Zimmer Biomet Holdings Inc (ZBH) 2006 Q1 法說會逐字稿

Good morning, and welcome everyone to the Zimmer first quarter 2006 financial results conference call.

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

After the speakers' remarks, there be will a question-and-answer session.

This presentation contains forward-looking statements within the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 based on the current expectations, estimates, forecasts and projections about the orthopedics industry and beliefs and assumptions made by management.

These statements are not guarantees of future performance and involve risks, uncertainties, and assumptions that could cause actual outcomes and results to differ materially from those in the forward-looking statements.

For a list and description of the risks and uncertainties see the disclosure materials filed by Zimmer with the Securities and Exchange Commission.

Zimmer disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events, or otherwise.

This presentation also contains a certain non-GAAP financial measures.

A reconciliation of such information to the most directly comparable GAAP financial measures along with the other financial and statistical information for the period to be presented on this conference call was included in the the press release announcing our earnings, which maybe accessed from the Zimmer website at www.zimmer.com under the section entitled Investor Relations.

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

Good.

Thank you, Wade.

Good morning, everyone and welcome to Zimmer first quarter 2006 conference call.

We're pleased to be hosting the call to discuss a good earnings quarter, albeit on an underlying constant currency revenue growth that's about 1% below our expectations.

Record margins, focus expense management and ratios, as well as a very strong cash flow production highlighted the quarter.

Joining me are Sam Leno, 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'll begin today's call with comments related to our first quarter 2006, including an update on operations followed by a Q&A discussion.

All comments and comparisons are on an adjusted basis, further, all adjusted discussion excludes acquisition integration expenses.

We'll really focus most of our attention on constant currency revenues, given the expanded foreign exchange headwind, and in light of the inclusion of FAS 123R share base payment, we'll try to provide, where useful, apples-to-apples comparisons to prior year.

As always, I wish to thank our Zimmer team for the continued hard work, with a special congratulations this quarter to our Dental team with a 23% constant currency sales growth, and to all the employees of our businesses with record operating profit ratios in the Americas, Asia-Pacific, and Europe.

In the case of the latter it's the first time Europe has ever earned $100 million in operating profit in any quarter.

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

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

Consolidated sales for the quarter were $860 million reported, an increase of 4% to prior year or in constant currency a 7% growth versus our expectation of 8%.

Since we provided our original guidance in late January, we lost about $5 million in anticipated sales, solely due to foreign exchange.

That leaves $5 million to $10 million of shortfall to account for.

We were on track to meet constant currency expectations right up until the final week of March when we lost almost $8 million in sales domestically versus the average of the previous 11 week.

It's difficult to really tell whether the change timing location of the AAOS and the resulting unexpected high attendance was a factor or not, but for us it appears it was.

What we do know is that our domestic business had 11 consecutive weeks of billings within a very tight range of $33 million to $36 million per week, but with the AAOS week at $27 million.

We would have expected a loss of only $1 million or $2 million.

While we see no change in our sales guidance for the remainder of the year, it is, nevertheless, frustrating when this occurs in the final week.

On a constant currency basis, our three geographic segments Americas, Europe and Asia-Pacific grew at 7%, 6%, and 10% respectively.

Total Company sales to prior year improved by 7%.

We believe on a weighted basis for our combined Zimmer-served markets this 7% will prove to be somewhat below market growth for the quarter, but primarily in our case due to Trauma and the LSP business without OrthoPAT and not related to reconstructive sales.

Reconstructive sales grew 8% constant currency, slightly less than last quarter, but at market and in our case measured against difficult knee comps, particularly.

For a little more granularity, we believe the global constant currency recon market based on about 75% to 80% of the market already reporting grew this quarter at 8%, composed roughy of 7% volume and mix and 1% price.

We perhaps differ a little from our competitors' views that we do see slightly less elective bookings domestically and actually a little more hip activity for the first time in quite a while.

But we can find no significant underlying future surgery demand decline or demographic trend differences.

Zimmer hips in the quarter increased by 5% constant currency versus the prior quarter of 7% in a market growing 6% to 7%.

Given the anticipated second and third quarter releases of the Trabecular Metal Stem and TM Acetabular Revision System, the EPOCH II system, and with expected 510-K approval for both ceramic and ceramic and large-diameter metal-on-metal we're impatient for the new products but for the most part comfort with our current hip position.

Zimmer knees grew at 8% constant currency down from more recent results of 10% growth but against a prior year comp of 17%.

We believe this quarter the global market is growing at about 9%.

We fully realize that knees are driven to a great deal by domestic results and Zimmer Americas business in the quarter was measured against an even more difficult comp of 22%.

Zimmer global reconstructive numbers grew by 8% constant currency in the quarter against a 2005 same quarter comp of 11%, composed of 17% knees and 3% hips.

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

Zimmer's 7.3% constant currency sales increase globally was composed of volume and mix growth of 6.8% and positive price of 0.5%.

Of course on a reported basis, we have a 3.5 point negative currency swing between first quarter 2005 and first quarter 2006.

We believe for the quarter, our 8% global recon constant currency sales growth will prove to be equal to the market growth, while our leverage of sales to earnings continues to be substantially higher than comparable businesses.

Our Dental operation delivered an outstanding 23% constant currency growth and well above market.

Trauma's 6% constant currency growth is better but still below market and needs to be at least double digit, while Spine delivered a respectable 14% constant currency growth and this quarter that 14% growth should prove to be at market.

Worldwide price improvement had a 20-basis-point sequential uptick for Zimmer and was positive 0.5% versus positive 0.3% reported in the last quarter.

In fact, if you look at the last three quarters of 2005, price averaged positive 0.5%, the same as first quarter 2006.

In the total of two years, the real moderation in global price for Zimmer has been less than 1.5%.

In short, there's been a gradual softening based upon our mix of countries easily offset by corresponding and continuing increases in our gross margin.

In the same two years that price increases moderated 1.5%, we have reported an increase in adjusted gross profit of 3.6%.

In any event, as we've said, it's already in the guidance.

Our strength in volume mix and margins combined with the model on which we operate the Company creates a successful result for Zimmer.

Here's some interesting price news for the quarter.

Specifically, our Americas geographic segment was price positive again at 1.6%.

Perhaps more important our Americas business actually increased price by 90 basis points sequentially from the fourth quarter 2005.

In fairness, the current 1.6% price improvement for Zimmer does, in part, reflect an earlier conscious decision to negotiate longer arrangements with key hospital groups and major accounts which we believe will prove to serve us well now, but particularly in the foreseeable future.

The positive 0.5% price globally in the quarter now includes slight price decline in Japan, and negative 2% in greater China.

While Germany improved nicely from minus 5% for all of last year to minus 3.6%, and Italy from minus 2% to even.

Iberia, Spain and Portugal combined, registered positive price, as did Belgium and Switzerland.

Only the U.K. faced much stiffer price in the quarter at minus 5%, the same as last quarter in a market with dramatically reduced government imposed access to elective surgeries in the quarter.

Europe price in total for Zimmer in the quarter was minus 1% for the same as the prior two quarters but with a little different country mix.

