.

Is there a difference, is there a one-day difference in selling days? I don't know if that's true or not but you would have a more difficult pricing environment in Japan after April 1, right?

And I would like to get your view on how the U.S. market and the European markets look second half versus first half? And then as we add all this together, how do we get to an acceleration in constant currency growth from the first half to the second half? Then we will address if you can the bottom line. Thanks.

Was that all one question?

It was all one question which basically -- which all comes back to the question of the drivers, the acceleration second half versus first half?

Are you getting an echo? We're getting a bad echo here so it's going to be difficult for me to talk over the top of this. Let me take it in pieces because it may look a little odd, it may look as if it's a hockey stick, but it's really not when you're running numbers even though I realize that it probably makes people uncomfortable at the time. I think new product for (technical difficulty) Zimmer Uni, TM stems --.

Ray, we are getting an echo now.

I don't what's causing it.

I can go ahead and close Mr. Weinstein's line so you can answer his question if you'd like?

Let's try that. That's better. Thanks, Mike. I appreciate it. Let's think new products for a start and then I'll run you through the components because as I commented and I'm not sure if you heard it because of the echo, it does look a little hockey stick and I know that can make people sensitive. But it is not really quite what it looks like. I'm going to stay with constant currency because you've already made the point obviously in reported there is a huge swing. There's a 4-point swing between fourth and first quarters, but new products full year Zimmer Uni, TM stem, EPOCH composite, a ton of new stuff in Trauma and a lot of these things come out. It would be nice to release them all January 1 but it just doesn't work that way. They release and rollout on a regional distributor country basis and it usually takes six months at any given point in time.

TM revision, which is huge, which is going to be starting. MIS in Europe is just starting. The new Natural-Knee with Flex and with Trabecular Metal just starting. In fact, hasn't started. New products in spine, the Optima system, new spacers, all these things are in new products. So those are pluses.

Hurricanes, I didn't waste much time on. In fact I didn't waste any time I don't think in this call. It probably was $1 million or so in the fourth quarter. I did not want to mention it but it was more than that obviously in the third, so call hurricanes 8 to 10 million. OrthoPAT is anywhere from 16 to $20 million in the second part of the year. That is clearly an issue. Ceramic and ceramic metal-on-metal we estimate at probably 10 or $15 million of swing value. That is going to take us through the second quarter by the time you get inventories going and a gain, get it out to everybody, get support materials out.

AAOS had a little fun with the last paragraph there because I don't want to disclose what we have got there and I don't want to disclose the DTC that goes with it, but I can tell you I know you are going to all be there. You will find it very interesting when you combine it with the comment I have just made.

Easier comps obviously again I don't want to overemphasize that but frankly the comps are easier and it makes it a lot more accomplishable.

Then on Price, Mike, and for everybody else, obviously Japan is less, but it is a lot less than we anticipated and when you look at what we're now seeing in U.S. contracts and the other countries and relative improvement, we think that is not the net negative half to half you think it may be keeping in mind that if you do the math quick in your head right now, if Japan is 10% of our business and it is 3 points better or going from 8 -- minus 8 to minus 5, obviously we have gained something there relative to our original planning.

When you run all those numbers, either reported if you want to use the big swing in foreign exchange or constant currency and I recognize I am not giving you enough from the AAOS because I can't, you would find that the hockey stick as it looks a little bit like is very doable. And in fact, as we have commented what has been 9% constant currency implied growth on volume ad mix, is 10 or 11 for '06. So we are looking forward to an extremely strong year even though admittedly superficially on the numbers. It does not necessarily look like that when you compare halves.

I hope that helps. LouAnn, could we move to the next one and we will try and avoid the echos?

Dhulsini de Zoysa, SG Cowen Securities Corporation.

I was wondering if you would comment -- I am curious your comment about volume and mix contributing 10 to 11% in '06. Clearly mix is -- it sounds like mix is picking up. Can you try to piece out for us? And should we be thinking of Zimmer as a high single digit revenue grower sort of a sustainable basis in this formula that we have seen from you in the past of bringing two times that down to the bottom line? Let me just leave it there for the moment.

Okay. I think mix and sort of forward guidance which I'll answer in a general way. We are seeing as much as it's talked about, we're not seeing as much difficulty as perhaps people might expect on the mix side because we feel the mix that we're marketing has very solid clinical and economic stories. So the pushback that people seem to be talking about -- I read a recent story on capitated pricing. There is a little bit of capitated pricing, there always has been and I'm sure hospitals would prefer it. But we are getting strong responses to the mix we're putting out there.

You cannot get 30% gross in Trabecular Metal and bill $30 million in a quarter. It is extremely -- we mark that up well. We do. We apologize not for it. You can't get those kind of growths. I think if you look at our competitors one of the reasons you're seeing, you've got a couple of new knee systems out there. I think they are getting very strong mix growth from their own surgeons. We're not losing much share to them. That doesn't mean they are not doing well with their own surgeons. Some of that is getting those flex knees and various other things into their system.

So I think the industry in general is getting a much stronger response to mix than people might expect but you have got to have the right story. You can't put fluffy stuff out there. You've got to put things out there that have patient benefit, that a surgeon can believe in, and obviously I think have economic benefit at some point.

On the go forward, Dhulsini, no, that would be wrong on a single digit. We have said since the day we spun out and we have modified it a bit I guess during the Centerpulse times because of the large European business that was flat when we inherited it, we said that our goal is always to grow one to two points faster than the market in the markets we serve, and I don't see that changing. If the market drops I guess ultimately to mid single digits, then I suppose you could pose that argument for Zimmer.