If the current trends continued in 2006, but including Japan, France, and Germany at low to mid-single digit price reductions, price for Zimmer, given our geographic weightings, could actually be slightly positive in 2006.

This latter scenario has not been accounted for in our current guidance of minus 1.2% negative price.

It's early and these are complex calculations given the variables, but we have a strong information technology capability for analyzing price and we do pay relentless attention to this data.

As noted, the expectations in price have improved in Japan, as well, certainly compared to our indications going into the year.

We now expect with confidence that the combined effect of the FAP, or foreign average pricing, and the [R zone], the annual Japan hospital price survey for Zimmer only to be an annual 2006 P&L impact of only minus 3.7% negative based upon our specific product mix and an April 1 start date.

With respect to HCA, we're pleased to have completed a new agreement.

Both companies have also agreed, with the wisdom of hindsight, to generally limit our commentary to what was in the press release.

We will honor that commitment.

Therefore from our perspective, the deal is for five years, our longest domestic hospital group agreement.

It is based upon achieved growth and market share.

We have carved out many of our unique technologies and negotiated the opportunity to introduce our full line of Trauma products.

We will provide orthopedic services relative to our trademark MIS programs in order to both potentially improve patient outcomes and drive cost savings to HCA.

The agreement has been signed by both parties.

Returning to the quarter, I'll provide some detailed geographic and product sales analyses 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've done so without the sacrifice of key future personnel additions or technology investments.

In fact, we're active on both fronts.

Adjusted diluted earnings per share, inclusive of the share-based payment, for the first quarter 2006 were strong at $0.82 on 250.1 million average outstanding diluted shares.

For the quarter, we delivered an adjusted diluted EPS increase of 16% over prior year, excluding the share-based payment.

These results are $0.01 better than the first call consensus EPS estimate of $0.81.

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.

Zimmer gross profit margin in the quarter on adjusted basis and excluding the share-based payment was an all time record 78.2%, up sequentially 10 basis points from the previous record in the fourth quarter.

Even with the share-based payment included our gross profit margin is 78% and up a strong 70 basis points from prior year.

With the vast majority of some $30 million 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 margins.

Looking at gross profit from a price impact perspective only, the 78.2% margin, ex share-based payment in first quarter 2006, contained only 0.5% global positive price increase for a margin net of price of 78.1%.

While the 77.3% margin in the first quarter 2005 contained 1% positive price for a margin net of price of 77.1%.

On a net of price basis, we have increased our gross margin by 100 basis points over last year.

We believe that 78% of our gross margins easily once again at near the top of orthopedic industry and major medical devices.

The remainer of the P&L analysis will be on a adjusted basis as usual but excluding the share-based payment effects in order to provide a more realistic apples-to-apples comparison to prior year without the repetitive language.

SG&A expenses and total operating expenses for the quarter, as a ratio to sales, were very good at 37.3% and 42.6% respectively.

At 37.3%, SG&A costs were 150 basis points better than prior year of 38.8% as we continue to remove unwanted cost and consolidate programs and staff relative to our acquisitions.

The actual absolute SG&A dollars versus first quarter 2005 were approximately the same on a sales improvement of about $32 million.

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 Ortho biologics starting with fourth quarter 2003 at 40.9%.

We had publicly targeted to reduce SG&A by at least 200 basis points with this quarter's performance continuing at nearly a 400-basis-point improvement from that point in time.

We expect that with the increase in total development projects and expanding number of external and internal technological and biological relationships our R&D ratio to sales would operate between 5% and 6%.

During the first quarter, R&D totaled $45 million, a $3 million, or 8% increase to prior year.

During 2005, we doubled our internal biological personnel and project related investments.

In recent months, with have signed an exclusive relationship with [Fabibricoring] for xenographic porcine tissue replacement products and even more recently committed $24 million to a new Warsaw-based R&D center that is now nearly 50% complete.

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

Late in the first quarter 2006, we announced the acquisition of all of the intellectual property from France-based MedTech SA as it relates to BRIGIT, our voice activated intelligent surgically assisted device.

We continue to shift R&D dollars to innovative investments, in some cases external to the Company, and away from "me too" product duplication.

We spend more, we hope we spend smarter and we will continue to spend on external technology acquisitions in Biologicals, Dental, Spine, and hospital productivity consulting, for the most part, in the $100 million to $400 million range each.

Total operating expenses for the quarter at $366 million represented an increase, as with last quarter, of only 1% to prior year.

Our 42.6% operating expense ratio to sales was a 130-basis-point improvement over the first quarter 2005.

For reference in the first quarter 2006, actual acquisition and integration costs were accretive $2 million, primarily due to the gain versus book value on the sale of the Austin facility and a reduction in the required InterOP liability reserve.

We expect acquisition integration costs for the year 2006 to be approximately $8 million to $10 million.

Adjusted operating profit in the quarter also reached an all time record at $307 million, the second consecutive period over $300 million and the sixth consecutive reporting period that we have produced at or more than a quarter billion in operating profit.

We matched our best operating profit to sales ratio ever at 36% in the quarter and up 230 basis points from a strong showing in the first quarter of 2005.

During the quarter, we believe we have recorded the highest operate margin in all of medical devices.

As previously mentioned, the Zimmer construct that we have today was modeled during the late 1990s turn around and well before Centerpulse to register approximately $0.40 to $0.50 of operating profit for each new sales dollar.

In the first quarter of 2006 we've delivered approximately $30 million more operating profit on approximately $32 million more in sales, or about $0.90 of operating profit on every new dollar of sales.

Record margins and tough expense control really deliver results, but $0.90 on the dollar isn't long-term sustainable while $0.40 to $0.50 should be.

EBITDA in the first quarter improved, as you might imagine, on an adjusted basis to 41% as a ratio of sales and up 220 basis points from the same quarter prior year.

Adjusted net earnings in the period continued very strong at $218 million with an industry leading 25% net margin ratio to sales, up 270 basis points from the same quarter prior year.

Our first quarter 2006 tax rate improved from the full year 2005 by 60 basis points to 29.0% and, therefore, our annual ETR basis as we begin 2006 is 150 basis points better than the 30.5% recorded in first quarter 2005.

We are pleased with these first quarter 2006 P&L results, notwithstanding that we would have liked to have been a point higher in constant currency sales growth.

We believe that we can continue to make substantial progress while simultaneously raising the performance bar.

While some slight deceleration can be fairly measured against very tough comps and despite endless real or imagined industry black clouds, the orthopedic sector appears to be generally performing quite well.

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

Cash flow generation remains fundmental to our story and our strategy.

Every company has their argument about what is important, we like cash.

We had another excellent operating cash flow quarter at the very favorable end of our expectations registering $203 million.

In the last two and a half years of combined operations with Centerpulse we've delivered well over $2 billion in cumulative operating cash flow.

Free cash flow in the quarter was $149 million, and at the end of the quarter we already have $416 million of cash and equivalents on hand with only $82 million in debt, primarily maintained in Japan due to favorable spreads.

During the fourth 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.

In late December, the Company repurchased some shares prior to the commencement of our normal year end black out period.

The black out lifted on February 1 and we contemplated repurchasing additional shares in February and March, but we did not do so.

As we've communicated previously, we expected the funding of acquisitions to continue to be primary use of our free cash flow.

In the first quarter, we were active in looking at a few transactions that would fit within our previously announced strategy to pursue additional acquisitions in the areas of Biological, Dental, Spine and hospital productivity consulting and these deals would likely be in a range of $100 million to $400 million each.

During the quarter, it appeared quite possible that more of one of these contemplated strategic transactions would be of some significance in the aggregate and would come together concurrently on an accelerated schedule.

Thus, we opted not to use our excess cash to buy back shares in the first quarter.

Currently, we believe that any strategic transactions we're considering would be more spread out and if these deals proceed to closing the timing will be more staggered.

Therefore, we feel that we presently have much more flexibility with our excess cash.

Speaking of enhanced shareholder value, shareholder equity has increased from $0.0 at the time of the spinout to a little under $5 billion today, or almost exactly $1 billion of new equity per year of public life.

Our first quarter combined working capital statistics continue to perform well, and consistent with the huge number of second half new product launch preparations underway.

Our combined inventory days are 285 days, up two days from fourth quarter as expected.

And as we pointed out last quarter a large part of the story, in fact, nine days of the increase to prior year is in the standard DOH formula itself.

We had 262 days on hand in the first quarter of last year, but that was with a 77.3% margin.

If you apply the same gross profit margin as last year, this quarter's ending days would be approximately 276 but still below the industry averages for our mix of products.

Our trade receivables collection continues to provide support for strong cash flow production.

In the first quarter, we delivered excellent global trade receivables at 57 days, two days better than the 59 days in prior year same quarter.

Combined Americas receivables results were very solid at 38 days equal to prior year same quarter, and again a notable achievement particularly in the U.S. hospital environment.

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

For the first quarter, worldwide reconstructive sales increased to $718 million reported, a sequential increase of $16 million over fourth quarter 2005, a 4% reported increase over prior year, but more important an 8% constant currency growth.

Knees grew at 5% reported and 8% constant currency.

Hips were flat reported to prior year but grew 5% in constant currency.

We expect the global recon market to be up about 8% constant currency in the first quarter, and we're delivering that same 8% growth in spite of our second half weighting of new product introductions.

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

First in products the knee category, on a worldwide basis, in the quarter, knee sales for Zimmer increased by 8% constant currency versus prior year to $366 million.

From a brand point of view, NexGen LPS-Flex continued a strong three year trend with 28% increase to prior year in the quarter and up sequentially by 6% from the fourth quarter 2005.

It's no coincidence that the LPS-Flex is the knee of choice for our new MIS Mini-Subvastus and trademarked MIS Quad-Sparing total knees.

After over a year, we have still seen very little direct impact from the two new competitive knee systems with respect to any actual change in operating room market share.

However, to their credit their low double-digit revenue growth suggests that these same competitors are doing a nice job of upgrading their own surgeons despite apparent investor fears the industry may have a tougher time selling mix components.

They are selling mix in their new systems and that's good for all of us as we release new products.

LPS-Flex and CR-Flex femoral component sales alone reached almost $50 million in the quarter, but are still only about 30% of our own Zimmer knee femoral mix.

The Legacy Centerpulse [Inex Knee], well regarded in mobile bearing circles, delivered excellent unit growth of 21%.

Our new [Uni Knee], the industry's first high flex single compartment knee, more than doubled unit sales to prior year, and when 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 more than 20% in the quarter, a good sign for the second quarter in a row.

Revision remains a future opportunity to representing historically only about 5% to 6% of total Zimmer femoral units, but with the potential for much more.

Our penetration of the hinge or salvage market has grown substantially with the combined Legacy Zimmer and Centerpulse brands delivering a 27% unit growth in the quarter.

Our new MIS stemmed tibial plate, for assembly inside the patient, quickly jumped to from an early launch to first quarter sales of nearly $4 million.

Trabecular Metal mono block tibial trays have continued to take share.

TM tibial tray units increased by almost 20% again this quarter.

We overachieved our 2005 target of $100 million in total Trabecular Metal sales.

As a data point of interest during first quarter 2006, Trabecular Metal product sales totaled $33 million, a nice mix contribution.

There continues to be excellent progress on the Zimmer minimally invasive knee front as evidenced by the early success of our new MIS stemmed tibial component, progress with intelligent-assisted devices, aka BRIGIT, and, of course, the newest reason why we're so beloved by competition, the Gender Solutions female knee.

Do we need female designs?

Is this the next battlefield?

And who actually cares?

I'll briefly update those activities later and I promise to be gentle on gender.

Let's switch to hips.

On a worldwide basis in the first quarter, hip sales were flat reported to $293 million, but up 5% in constant currency and equal to the 5% average constant currency growth for the last five quarters in a row.

For us, porous stems and MIS will be given additional new life by the TM, Stem, and EPOCH Stem, along with our new anterolateral, posterior lateral and anterior supine MIS techniques.

We're 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 polys, and the related hospital productivity consulting for MIS.

Zimmer Fiber Metal Tapers, along with the new M/L Taper, are the stems of choice for our current MIS mini-anterolateral and 2-incision hip surgery.

In the first quarter, these two stem families grew units by over 10% bringing the combination fiber metal [enamels] this quarter to $30 million in sales.

Speaking of MIS, new instruments for Legacy Centerpulse brands in Europe are having an impact.

The CLS [paternal], with a longstanding $40 million two-year sales base, mostly in Europe, had unit growth in the quarter of over 16%, or almost three times the current European market growth and that's equally true for the Alloclassic, with double-digit unit growth.

As mentioned previously we've just launched two new platform technology stems, the very first Trabecular Metal stem and the EPOCH composite [fulco], a great addition for MIS and only successful composite stem on the market.

In acetabular cups, Trabecular Metal modular and Duron hip resurfacing continue to perform well.

Trabecular Metal cup sales increased to some $14 million in the quarter and a unit increase of over 35% from prior year.

The Duron cup and stem sales, including our fast growing resurfacing product available selectively ex-U.S., grew more than 50% to approximately $7 million.

Premium price longevity in Durasul ® Highly Crosslinked Polyethylene liner units increased by yet another 12%.

Not only is the growth rate way above market but the base of sales is very different from our competitors.

Our two highly crosslinked brands, when annualized, deliver over $100 million in per year sales and despite competitive releases once again sequentially grew sales from prior quarter.

We believe that in the future, cold or radiated mechanically [nealed], or other poly technologies exclusive to us will be the true second generation offerings and could potentially revolutionize the industry just as Zimmer and Centerpulse did several years ago with the Longevity and Durasul brand polys.

As long as competitive polys being offered today contain free radicals, they are by definition first generation in wear.

As you know, our Trilogy brand AB ceramic-on-ceramic PMA has been accepted by the FDA as fileable, and we've completed all FDA plant reviews, with to our knowledge, no relevant 483s.

The lack of ceramic and ceramic and large head metal-on-metal, the filings for which are also complete, are causing us some loss to individual surgery sales and we're patiently expecting to recover those fully in the third and fourth quarters.