I would love to have double drop through. I would never commit to that on a long-term basis but we do consistently say that we are structured and set up to push hard on that $0.50, drop through on the new products. We continue to deliver that over and over and over by division, by business. So I think we will continue to hold our reputation as growing faster than the market, although short-term with Centerpulse it is not completely been that way. And obviously, we have highly leveraged earnings and we have continued to prove that in multiple kinds of environments including with a couple points off of price. So I think that that is substantial relative to the future.

If I could just follow up on your comment regarding the market's growth rate then, your numbers, 9% constant currency, matches what we have for the quarter. Is it fair to say then that as you look out to '06 you expect that market growth rate to strengthen as the year progresses?

I don't know that it strengthens so much as the year progresses. I tend to think it will but I think the answer I gave Mike was more about -- there's a lot of specifics with us that can vary quickly on a piece of paper lead you to believe that that second half is extremely strong reported or constant currency versus the first. I still think this market is going to be consistent over many years. It depends on your mix of product. Our competitors, we all have different mix but if you take sort of hips and knees and shoulders and elbows and throw those into play, I still think we're looking at a double-digit marketplace over many years, low double-digit, and we use 9 to 11. We still use 7%.

I have not seen any data of any kind that leads me to believe that the units of surgery if you will would not be around 7% on traditional recon. I know the studies are out there that say what if it is 4 or 5 and this and that. The fact of the matter is that those studies are sort of done on regressive models and they are not looking at things like obesity. They're not looking at people living longer. They're not putting all the factors in place.

So we are optimistic on the marketplace I think as are our competitors and we will continue to try and drive Zimmer 1 to 2 points over market in sales and keep that high leverage profile and high leverage model going.

Okay, great. We look forward to seeing you at the academy.

Katherine Martinelli, Merrill Lynch.

Just want to talk about a relatively small piece of your business on the Dental side. Ray, I know you don't give line item guidance but are you assuming that the arbitration decision and the next plan to launch an Internet based product does have a meaningful impact on your Dental business that we should be assuming hits in 2006?

No, we are not, Catherine. The final decision on that was a split decision. I forget how many components there were. The lawyers could tell us. There's probably 8 or 10 components to it and basically [Jerry] won about half and we won about half. Since we had to take over the battle, if you will, from Centerpulse and Sulzer. Jerry has a following, very bright Dental guy, done a lot of things obviously in the past and I think he'll have some impact not just on us but will have some impact with the Internet.

But we don't believe and based on anything I can read of the two big horses in the Dental business on their strategy and what they say publicly, I don't think any of the big Dental business are really moving much that way. This has been tried before. It has not been successful, so will it take a little business from everybody? Probably. Is that the direction we will be heading? I don't think so. I think the industry is going to digitization, pro-smile work if you will, not just reconstructive work, computer assist, lots of teaching particularly for the GAAP who is not accustomed to implantology. You can't do that on the Internet. You certainly can't do it effectively. So the answer is no, but yet, he will I'm sure take a little bit.

And then in terms of the '06 guidance and any assumptions or any color you can give us in terms of what we should be factoring for the buyback in terms of your full-year shares outstanding that are assumed in those numbers?

No, because it is situational. Obviously based on stock values and decisions we make at time and the programs, so there would be no way. If I was smart enough to tell you that I would know exactly what our stock price was going to be each day, in which case I would probably stay at home and be a day trader and make more money.

As you also know, Katherine, we have said very clearly our first choice use of our excess cash is as a source of capital for acquisitions. So without knowing what we have in mind, you would not be able to second-guess how much of our excess cash would go towards acquisitions versus stock buyback.

Then just lastly the comments you made on the conference call about 2006 and 2007 seeing continued leverage tied to Centerpulse, can you just give us a sense for what we would see that would continue into '07 since that is fairly a few years post the deal and you've done a lot on the manufacturing side? I'm just trying to get a sense for what could be some of the factors that could drive the earnings growth above your historic mid-teens target?

I will let Sam finish but I think what we said was that we don't expect to see anything much at all on the integration side after the end of '06. What we expect to see continuing in '07 is vertical integration, automation, robotics, reduced tax rate and those kind of things. So we are actually splitting the two. It may have come across perhaps the wrong way. We are actually trying to split the two.

Some of the set-ups that we'll do as a result of completing the integration activities largely by the end of '06 will give us the ability to continue to focus on improved margins. Also as we get into '06 -- as we leave '06 and '07, in '07 we'll get the full year benefit of whatever we end up as partial benefits contributed with the final activities that we take in manufacturing in 2006. So we have some residual effects going into '07 from the '06 actions plus we have set up a more efficient manufacturing operation, and a more efficient tax structure giving us the ability to continue to leverage going forward with sales growth.

Great, thanks.

Milton Hsu, Bear Stearns.

Ray, just one question on the guidance, actually with new products too. It sounds like you are expecting 100 or roughly 200 basis point improvement in the volume mix component of growth. Is '06 a better year for new products than you have seen over the last three years? Because it sounds like it's going to have a more significant impact than any of the last two.

I think that is right. I haven't got the 200 basis in front of me, Milt, so I would have to check that. But I think as we look at -- and as part of what you talk about with people you give these increases each quarter, we do, and its 40% in this and 30 in but very clearly the total isn't that amount. And one of the reasons for that is as we replace these old products and develop into the new technologies, we have never had more new technologies and new products under way than we have under way right now and we have averaged 18% over seven years but clearly been running at 21 or 22% as a component of sales.

The other factor I would put into play is historically as we built new products much of that was me-toos and fill-ins and size additions and things that we needed. If you look at the mix now it is high mix, high added value, high upgrade value, good clinical story, good economic story. So I would suggest that you've got a couple of things going here. One we have never had a more complete pipeline and a more interesting pipeline. Secondly, the content of the pipeline is in products that have high margins. Thirdly, the content is really highly focused on mix related but mix that is sellable in the environment we live in today.

So, yes, I think I would agree with precisely what you said. I don't know the 200 basis point. I would have to do the math but I agree with you at least in principle on what you're saying.

Okay. Then how do you convince payers or providers -- providers and payers for that matter -- that given that it takes an ortho 7 to 10 years before you have some type of superiority data and given the evidence based environment that we are in now, how do you convince them to pay 15, 20% more for a product?

That's a great question. I think you give it back to them elsewhere. You can convince people without data. Highly cross-linked poly was so strong in the lab and had such a strong support level that the uptake on it was really without in vivo data. But I think the world we're heading into is less likely to be supportive of that, more likely supportive of data. So our view is you put out the opportunity to offset it elsewhere. In other words, a lot of what we're doing is we're saying this is going to do great things for patients, here is our explanation, here is our science, here is our story. And by the way here is how we offset it with improved productivity, improved operating-room efficiencies, here is how to utilize the product better, here is how to attract patients better.

So what we're trying to do is take things that really do have high clinical value in a hospital market that is probably a little tougher and allow them to offset that economically in their environment with other improvements that we can make. It's one of the reasons where I believe our consulting services program married with the new products is going to have a very nice impact with not only with hospitals but I think as we get out and start marketing it directly to insurers and directly to large companies. And that is a story we will take to the market.

Okay, thanks.

Tao Levy, Deutsche Bank.

I just have two questions here. Ray, I was wondering if you could maybe walk through the percentage -- I know you mentioned in prior quarters the percentage of new pricing contracts that come up for renegotiation this year and is there any big wiggle room on the pricing side that hospitals can negotiate?

Obviously small agreements in single hospitals come up all the time randomly. I assume what you're asking is sort of the larger, more impactful thing. No, we only have one. That was my comment that we have been making for some time that we have really renegotiated many of these deals back 12 and 18 months ago and have somewhat more extended periods on. They tend to be three years instead of two years or one year. We do have some automatic annual increases that might be medical CPI or some indicator built into them. And this year, meaning '06, we only have one what I would call -- there's sort of a 15 or so large agreements. We only have one that is a medium or large that is up for negotiation this year to the best of my knowledge. So we are pretty well set with what we know what we're doing.

Okay, so your visibility into the 2006 U.S. pricing environment is pretty good at this point?

Well, I think it is pretty good based upon the system information technology systems and forecasting we have here and I think it's pretty good based on the major contracts. Obviously on a day-to-day basis with single hospitals you can run into ups and downs. But I think our statistical capability combined with having already negotiated a lot of agreements leaves us in pretty good shape from a visibility point of view.

Okay. Just touching on your guidance, the back half of the year on the revenue side on the fourth quarter, we can get there. We can push it. We can get to 10% range. We are having trouble on the earnings side of things and the only way you get there is significant margin expansion. Is this sort of what is built into the model in the fourth quarter?

There's a number of things built and I'll let Sam comment on the margin. There's a number of things built in a margin. There's a number of things built in on expense and there's a number of -- we're getting some bounce back again there -- but there's a number of obviously tax and other areas built in. Use of cash for interest creation or stock buyback obviously could also be a factor if it's not used for acquisitions. So you can really focus on all the lines but since you've asked about margin expansion, do you want to do it?

I will do it. First of all as we grow unit volume, unit and mix volume at greater levels in the second half versus the first half to some extent, we do get better increased leverage just from natural sales growth with our fixed variable relationship. We also have the mix of existing products helping us, the mix of new products helping us. We have year three of our synergies that continues to ramp up. We get in 2006 not only the benefit of initiatives taken in 2006 that grows throughout the year but we also get the benefit of the full-year impact of things that occurred throughout 2005. Even putting synergies and the Centerpulse integration aside, we have mentioned this many times, as a standard part of our normal operating practice, we mandate to our manufacturing folks that they build operating plans that take 2% of standard costs out every year over and above anything that might get from synergies.

We also have a more favorable effect from the way in which we handle foreign currency contracts. As you know, we average those contracts in over a 24 month period and as a result we're now beginning to reap the benefits of contracts that we put in place 24 and 12 months ago, and all that helps us in the margin.

The other thing I would say too is we had the benefit of growing non-royalty bearing sales at a little faster rate than those sales that carry royalty, and that helps margins as well because we record royalties in the cost of goods sold.

I think Sam went through that first point very quickly and I won't belabor it because we don't have time here, but again our construct, the big box construct, highly automated, highly vertically integrated, foundry at the front end, automated distribution center, I don't think people realize the huge leverageability we get from that kind of construct versus people that have smaller plants, multiple plants, and that sort of thing. If you add all those things together it is there. We have modeled it many times.

Those aren't new. We have been building those activities for several years, which is why even with a more modest pricing environment that we saw in 2005 we are able to have pretty substantial improvements in our gross and operating profit margins.