We have been really pleased with our U.S. performance on Palacos bone cement products.

During the quarter, bone cement and accessory sales increased again by well over 50% to prior year.

New platform products, including the Trabecular Metal hip and EPOCH composite for MIS, TMS, new techniques like the Zimmer anterolateral and now the posterior lateral and anterior supine, bigger metal-on-metal heads, a little ceramic-on-ceramic, and a new antibiotic bone cement are targeted to make the second half much better.

In upper extremity joints, Legacy's Zimmer Bigliani/Flatow and Legacy Centerpulse's anatomical shoulders, amongst others continue, to grow worldwide with a solid 14% increase constant currency in the first quarter.

Early approval for our new Zimmer anatomical inverse shoulder allowed for the first surgeries in April, and our new Trabecular Metal reverse shoulders were just released to developing surgeons.

Total Zimmer extremity sales are now annualizing at well over $70 million.

To complete our reconstructive discussions, Zimmer Dental had an extremely successful first quarter, with sales over $40 million up 21% reported, and 23% constant currency.

The Dental business showed excellent balance and above market performance with Americas, Europe and Asia-Pacific sales and constant currency up 24%, 16% and 42% respectively.

Dental implants and prosthetic products increased 20.1% and 38% constant currency respectively.

Dental regenerative sales, including our new biological graft Puros were equally strong at almost 30% growth.

We will continue to move into biologics, computer assisted and digital technology, and of course value added education.

Congratulations to our Dental group.

On a worldwide basis in the first quarter, Trauma sales grew 6% constant currency to $47 million.

The Trauma market in general is having stronger results and we will need to at least double our current rate to match the global market.

We've only begun to deliver new products and 6% is close to last quarter, but still it is a modest disappointment.

With expanded field releases of our new locking plates, periarticular unit sales jumped by 42% and quickly reached an annualized rate approaching $30 million.

But it's all about compression screws, as they remain weak and we're down to prior year by 15%.

Fortunately, they are declining as an operating room solution too instead of the mainstay they once were.

Plates and screws in total were up 17%, [Ex-fix] 10%, and Trabecular Metal OM rod over 100%.

MCB plates jumped by ten fold with major releases.

ITST nails are still growing in units at more than 25%.

As we convert new products from old, deliver innovative solutions, and make our recently announced Trauma division fully operational results should improve.

The targeted Trauma brands are growing very well, but older offerings are temporarily weighing us down.

Our Zimmer Spine division sales increased by 13% reported and 14% constant currency in the quarter to $43 million.

We're really pleased with this continued sales improvement.

Excluding Spine, Ortho biologicals is clear the spine market was softer in the first quarter, primarily due JMJ's size and results and, therefore, with our 14% being at global market growth.

Tape sales remain firm for the sixth consecutive quarter at just under $8 million, and now represent just under 18% of Spine division sales versus 50% to 60% in the preacquisition years.

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

Sales reached almost $13 million in the quarter, up 54% to prior year and outselling cages by some 60%.

Dynesys continues to grow as a $50 million brand, and when combined with some $3 million of spinal Trabecular metal, these two new technologies delivered almost $16 million in sales, or more than double the contribution of cages in the quarter.

Zimmer's Spine U.S. launched our CopiOs bone void filler sponge in March.

This is the second generation osteoconductive filler which uses proprietary mineralization technology to control the local bone forming environment.

This quarter, after several years of development, we released our [Deenardy] artificial lumbar disc in Europe only.

The disc itself is unique with a semi-constrained poly insert with a variable radius, more like the body's natural disc, a convex implant to bone interface to better match with concave implates, avoiding early micro motion and enlarged footprint to help resist subsidence.

The first surgeries were successfully completed two weeks ago in Switzerland.

As we've noted several times, the combination of Trabecular Metal, dynamic stabilization in MIS with our new pipeline, and few technological and biological acquisitions, and now even the beginnings of a European disc and nucleus underway should create a globally competitive and formidable spine business.

We would hope to keep this market growth going.

In our orthopedic surgical products division sales fell sequentially by $5 million from prior quarter, and declined versus last year by 2% to $52 million on a constant currency basis.

Obviously, OrthoPAT declining by $5 million to prior year, took it's toll as we phased out this distribution agreement.

We expect to see this decline to affect sales growth negatively by at least $7 million in the second quarter 2006, and this is assumption is already implied in the latest guidance we have provided.

Only our Japan limb [intech] endoscopy business saved the day for OSP with 24% growth in the quarter.

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

During 2005, we had 106 different releases on 78 different projects while we continue to operate between 160 and 170 active total projects.

Nearly two-thirds of our R&D investment spending relates to innovative products and platforms with a real bent toward improving patient quality of life.

At the end of the first quarter, we are managing 164 active new product development projects.

Hip product launches in the first quarter included the develop or release of the first Trabecular Metal stem, the Trabecular Metal acetabular system, and the new mini-posterior lateral and anterior supine MIS technologies, the latter for the European market.

Coincident with these releases, three new hip projects were initiated.

In knees we delivered release on new MIS Quad-Spring guides along with MIS modular precoat stemmed tibial plates and we initiated two new projects.

In Trauma, three more Periarticular Locking Plates moved to full market release along with new modular MIS guides for the ITST nail and additional releases of the MCB Plating System.

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 million to $700 million in sales organically each and every year.

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

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

New product sales for the first quarter 2006 were excellent and totaled a record $196 million or 22.8% of sales.

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

America has had a challenging close to the quarter with the AAOS, but increased reconstructive peer price was very successful.

Americas revenue for the quarter was $516 million, the first time to reach the half billion mark and up 7% over prior year.

The Americas reconstructive growth in the quarter was up 8% and not a deceleration from last quarter, and delivered $418 million in sales or sequential increase from fourth quarter sales of $23 million.

This would imply that during the quarter Zimmer Americas had over a 7% growth in pure reconstructive surgical procedure volume and mix or based at least on competitive reports to date the same as the market growth.

There seems to be some sort of external feeling that our competitors are doing vastly better in domestic hips and knees than we are.

The data, however, does not support that.

Biomet and Stryker, both with major new knee system releases, are growing combined hips and knees at 9% and 8% respectively in the quarter.

And Zimmer with primarily second half new product releases grew the first quarter at 8%.

Therefore, 9%, 8%, and 8%, not much of a difference in a market growing at 8%.

In our Americas reconstructive growth, knees had respectable growth of 8% increase to $240 million, same as last quarter.

Still up almost 10% sequentially and despite the difficult prior year same quarter comp of 22%.

NexGen LPS and CR-Flex, the new high flex [uknee], Trabecular Metal tibial components, the new MIS stemmed tibial 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 7% to $142 million, and better than the domestic markets hip growth figures that now appear to be likely at 6%.

We're not satisfied with the Zimmer hip growth in the quarter, even though it is above market, but given the new stems coming and hope for approval of ceramic-on-ceramic and large head metal-on-metal we're, in fact, well positioned.

America's hip performance benefited from MIS porous stems, Trabecular Metal cups, highly crosslinked poly, both Longevity and Durasul.

Our Dental business in the Americas grew at 24% in the quarter to $24 million and we believe well over market.

Zimmer's combined Americas total reconstructive growth of 8% with a more balanced performance from hips and knees would appear to be slightly above market.

Here's a statistic we are always proud of, the new combined Americas operating profit in the first quarter 2006 set a record in dollars at $275 million, and exceeded the previous operating profit to sales ratio record, improving to 53.2%, up 110 basis points from the same quarter prior year.

A few more million in sales during AAOS week would have been nice, but still, what a domestic machine with quarterly operating profit approaching $300 million.

Let's take a look at Europe.

We're generally pleased with the underlying constant currency sales growth and the traction being gained.

In the first quarter, European revenues were $228 million, down 3% reported, but more important up 6% constant currency.

With our product mix this is close to market.

As mentioned previously, price decline in the quarter for Germany improved to minus 3.6%, and this along with the U.K. contributed significantly to our negative 1% price for Europe during both this quarter and the full year 2005.

We do not expect this to change 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 in very, very late 2006, and some improvements in Iberia and Italy.

Reconstructive implants in Europe delivered sales of $208 million in the quarter, an increase of 6% constant currency.

European hips were negatively affected by German and U.K. pricing changes and surgeon [INAUDIBLE] but despite the circumstances stayed in positive territory with a 1% constant currency growth.

Knees grew solid 9% constant currency.

Positive gains in the quarter reflect the continuing acceptance of both Durasul and Longevity Highly Crosslinked polys, some early impact of minimally invasive instrument deployments, the growing acceptance of Duron 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 competition and prior year.

South Africa, Sweden, Norway, Finland, the Netherlands, Spain, central and eastern Europe, all grew sales for the quarter in double digit or better constant currency.

Italy and Germany, despite their size as well as price declines and tough competition, also remain solidly in positive territory.

The most significant difference between being at 7% to 8% constant currency growth in Europe versus our actual of 6% was the U.K.

These results were, for the most part, courtesy of a government imposed elective surgery cancellation, but the balance from our own restructuring work.

For the quarter, Europe delivered all time record operating profits of $100 million, and an all time record operating profit to sales ratio of over 43.6%, a 560-basis-point increase over first quarter 2005, and a long, long ways from the 24.7% ratio to sales we've registered during our first full quarter combined with Centerpulse in 2003.

For really old boring history, in 1997 when we started the turnaround, Zimmer Europe's operating profit was negative $25 million.

That's a big swing to positive $100 million today.

Congratulations to our Europe team for their excellent earnings performance.

In Asia-Pacific, revenues in the first quarter were $116 million, and an increase of 2% reported, but more important 10% constant currency.

These are good constant currency growth results given our significant Japan mix and considering Japan's negative 1% price in the quarter.

We believe the Asia-Pacific reconstructive market is growing at low double-digit rates in local currencies and, as a result net of disynergies in the distributor reorganization, we appear to be close to the market.

In the first quarter, our combined Asia-Pacific businesses were led by good constant currency reconstructive growth, up 10% to $92 million in sales.

We expect Trabecular Metal tibial components and NexGen CR-Flex Knee and the strength of the Centerpulse Natural-Knee to continue to improve Asia-Pacific's knee performance this quarter, a gain solid at 10% growth.

A new Japanese DCM-J hip stem to be released late this quarter and dedicated to the Japanese anatomy, some hoped for Trabecular Metal regulatory approvals, and MIS driven expansion will help to further grow our hip performance, this quarter accelerating to 8% constant currency growth.

While our Dental business is small in Asia-Pacific, it did deliver another very strong 42% sales increase.

Constant currency country growth rates were good.

Korea and southeast Asia at plus 20%, and greater China delivering an excellent 15% growth, despite more difficult government pricing in both Taiwan and China.

Japan had a much improved 10% growth in a market that doesn't grow much over mid to single digits.

Displaying their usual strong earnings drop through from sales, Zimmer, Asia-Pacific businesses delivered $56 million in first quarter operating earnings and all time record 48.4% operating profit to sales ratio, up 270 basis points from the first quarter 2005.

Good job.

Let's move from products and geographies to hot topics.

Since we have already thankfully covered price and HCA, both of which have improved, I'll focus our discussion down to briefly updating on minimally invasive utilization, some discussion of Medicare IPPS payment recommendations and prospects, a little bit on knees for the fairer sex, and an update on hospital productivity consulting.

First on MIS, the Zimmer Institutes remain busy in the first quarter with almost 500 surgeons trained, and 400 of those were trained on MIS.

The advent of new European MIS hip instruments for the CLS and Alloclassic, MIS for the Natural-Knee, introduction of new Trabecular Metal stem and posterior lateral and anterior supine techniques will all accelerate interest.

Agreements to provide hospital productivity and efficiency courses related to our MIS will push the curve further coincident with progress on BRIGIT, our intelligent-assisted device and the almost certain expansion of MIS into Trauma and spine.

There has not been material change in MIS utilization for hips, at about 54% of Zimmer surgeries with the two-incision remaining solid at 6% to 7%, but with anterolateral increasing to 7% and the standard mini down by 6 points, all of which went to the anterolateral.

These are very similar with 52% of Zimmer's surgeries utilizing MIS, but with Quad-Sparing increasing to 7% on 1,300 distributed instrument sets and standard minis at 45%.

The knee data and Quad-Sparing data are U.S. only I would point out.

On the MIS intellectual property front, we were issued new U.S. patents during the month.

U.S.

Patent 6953480 and U.S.

Patent 6991656, specifically for both our one-incision mini and two-incision MIS hip techniques.

These two patents provide even broader claims and we continue to preserve the opportunity to pursue these against those who would inappropriately copy our efforts.

With so much recent attention given to the inpatient payment system, or I PPS, I thought we would spend a little time on three key aspects of potential future changes and what make them at least problematic, if not improbable.

Generally speaking these components are, number one, hospital specific weighting.

The current system is a single national weight.

Number two, actual costs weighting.

The current system is based on charges.

And number three, severity of illness.

The current system has little use of refined DRGs and absolutely none for total joints.

There are substantial inherit weaknesses to each of these, if in fact, we wish to make permanent improvements to health care at a reasonable cost and avoid ineffective cost shifting.

For starters, the effects of the MedPAC rebasing proposals are by no means certain.

In fact, two different independent studies failed to even find the redistribution effects that MedPAC suggested its proposals would provide.

One recent study by the American Hospital Association, the AHA, found little evidence to this effect at all.

Another study found no impact at all on orthopedic DRGs.

The inability to replicate outcomes by independent non-government evaluations is a real concern.

Keep in mind a great deal of the new MedPAC IPPS recommendations, that would redefine the system, are being done in a large part for the purpose of addressing physician-owned specialty hospitals.

Never mind that physician-owned specialty hospitals represent less than 1% of the more than 5,000 hospitals.

Case mix data shows there's a much larger number of special hospitals than just those owned by physicians.

Let's take a look at the three primary issues.

First, hospital specific weights.

MedPAC's proposal for hospital specific weights attempts to remove the effects of DRG differences in the level of charges across hospitals.