Bob Hopkins, Lehman Brothers.

Thanks and good morning. I have a question. In the past you have been willing to be at least somewhat specific on the target areas that you focus on from an M&A perspective. And I was wondering given the state of your balance sheet and the liquidity that you have if you could kind of highlight that again for us in any level of detail that you feel comfortable giving.

Yes, I think the only level we would be comfortable, Bob, is probably what we give at investor conferences, and that is very clearly Biologics, Spine, and Dental. I do not think we have changed on that and that continues to be our focus. We continue to be highly active. We have a group in business development here that is very active in that process and obviously we would like to do some things there. There is no secret on that. I think after you get below that level we wouldn't be able to give you below that level in detail.

Sure. Should we expect activity in '06 or don't you want to be that specific?

Thank you for answering my question for me.

Okay, and one other question on a different topic, you've talked a lot about new product flow in 2006 and you obviously mentioned quite a number of projects and products. I was wondering can you just be a little more specific and give us what you think are the top three or four product launches that will happen in '06 and specifically when we should expect those?

I can. They are mostly -- I think when you can expect -- they are almost all AAOS oriented or slightly before that. Some are later. Certainly the new TM products from the shoulder humeral we just got done, the huge TM revision system, the TM stem, so that whole list of products is clearly very important. I would group a whole list of Trauma products together. We have been without perital locking plates. We have new contract bridging plates. We have a new nail coming to the U.S. market, courtesy of codevelopment with Centerpulse. So the whole Trauma grouping I would consider very important. I think there's another grouping that I would call the legacy Centerpulse grouping that starts to move huge amounts of MIS capability progressively through the year, starts to bring out and add flex and Trabecular Metal and MIS to existing natural knee systems where there is a huge following.

Then lastly I would probably -- there is the inverse of the OrthoPAT relationship, so either we have nothing but it is still favorable because it is no longer a loss or we bring something in that is better that is a double positive, so that one is hard to call at this point but it is big dollars. It is 35 or $40 million on an annualized basis that is affecting the growth rate. There are some things at the AAOS that will have fun showing you that I can't talk to that I think you'll find particularly interesting. And then the last grouping is I think there's 10 or $15 million worth of ceramic and ceramic metal-on-metal that are onesie, twosie surgeries that we're losing all over the place that we would easily get back because those are very strong by Zimmer surgeons and the minute we have product we will get them back. I think we have gone through this obviously in pretty refined detail and again we are very comfortable with that. I know it looks a little funny on paper but we are very comfortable with that second half/first-half situation.

Lastly real quickly, I hate to bring up this comparison but the only company in medical devices I know of that has achieved operating margins in excess of where you are right now is Boston Scientific at the end of the 2004 timeframe and I was just wondering if you could talk about that and any level of detail that you feel comfortable giving about the future and how much more leverage above the 35, 36% level that you are currently achieving might be possible.

I think depends on acquisitions in part and I think it depends in part of what Sam said. We still have a long list of things to do in the margin area, the expense area, the flow. The comment I just made on the plant and the construct, the model we have got really works and it works for a lot more years than just this and it never was anything to do with Centerpulse. Centerpulse has really been a bonus as people can tell from cents on the dollar drop through.

I think it has got several years of work and effort and expansion across multiple lines. Sam just commented if we do the right things on the tax side and we get products coming from the right plants and jurisdictions and mix, there's a ton we can do just on tax. But inevitably part of the growth of this business is going to be by acquisition and I think it depends upon what you buy, what their margins are, and how quickly you can accelerate and integrate. So far we have been pretty good at integrating, so we are comfortable wit that. But it is tough to answer it without qualifying it with a -- sort of with or without acquisition kind of answer.

Typically our guidance and our forecast going forward always have more significant growth in earnings and earnings per share than sales and whatever individual's build into their models for some modest improvement in tax rates and improving interest income, you can't get there. You can't get that kind of drop through without continuously driving to improve operating profit drop through as well.

Thanks, guys.

Glenn Reicin, Morgan Stanley.

Matt is going to pipe in a second. I had some clarifying questions and Matt had some questions on new products. But in terms of the tax rate for 2006, is it going to bounce around from quarter-to-quarter? Do you have some guidance there? And Matt is going to have a couple. But Trabecular Metal, what are your expectations for '06 in general and what are the long-term expectations? Matt, do you have any follow-ups?

Do you want to answer those questions first?

Tax rate, taxes are kind of strange. We finished the year at 29.6%, so that is our going forward position and I mentioned that we should have the opportunity to improve that somewhat going forward. But on a quarter-by-quarter basis, it can vary because any time there's an event that whether it is a catch-up, a true up as a result of filing your taxes and filing the tax returns in the September timeframe of the following year or whatever, any true ups are events that get built into the quarter in which the true up occurs.

The operational rate is one that we must predict going forward for the full year and we're obligated as all companies are under U.S. GAAP to at any given quarter end have the year-to-date tax rate be what we think it will be for the full year. So as things unfold, as we are able to move more and more product into low tax jurisdictions, whether that is Puerto Rico or Switzerland, those are issues that could cause the quarterly rate to bounce around a bit. So yes, it won't be a smooth sledding for the full year. It shouldn't be for any company frankly because of those issues.

But the fourth quarter is not significantly lower than the other quarters? Ray mentioned something about the fourth quarter being lower than other quarters -- that's not the case?