Conceptually not a bad idea if all cost differences between hospitals were attributable to inefficiencies, but they're not.

Hospital volume, economies of scale, bed size, labor and many other factors play a role.

Think about orthopedics and teaching hospitals.

To the extent that more complex, more technologically intensive procedures tend to have a lower charge markup this would penalize those same teaching hospitals and introduce systemic bias.

Let's talk about the risk of moving to cost base weighting.

Cost base waiting is plagued with difficulties.

Cost based weighting was considered and rejected in favor of charge based weights when the current IPPS system was established.

Medicare IPPS is not a cost based system so it only minimally incentives for providers to accurately even report costs.

In order to be successful, cost based weights would have to rely upon data that is in many cases two or more years old.

Thus in calculating a 2007 payment rate, CMS would use 2005 Medicare claims, combined in many cases with cost reports from 2003 and 2002.

The cost reports used may very well not be audited or even reconciled.

In a world of rapidly advancing medical treatment technology, this potential discrepancy would introduce significant disadvantages to these new treatments and technologies.

For example, the imposition of cost based weights would mistakenly penalize technologically intensive short stay procedures.

These types of procedures, as we know from studies in orthopedics, are precisely the very ones that permanently reduce overall costs by allowing patients to leave the hospital more quickly and in better condition.

Moreover, cost based weights are not based on real costs, but are, in fact, estimated costs that are calculated using charges from claims and then reduced by the famous CCRs, or hospital cost of charge ratios.

CCRs are remarkably inconsistent.

It was actually the 2005 IPPS final rule itself that stated that the variability with which hospitals assigned costs to departments, and the minimum lag of one year to obtain hospital cost information was in fact not acceptable.

We're still implementing cost based weights in combination with hospital based weights with exponentially exacerbate the problem.

Lastly, the severity based, or APR DRGs.

Much of the intention here could be good, but it depends, in part, on the ability to move current procedure codes accurately to newer ones and still ensure proper distinction between procedures.

A specific weakness involves the potential to reduce patient access to complex procedures.

In one test, the APR DRG failed to recognize the distinction between a unilateral and bilateral [pulled joint] surgery, or even provide any access at all to revision.

This is not acceptable.

It's important that we don't end up with unintended consequences composed of changes that are impossibly hard to execute or measure, the outcomes are not clear, and the new process is based on a premise that may have had more to do with corralling physician-owned specialty hospitals than the elimination of permanent waste and inefficiency.

Let's switch topics.

What about Gender Solutions.

Are gender-driven innovations really necessary?

Is it science or marketing?

Why should we care about Gender Solutions?

There isn't any data suggesting higher clinical failure rates in women, is there?

Is gender the new battle field?

According to a recent Wall Street Journal article, medicine isn't gender neutral.

I quote, "the differences between men and women are turning out to be significant in the diagnosis and treatment of everything from heart disease to depression."

In fact, 10 years ago the government medical community itself changed their own rules for approved research to include, again I quote, "gender inclusive studies."

The results are changing the way medicine, including orthopedics, could be practiced, and we believe Zimmer is simply on the forefront of this innovation.

One of the less precise, but more important tools we utilize at Zimmer to measure potential new product success is the level and intensity of comparative insults being hurled at us.

We're very pleased to report that Gender Solutions in 2006 is right up there with Highly Crosslinked Poly in 1998, high flexion knees in 2000, MIS hips in 2001, and MIS knees in 2004.

Our commitment to improving patient quality of life and apparently our penchant for abuse is limited not only to implants, but clearly to new techniques and instrumentation, as well.

One industry scholar said our efforts to reach patients has turned the orthopedic industry into the equivalent of selling soap.

Gee, no.

Now you're getting nasty.

What's driving the gender change?

Is it science or marketing?

The simple anatomical differences between men and women are both obvious and well documented.

Our marketing will attract a crowd and clearly point out the competitive differences.

We will reach the target audience, but we believe it is science, Zimmer science, that has brought it all to life.

The intellectual property that we own is the culmination of five years of complex female bone morphology developed by the University of Tennessee and the Oak Ridge National Laboratory staff under the direction of Dr. Mohammed [Maphuse].

Support details to our 510-K filing are over 1,000 pages and of the 22 different three-dimensional measurements taken on 200 of the 800 sample adult femurs and patellae, 21 were statistically significant.

This is only the beginning of the race.

You can be win this market only with a few more sizes or a few smaller sizes.

Our communication plan and science will allow women to get this story right.

But you say if there are so many compromises in an inter-operative implant selection, why isn't there any data supporting higher clinical failure rates for women then men?

It's simple.

Never before have so many knees been put into so many younger, more active women than than the last 10 years, and clinical failure, as defined by a revision, is unlikely to be the end point improvement target that we see.

The current data measures second surgeries, not unhappiness.

Our development team has a wealth of both implant design and clinical experience.

Together they implant more than 5,000 knees per year, in many cases in a university teaching environment.

Collectively, they see hundreds of female patients per week.

They believe that there are higher dissatisfaction levels in women including patella femoral and patella tracking issues, for example, and clearly more underlying and at times reported pain.

There's an old saying that says if the only solution you have is a hammer then every problem looks like a nail.

Our goal is to expose the real problem and fix it, preferably alone.

Is this the next battlefield?

Yes, it is along with xenographic biological solutions, such as our deal with Revivacor, Inc., and Zimmer didn't just show up in this battlefield.

We chose it.

We have a ready made audience for which we have some unique reach methodology.

We have complex design change, tons of science and intellectual property.

We have marketing horsepower dedicated to the task.

We have Zimmer Institutes to teach the changes and the precision of BRIGIT to help deliver them.

We have unity of belief on the issue from our developing and key clinical surgeons, and we have product on the shelf already manufactured and waiting for word on our 510-K.

Now we chose the battlefield, for the time being I'm afraid it's unlikely to be a quiet one.

With respect to hospital productivity consulting, I'm pleased to announce that we're in the process of acquiring the outstanding share capital of the privately held Musculoskeletal Management Systems, LLC, which is better known nationally by its primary brand, the Human Motion Institute.

HMI was established in 1998 to provide hospital focused consulting services to help member institutions design and manage successful orthopedic programs of distinction.

HMI today employs over 50 full-time staff and operates approximately 70 long-term hospital service agreements designed to accomplish the following three goals: Firstly, build volume by enhancing unique physician loyalty and creating consumer brand awareness; secondly, improving care by providing an integrated seamless continuum of care that effectively links community programming, primary care physicians, orthopedic physicians, hospital services and after hospital care; and thirdly, increasing hospital margins by combining gains in volume through effective branding and improved clinical care synergistically with some proprietary cost strategies.

HMI will be the marketing and implementation arm of Zimmer's hospital productivity consulting team.

They'll work hand in hand with the Zimmer healthcare economics group who will provide statistical support for effective clinical improvements, utilizing amongst other techniques our trademark MIS procedures.

We're excited to have the HMI group join the Zimmer family and believe they will provide us with the initial infrastructure to address hospital concerns focused on improving patient outcomes and enhancing the efficiency and profitability of their operations through permanent cost reduction.