He was talking about the fourth quarter 2005 and that was nothing special. That was because the full year rate dropped from 29.9 at the end of the third quarter to 29.6 full year at the end of the fourth quarter. The fourth quarter ends up being a squeeze.

There is nothing magical, Glenn. That was a indication from the Swiss government on the approvals of what we were looking for and we had to make an adjustment on the deferred taxes. There is nothing magical about the fourth quarter (multiple speakers) relative to -- that was '04 and this year it's just adjustments to catch up full year ETR. There is nothing magical about the fourth quarter.

Trabecular Metal?

Trabecular Metal -- the number I would be looking for is up in the 150 million range but it is really dependent upon the phasing and timing of our ability to get those new products out from this point forward. You may have caught on the call that I talked about getting the TM stem out now to the developers. Obviously it will be out in the quarter and the AAOS. The phasing of the TM revision system which the call TMARS, the bringing out of the shoulder. So it depends on the effectiveness of phasing and building inventories, but I would expect to have something up in that dollar range. For the next conference call I will actually try to get more specific on that, but I think that's a good expectation.

Matt had questions too. He's on the line.

Thanks for taking the question. The question on knee, it sounds like you've got some catalyst for hips with the Trabecular Metal stem and the revision system as you mentioned. For knees, what can we look for in the second half to get the growth going again? Just because it seems like that is what has to happen to get up to the numbers that you're talking about for the full year?

Yes, I think that's right. I think you have got to look at a full year on the Uni and its extensions. You've got to look at what we're doing over on the Centerpulse legacy side because you've got a tremendous amount of activity there with putting flex onto the Natural-Knee. The Natural-Knee has a huge following not dissimilar from the NexGen following for the size of company that Centerpulse was in the U.S. and Europe. You've got the addition of Trabecular Metal to that whole Natural-Knee productline. You've got the assembled inside the body stem tibial components were just active really in the last part of this year and have really taken off well. Those are going to have a big full year.

And then the other catch to this I guess -- and those are good ones. The other part of this is some of the things that are very interesting to AAOS are the parts I can't tell you about but I would suggest to you that you will be fascinated with some of the knee things there. But unfortunately I'm trapped into not being able to describe it for you. So it sounds like I'm playing games with you, but I'm not.

Okay, I look forward to seeing them. But in the second -- is any of this -- you've talked about signing a lot of -- sort of signing a lot of contracts ahead of the pricing moves in orthopedics in general and not having an awful lot of new contracts to sign this year. Is any of this sort of an annualization of price, some of the pricing pressure we saw in the second half of this year for knees and for gross margin?

No, not really. I think it is more new product oriented. I think a lot of what's, despite articles written a lot of the differentiated product and things we have broken out and are able to get into those agreements are broken out in differentiated categories and do attract much higher margins and notwithstanding the articles written, our percent breakout of those articles in guaranteed contracts over the next year are much higher than what people perceive they are relative to Zimmer. So no, I think a lot of it is attractive mix items broken out separately and locked in over the next year or two.

The increases in and of themselves may be small, may be nothing, may be medical CPI. They really vary all over the place but very clearly we have good visibility to it.

Then just to follow up on these new product, the EPOCH and the TM stem, data that would show some better clinical outcomes, stress (indiscernible) data or whatever it is that these are going to provide. When do you think we will see that kind of data for those new products?

The TM stem will be a reference to the surface material itself. It's a wrap around portion that's put on a proximal part. It is MIS sensitive and we will provide data on TM that corresponds to those kind of stems. In other words that design whether it is in fiber metal or other things has had a very strong history of success. We need to apply Trabecular Metal improved data to it if you will based on the material itself.

The EPOCH is ten years of work and we have excellent data on the EPOCH. We have radiographic data relative to bone remodeling. We have very specific data relative for instance to reduced thigh pain. So that is a product that has considerable data and considerable history and really is the only one on the market. There is no other product like it, so it is very, very unique. But it is data rich because of the history.

And that will be second half sometime?

No, we hope to get those out between now and the AAOS or at the AAOS I suppose is technically correct. By the time you load the distributors and get everybody trained and everybody up, a lot of it is second half impact or late first half I guess.

Great. Thanks. I'll jump off.

Raj Denhoy, Piper Jaffray.

I just have a couple of quick questions. You mentioned OrthoPAT. I guess you officially baked it in at a -1% for the year but it sounds like its still a bit of a moving target and there might be a chance to maybe replace that product with something else. I wondered if you could maybe just frame what the possibilities are for OrthoPAT?

Actually we rounded to 1%. If you thought of it as what we would have liked to have had I suppose for 2006 would've been between 35 and $40 million of sales. It is going to be next to nothing. We round that to roughly 1% -- I suppose 1.2 or 1.3. We're in negotiations with two different companies. One of the units that we could bring in right now and certainly get approved and get selling by about the summertime we've got mixed feelings about. It's got the fundamentals to it that we like, but if we wait probably six months, seven months longer and really start the next year, we can put the characteristics design-wise into it that will make it better we hope than anything that's out there.

So our assumption at this point is zero all the way through '06. If we go with the former strategy and I don't think we will, but if we do, we would let you know we're doing that and we would let you know what our expectation is for sales. But at this point I'm leaning towards actually getting the one that we really like and then making it a dynamite product for '07 is my leaning at this point.

Okay, fair enough. Then just a couple on potential clinical trials. You mentioned ISTO is actually -- you now have applied with the FDA to begin a trial. Maybe you could frame what that trial looks like? When we might see something on that going forward?

I can't at this point and I would like to but I don't want to disclose the protocol data at this point and I would tell you if I had any indications at all but we have not. It is a preliminary IND. This would be a relatively small safety trial, human obviously, and then we will go from there. I don't expect it's going to take forever to hear on this but I don't have enough to tell you anything now that's even meaningful.

But is it fair to say that since it is a small trial, maybe we see some data in 2007, that timeframe -- mid '07?

Yes, I think by the time you correlate the data and get something together depending upon what we end up getting approval on, it could be even a little less than that frankly. But I think you can expect something between 18 months and two years unless it is abnormal or different from other things.

And just a couple of quick follow-ups as well. On Dynesys, that product continues to do well but have you outlined your strategy to officially do sort of a motion preservation trial in the U.S. or what is your thinking there right now?

We have not. In fact, we were talking about that this morning. The spine group is working on that now and there is no update on the existing one but that is something we're going to update on the next call as a matter-of-fact. We decided not do it here because we're going to have better information on the next one, but that is a fair question.

Just lastly on hip resurfacing, where do you stand there is far as beginning a trial in the U.S. and what is your strategy in bringing somebody to the market?

The trial will begin but obviously what we have done is to put in place the data to the government to do femoral and acetabular site separately. We obviously can't market them together as a resurfacing product since it would be off label marketing and we're not going to do that. The trial work and preparation for that has started and of course the product where it is selling in selected countries outside of the U.S. is just doing gangbusters. And as I commented on the call, without a huge amount of effort for us and not a lot of background in that area frankly in legacy Zimmer because it came from Centerpulse, we have gone from 5 million in the last quarter up to $7 million in sales this quarter.

So it is a huge sequential jump just with the addition of a couple of new countries. So we are happy with it. But in terms of marketing in the U.S. under a combined resurfacing basis unless they somehow change the rules or down class or something else, we are obviously several years away.

Is it possible though that you might follow a similar strategy what Smith & Nephew is trying here with bringing just European data trying to get an approval on that? Or are you pretty much committed to doing something in the U.S.?

It would be nice to just bring European data but I think if you look to -- you know, the thing that was unusual about the Smith & Nephew was the sheer volume of the data. It was very high because with Dr. McMinn and the fact that it was a single surgeon. So they were in a position they had a great deal of data. We have done a lot of this work -- we meaning Sulzer/Centerpulse prior to Zimmer, but it is not at the volume levels that would match up to that I don't think. I would have to match them -- I have to look at them, but I'm pretty sure that is correct.

Great, fair enough. Thank you.

Ben Andrew, William Blair.

Just a quick question on Japan. Can you talk about what changed that improved the situation and how confident you are that in fact that is going to be the result that you described?

What changed I think, well, two things. One, the sheer level of data and the application of actually giving the Japanese government the data they wanted and a very thorough statistical comparison -- this was a lot of reading, a lot of work for people. I think the tremendous efforts of AdvaMed in taking a stronger leadership role in negotiating on all our behalves certainly clearly had a benefit, as does the U.S. government at times. So that is certainly a large part of it if not most of it.

The other factor that I would bring or the other answer to your question is at this point barring something unusual -- on Zimmer now, again I was careful on the call because of the components now, you've really got to talk to companies individually particularly because of the trauma addition -- but I'm 99.5% confident.

Great, thank you.

Bill Quirk, RBC Capital Markets.

A couple of questions. First CapEx spending relating to instruments was lower than our numbers. It looks like actually it was the lowest run rate in over two years. Should we be reading anything into this or should we expect spending here to increase as we get further into '06?

Are you talking about the fourth quarter run rate?

Yes, that's right.

I wouldn't call it a run rate. We issue instruments to the field based on what the specific needs are and we have done a pretty good job of issuing ample instruments in the first three quarters and we were able to cut back a bit on those investments.

There is nothing there relative to sales or if you are trying to correlate because it doesn't work. The lag times relative to training and when you issue and how many sets you issue to a hospital and where you move them. We are also moving sets up there all the time and taking sets more efficient on a per turnover basis. So on sort of the quarterly depreciation and activity level you've got to look at it I think over a year you can see patterns but I wouldn't pay too much attention to quarters.

One of the benefits too of our in-sourcing is by in-sourcing it ends up being less costly for us. So one of the benefits (multiple speakers) we see as we go forward and we saw a little bit of that in that in the fourth quarter is significant benefits from making the high-volume instruments ourselves.

Secondly just on the housekeeping side, what is the basis for the delta between the pure price change in Japan and the P&L impact? Does it just come down to timing differences between closing the books?

No, it's timing difference of execution by the Japanese government. They have the April 1 target. So any numbers I give you I tried to give you the rate as delivered by the government and then the impact on us. That factor though unlike everything else I said is common to everybody in the industry. It is always April 1. In fact they are usually late a little bit and it's usually a couple weeks after that, but that's the only differential.

Understood, thanks.

Steven Lichtman, Banc of America Securities.

Most of my questions have been answered. Ray, I think you're going to be talking about this at AAOS but can you describe a little bit in terms of how you can use these economic benefit studies with MIS? How you intend to use those studies?

We intend to use them with different groups of people, major insurance companies, major hospital groups obviously and individual hospitals. And then we're debating upon whether you use them with major, very large companies where they have commitments in their own health care programs and the use of them is to get optimum mix quality of life type implants and techniques into the environment offsetting the costs of that with improved productivity relative specifically to those Zimmer products into the hospital environment at simultaneously attracting more patients to those individual hospitals. The theory being that try to take costs permanently out of the system, don't be cost switching. Take costs permanently out for everybody.