HMI marks the beginning of Zimmer providing meaning hospital relevant orthopedic services.

Sam, what are your thoughts on the quarter?

Thanks, Ray.

Similar to the format of past earnings calls, I'll add some detail to several key areas, including foreign currency, the impact of FAS 123R, acquisition and integration costs, interest and debt levels, minority interest, our effective tax rate, capital expenditures, amortization and depreciation, share repurchase, and finally guidance.

Ray has already extensively discussed our sales results in our form 10-Q, which will be filed no latter than May 10.

We'll include a detailed breakdown as we have in the past of price, volume, mix, and foreign exchange growth factors for each of our three primary geographic segments, and each of our key product categories.

In the interest of time here, I will not address those details.

In the first quarter, the negative contribution of foreign currency to sales growth was $5 million greater than expected, reducing sales by 3.5% or $29 million.

Even though the first quarter ended with the U.S. dollar stronger against most foreign currencies than it was when we provided our previous guidance it's weakened more recently, and is now close to the levels in place when we set the previous guidance estimates at the end of January.

If the U.S. dollar holds at current levels for the balance of 2006, the contribution of foreign currency to sales growth should be negative $25 million, or about is 1% for all of 2006.

Effective January 1, we adopted FAS 123R, share-based payments, using the modified prospective method.

In accordance with this adoption method, we're not adjusting our historical financial statements to reflect the impact of share-based payments in 2005.

The adoption of this new accounting standard in the first quarter reduced earnings per share by $0.05.

In order to understand comparisons to prior year, I'll identify the dollar amount of this new accounting standard on each line of the P&L.

In both cost of goods sold and gross profit it affected us by $2 million, or 0.2 of a point of sales; in R&D, an expense of $2 million; in SG&A, an expense of $14 million, or 1.6% of sales; in operating profit, at total of $18 million, or 2.1% of sales.

The tax effect of that $18 million in operating profit was $5 million or 0.6 of a point of sales, and finally net income, net of tax, $13 million, or 1.5% of sales.

Our acquisition integration line this quarter was a negative expense or income of $1.8 million.

Included in this line of the P&L this quarter, besides $6 million of integration expense, was a gain on the sale of our Austin manufacturing facility that we closed in October of last year, a favorable adjustment to the acquired reserves from Centerpulse related to the InterOp recall, and finally the write-off of in process R&D resulting from the acquisition of CS technology from MedTech in the first quarter.

Since the acquisitions of Centerpulse and Implex, we've spent $314 million on acquisition and integration cost, $216 million of those costs have been expensed to the P&L.

Although the vast majority of integration activities are behind us a few items still remain and should be completed throughout 2006.

Some of those items include continued IT systems conversions, continued manufacturing insourcing, and a few miscellaneous items.

These items should result in approximately $8 million to $10 million of pre-tax integration expense throughout 2006 and there should be no additional integration cost beyond 2006 for the Centerpulse and Implex integrations.

The only debt we have in the books, as Ray, is $82 million in Japanese debt because it carries a very low interest rate.

With our continued strong operating and free cash flow performance, we have accumulated $416 million of cash on the balance sheet as of the end of the quarter.

Subtracting out the $82 million of Japanese debt we have a positive net cash position of $334 million.

Interest income in the quarter was $500,000 compared to $7.2 million of interest expense in the first quarter of last year.

In the quarter, we recorded $300,000 in minority interest expense related to one of our small European subsidiaries, and our effective tax rate, as we refer to it here, will be on an adjusted basis.

Our ETR for the quarter was 29% and that's 60 basis points below the full year 2005, and we do expect that the 29% is a good overall target for the full year 2006, although some quarters of 2006 may be a bit higher, some a bit lower, depending on the mix of geographic earnings, as well as other factors.

Capital expenditures for quarter were $54 million, consisting of $32 million for additional instrument sets and $22 million for all other property, plant, and equipment fixed asset additions.

We continue to expect we'll spend approximately $265 million for the full year, consisting of $115 million in instruments and about $150 million in all other personal property, plant, and equipment fixed asset additions.

Depreciation expense was $34 million, and as a result of the Centerpulse and Implex acquisitions, in the related $596 million of amortizable intangibles recorded, amortization expense in the first quarter was $12 million.

On December 15, we announced our Board had approved a share repurchase program authorizing us to repurchase up to $1 billion of Zimmer common stock through December 31, 2007.

In the first quarter, we processed settlements with the share repurchases that we executed during the last few days of 2005.

These settlements closed on the repurchase of 104,000 shares in the first quarter and at an average price of $68.04 for total cash outlay of $7.1 million.

Turning to guidance, as we mentioned in our press release last night, we are reaffirming guidance for the second quarter and the second half of 2006.

Foreign currency rates have changed only modestly since we provided sales guidance during our fourth quarter earnings call and as a result we're reaffirming our previous sales guidance for the second quarter and the second half of 2006.

Our second quarter sales are expected to increase 5% to 6%, and our second half sales are expected to increase 10% to 11% over prior year.

The current consensus estimates in first call are consistent with these growth rates.

We're also will reaffirming our guidance for adjusted earnings per share including the impact of FAS 123R share-based payments for the first half of 2006 to be the range of $1.63 to $1.64.

With the first quarter being $0.01 over the top end of our range, we expect the second quarter to be $0.81 to $0.82, which is $0.01 less than the previous guidance for the quarter.

With the entire quarter remaining in tact.

The entire half remaining intact, excuse me.

Sales are are expected to be the greater in the fourth quarter than in the third as a result of continued introduction of new products throughout the year, as well as seasonality.

Similar to 2005, we expect approximately 21% to 22% of full-year adjusted earnings per share in the third quarter and approximately 28% to 29% in the fourth quarter.

As a result, we expect adjusted earnings per share to be approximately $0.76 in the third quarter and approximately $1.00 even in the fourth quarter.

Full year 2006 adjusted earnings per share guidance is approximately $3.40, and that's the midpoint of the previously provided guidance range of $3.37 to $3.43.

The $3.40 is also consistent with existing first call estimates.

So in summary for the quarter we continue to demonstrate our ability to generate excellent earnings per share growth under a variety of different business conditions, including a somewhat softer sales environment, and we expect, and we exceeded first call consensus by $0.01.

In addition, we signed an exciting five-year agreement with HCA, we acquired the BRIGIT intelligent assist technology, we saw an uptick in overall pricing from the fourth quarter driven by the Americas, breaking the trend of nine consecutive quarters of reduced benefits from pricing.

We introduced our new Gender Solutions knee product at the AAOS, and new products as a percentage of total sales rose to 23% in the quarter.

We successfully completed the sale of the Austin manufacturing facility acquired with the Centerpulse acquisition.

We delivered above market Dental sales growth of 21% reported and 23% constant currency.

We grew our Spine business with double-digit sales growth for the fifth consecutive quarter, and all three of our geographic regions achieved record operating profit margins in the quarter.

Continued strong margins coupled with sound asset management contributed to a very healthy operating cash flow of $203 million which is almost 100% of our net income as drop through.