That benefits us in selling high mix, high-quality products and try to attract patient flow to a hospital. Hospitals are essentially fixed cost and some other institutions where volume much like our plants is a factor and try to be sensitive to the fact that given the demographics we've got insurance companies, people under 65, non-Medicare air will become a higher component.

As we put all that together we're going to try and marry a consulting for lack of a better term, consulting package on productivity and MIS married specifically to our products and our data and sell that not just to hospitals but start to bring in other payer provider components. That is the theory.

Great. And you said we would learn a little bit more about that at AAOS, correct?

You will.

Great, thanks.

Robert Faulkner, JMP Securities.

I wonder if you could run us through your outlook for U.S. hip and knee market growth? I think you mentioned about 4% this quarter and I wonder if you could -- for hips and I don't recall a number for knees -- if you could give us your thoughts on that, that would be helpful? And talk about how much you think is volume price and mix for that both now and going forward?

Okay, I think that is correct. I think hips can turn out to be 3 or 4%; obviously knees will be considerably higher than that. I think one of things you have to be careful of Rob, on any quarter is if I look at a couple of our competitors in there are the [Depew] numbers that have that 4-4-5 thing but its in December. I don't think it makes a difference of 8% and they were really at 13. On the other hand it would be unfair to Depew to say they were really at 5 or 6%.

Stryker is coming off some really tough comparisons in ceramic-on-ceramic and other things. So I think one of things we have to be careful of is not to get overfocused and say there see, the market is growing at 4, etc. I don't think that's true. I think if you put all the companies together and try to rationalize this, we've still got a market place for all of the industry that is going to be in that average 7% growth recon for surgical units. That takes into consideration length of life, females, obesity, demographics, age and baby boomers and so on.

I still think that knees will continue to grow on a rate of surgery basis at 50, 60, maybe 100% higher but certainly 50 or 60% higher primarily because of women. I have not seen anything that causes me to change any of those go-forward beliefs relative to mix. Price is a bit of a variable but I think it seems to be settling down if not coming back as we have commented in more recent couple of months.

So I always caution people just be careful as we look at our competitors and as we look at the market, we try to rationalize not what makes us feel good, but rather what is really going on there. And I think what's really going on there is very close to what we've always said. You can get ups and downs in a quarter in elective surgery timing preferences or elected surgery gross and that has historically been true as well. But I don't see anything. I've looked at more data than I ever want to look at my life side and I don't see anything underlying this industry that gives me discomfort on a surgery unit basis in recon out several years, despite I recognize the fact that there's some analysts and other people out there who see it differently. That is fine, but I don't see anything different.

And when you add price and mix to that 7% underlying procedure growth rate, where do you come out?

I wouldn't put price in at all at this point because I don't know. We're all trying to study that and give you the best granularity we can so on a long-term basis I would not give you a price number and that is not because I think it is negative or positive. It's just because at any given point that one is tougher to do.

If I look at competitive new products, our new products, the ability to market those and I look at the mix part, I think mix has got to be 2 or 3 points. I think you're still going to end up with this hip and knee, shoulder, elbow market that is somewhere in that 10% billable ex price, ex foreign exchange. And if I am wrong, and I'm sure I could easily be, I might be wrong by 1 point or 1.5 points either side but you're still talking 9 or 10 or 11 on the top.

So I just don't see anything and clearly we are candid at times to our -- create problems with it I suppose -- but we are candid about what we see and I just don't see anything any different.

Do you have an estimate for procedure growth rate today in hips and knees? I agree heartily that these are odd quarters with hurricanes and J&J's numbers and the like, but just in terms of underlying hip versus knee procedure growth rate?

I think knees -- sorry hips are 5 or 6 points and knees are going to the up in the 10-ish, and you're going to end up at 7-ish. People used 7.5 or 8. We are conservative. We use 7% inside but you can get arguments that pose as high as 8% and I don't disagree with them. I just don't happen to use those high numbers.

Thank you.

Michael Matson, Wachovia.

Good morning. Another question on your acquisition strategy, you talked a little bit about the areas you're looking at. I think Ray was quoted in a Reuters report saying that you all were interested in things in the 100 to $300 million size range. Is that still accurate and was that 100 to 300 million market cap or sales?

I wish it was sales. I think it is more reflective of what those markets have in them. It is sort of not exactly high disclosure because generally speaking, that is the components in those markets. I usually say 100 to 400 but I may have said 100 to 300. That is either could be private company assess valuation or it could be market cap plus premium and I think that still stands. I might probably say 100 to 400 but I think that still stands, Mike, primarily because if you're looking at the components that I described, the three pieces I described, a large part of what is going to be there or be attractive as a target to you is going to be in that range.

Okay, that's helpful. It seems based on the guidance you gave for your options expense, it seems like it has trended up or you're expecting it to be a little bit higher in '06 versus '05? Just wondering why that is? And then also in terms of your reporting when you begin to report in '06, are you going to continue to offer a P&L, like a pro forma P&L that would exclude options expense as well?

I'll do the first one and then Sam can pick up the end of the question. It is higher. We have come to the end of a program we were doing relative to options and mix and stuff all of which we file and disclose and we're simply going to a new program which has some annual components to it but has a three-year component. And in the way the accounting works for that is it tends to drive up the front end from a recording point of view. So there is some change you will see in that but it is primarily to do related to the componentry of it and how you must book for it. Did you want to comment on that, Jim?

You have to understand that the share compensation expense is amortized over four years. That is tied into the divesting period for the options so you have to go back actually and look at the disclosures in the end report you would see the Black-Scholes value in 2002 which is the year that is rotating off and 2006 was $11 and that compares with Black-Scholes values in these more recent time periods of about $25. And that is really what's principally what's driving the increase and the expense.

But you'll see as we disclose, you'll see the new program as we disclose. We think it is a pretty good three-year program to drive employees.

To answer your question on whether or not we will have pro forma P&Ls, we are reluctant to have pro forma P&Ls because it gets confusing enough having reported and adjusted from the respect of trying to back out all the costs related acquisition integration. We have however in all four quarters of 2005 disclosed on a quarter-by-quarter -- and you can look this up in each of our filings -- how that $0.18 was spread. So you will have that available. We probably won't be talking about pro forma because if we did we would have to have then reconciling schedules attached to our already 22 page-long press release. So we probably won't be doing that.

But you'll have plenty of information available to be able to disaggregate it and know what we're growing operationally and how much of the reported expense is coming from options. We will disclose the option expense as a separate component.

Okay. That's all. I appreciate it.

William Plovanic, First Albany Capital.

Just two questions. First of all you had 90% positive drop through. Are we actually seeing a lowering of the commission rate that's being paid out?

No, not relative to the big commission system is, which is all direct commission, 100% direct is in the U.S. And no, we have had no changes in our commission system relative to our relationship with distributors, no.

Secondly, we have heard rumblings that the OIGs out there subpoenaing physicians and deposing them at this time which is a step up in activity -- according to what we believe -- just your general thoughts on that?

I would not -- obviously it is an active investigation. I would not comment on somebody else's subpoenas. I would tell you that I have heard nothing that would lead me to believe they're not going through the ordinary course of doing the work I am sure they feel they need to do and there is nothing new on us. But I wouldn't -- because for me it is secondary or whatever hearsay, I would not want to comment on somebody else's.

Great, thank you.

Your final question comes from Bruce Nudell, Sanford Bernstein.

One of the things that we have noticed in the market growth rate over the year for all players including yourselves has been a very strong O. U.S. market and I was wondering if -- you're at around 10% and I was wondering if you guys could comment on is it just generally speaking is it underpenetration in European knees? Is it mix in Europe which has typically been stingy? Or is it O .U.S. or Asia-Pacific ex Japan that has really pushed the ball forward and is it sustainable?

The second O. U.S. question I have is if the O. U.S. pricing in Japan is -6% for the three quarters of the year that will be there, with mix in that three quarters of a year, is the net ASP impact likely to be 4% or 3% or something like that? If you could just illuminate that, that would be great. Thanks so much.

Okay, on the first one, you are true on O. U.S. and that is correct. A lot of it is if you'll note it's very knees oriented and I think a lot of that continues to be on by country basis catch up in the sense of not bolus coming through but just catch up on historical rates relative to the U.S. There's no differences in osteoarthritic joint rates of decline in Europe and Asia, with the exception of probably the obesity factor being less generally speaking in those areas. So as knees become more accepted, as total knees become more accepted on a country basis, I think it is catching up from what has historically been a huge hip market and that is also true in Asia, although slightly less so.

I am not aware that that there is really much of anything else, Bruce, that is going on there that is unique and different. It may vary a little bit by country.

On the mix side in Japan, the mix components first of all you've got a longer regulatory system and one that is less willing to pay you a lot more for mix changes, so you don't get quite the benefit. Secondly they have put in a new system called I think the acronym is PAL, which is an even tougher regulatory system and even more difficult on mix. So I think the mix components that you have in place whether it is us or our competitors that are there and operating today have good stories on them or are differentiated for Asian populations and have a very strong story there. And you can get the return from them that will help offset the price decline that you just referred to.

In terms of getting in huge amounts of new high mix products, the problem will be regulatory timing relative to the three-year price timeframe I just gave you. I don't think you're going to be able to get new things in quickly enough to fully offset it, although I wish that was the case. But I don't think that's the case.

But just to capture that again, if it is -5% in a portion of the year, could the net ASP hit be brought down let's say -4 or -3 with whatever ongoing mix shifts you have in Japan?

Yes, it can be. I don't what the exact numbers are. I'd have to take a look. It would be by company so I would have to take a look at precisely the new product impact of relative mix and layer that against the price decline. That is absolutely true provided those products are already approved in the system there. If you're putting an approval in now or even you six or eight months or a year ago into Japan, you would not get it approved in time onto the regulatory system fast enough to have a favorable impact against the price. That was the comment I was making. I wish that was right but it is only going to apply to things that you already have or anticipate regulatory approval for in the next few months.

Thanks so much.

There are no further questions at this time. I would now like to turn the call back over to Mr. Ray Elliott for any closing remarks.

Thanks, LouAnn. We don't have any. We look forward to seeing you folks on the next conference call and look forward to seeing you obviously at the AAOS. I hope all of you make it out there. I did my part and my presentation was decreased down to 55 minutes but Sam went crazy on me plus with his long answers and we ended up 2 hours and 15 minutes anyway. So I give up on trying to get this shorter. I hope everybody is well. See you.

This concludes today's conference call. You may now disconnect.