Operating cash flow and free cash flow increased 33% and 63% respectively on reported sales growth of 4% and reported net income growth of 18%.

We are building cash in the balance sheet that can be used as a primary source of acquisition capital or to buy back shares.

Our effective tax rate is at an all time low of 29%, and we have reaffirmed our sales and earnings per share guidance for the remainder of the year.

Our second quarter 2006 earnings call will be held at 8:00 a.m.

Eastern Daylight Time on Thursday, July 27, 2006.

Now we would be happy to take your questions.

So Wade, I'll turn the call back to you.

[OPERATOR INSTRUCTIONS] Please standby for your first question.

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

Thank you, and good morning.

Just a couple questions regarding the EPS, because the stock option expense was $0.05 in the first quarter and at the January call you guys had been guiding to $0.06.

Just would like a little bit of clarity on what we should be assuming is baked into your $3.40 estimate for the year.

I think you were at $0.23 to $0.25 back in January.

Is that still what you're expecting for the full year?

Yes.

I will let Sam add to this.

It hasn't changed.

I understand the appreciation of thinking that's the overage to the street, $0.82 against $0.81 and technically that may be correct, but the range is, it's probably $0.22 to $0.25 that we would use now.

There's no real difference.

We have team share and stock programs from employees, where we assess each summer in July and August, and of course we don't know at this point which shares we would give out to acquired employees as part of the same kind of broad employee programs.

So I don't think there's much difference, maybe $0.01 or maybe not.

The other comment I would make, Katherine, I guess in related is, I don't look at the overages as one-off items because I can sit back and say, yes, but we didn't, as an example, we didn't purchase stock.

We could have purchased $0.01 worth of stock, if you will, and then we're at $0.83 instead of $0.81 and are we two over because of that or one over?

So while it's mathematically correct I'm not sure we single out items like that and sort of -- unless they're particularly unusual.

I think they're offset by other things.

And the reason that we have a range at all is because we do have, as Ray mentioned, some additional decisions that we have the opportunity to make with respect to any additional options being issued, as well as some volatility with what happens with our earnings performance and the associated effect it has on option expensing.

No, I think that's very fair I just wanted to make sure we shouldn't be annualizing $0.05 which would suggest that the ex-options number was different for the full year than the $3.40.

$0.22 to $0.25.

That's very helpful and, Ray, I'm sure you don't want to talk specifically about the second quarter, but is there any color or perspective you can can give us with respect to what happened with weekly billings, post AAOS to increase conviction that it was really an anomaly tied to that?

And then lastly, and I'll hop back into the queue, anything you can provide in terms of variation in billing days, either Q1 or Q2, given that that Easter fell in, I think in Q1 a year ago and Q2 this year?

Katherine, I'm shocked at your first question, I won't even comment.

The next one is we don't see much effect because of where the extra day fell.

We didn't see much effect, and I think I heard on previous calls and mechanically it could technically be 1% or 1.5%.

We didn't really see much effect from it.

To your point, it is so messed up this year with the AAOS, the switch of location, but it's not just that.

It's the effect it had on surgeons' spring breaks, that they'd already arranged with their families, those get moved.

Do they get tied now to Easter?

I don't think any of us have an answer and I'm absolutely not ducking your question.

I can assure you.

I just doing think any of us have a real answer or if others do they can explain it to me.

What I do know and I won't comment on April, obviously, but what I do know is we had 11 straight weeks in a very tight range, $33 million to $36 million in billings, increasing as they naturally do, and, bang, we went to $27 million.

We were, I mean we were looking good until the last week.

I don't know what to tell you about that, it's very confusing this year.

As I commented in the script, we don't see anything underlying that's any different, but it is frustrating when it's in the last week.

And that 33 to 36, that was your total U.S. billings?

That's U.S. domestic day-to-day billings that we look at every morning at 7:00.

They're in a tight range growing.

It's total, and, therefore, would apply to those folks that attend those heat meetings, but I can't guarantee that, I'm just saying, those are the statistics and, obviously, the last week took us by surprise.

Okay, thanks so much.

I'll hop back in the queue.

Your next question comes from Matt Miksic with Morgan Stanley.

Matt, your line open.

Hi, this is Matt.

Hi, Sam.

Hi, Matt.

How are you?

So, wanted to ask a question about the European deceleration, you mentioned surgeon disynergy.

I understand pricing.

Although it didn't sound like U.K. and Germany was that different from the prior quarter.

But could you explain how it was different and maybe something about this surgeon disynergy.

Two things one, you'll note hips.

Knees were okay in Europe and I don't think there's anything special there that I know of in the quarter.

Hips were quite a bit less and Alloclassic and CLS paternal had strong results, so there's two, or three things going on.

One, we're moving out of some brands, and, obviously, accelerating the big brands and focusing on them, so there's a trade off there that you don't get much net growth, certainly in the hip area.

The MIS techniques that we put in place are just starting now.

The two techniques we're doing now are really focused on Europe because the ones we've previously taught weren't as European-oriented in terms of their technique.

The U.K. and Germany are hip affected, so it's not so much the U.K. and Germany we're dramatically different it's the implications it had on hips, and then on surgeon disynergies, the folks that leave for one reason or another were very hip-oriented and lots of reasons why people leave, and obviously we get new surgeons too.

But we seem to lose some more in hips and get some more in knees, there's individual reasons for that.

When you add all of that together there's nothing there that is particularly unusual, or doesn't have an explanation to it.

But it had the effect that it had.

And then a question on price in Japan and the U.S.

It sounded like you were getting a bit more optimistic about how things were trending in the U.S. and also sounded like Japan for the full year '06 impact was going to be a little lighter than you talked about before.

Can you talk about why?

I think I can talk about why.

Part of, let me do the U.S. first, and again, remember what I said in the script, it's early, don't everybody go running out and changing their price guidance on us because I'm sticking with what we had.

I was just trying to give you a theoretical explanation as if we held where we are today.

One thing to remind you of we're the only company, I think, that still does [Jan. 1] new price introduction on list price, so we get a little bit of benefit there although there's not a lot of selling at list price.

Most of the companies I think are in the fall or late in the year.

Secondly, we did going back over the last 18 months now, probably even two years now, renegotiate a lot of deals into longer agreements.

We gave up here, we gained there, and those agreements are all in place.

We're not doing much here in the way of negotiating, we have one that we're finishing up.

HCA is done, as you know, and we're certainly gaining some benefit from those agreements that still run out a year or two on things we've negotiated some time ago, and they're fair and reasonable price increases, but they're having some modestly positive effect compared to what we have had.

Japan is just a case of fine detail.

Once we got back the entire listing line item by line item product and ran it against our current trends, not necessarily our plan, but precisely where we're at in Japan, the ups and downs in various product lines, it simply came out to 3.7% negative instead of something between 4% and 5%.

So there's nothing magical about that other than doing detailed math and figuring out where you are at.

Okay, that's helpful.

Thanks, Ray.

You're welcome.

Your next question comes from the line of Dhulsini de Zoysa from Cowen.

Good morning.

Sam, you get this question every quarter, I guess it's my turn this time.

You already have industry leading margins.

Can you comment on sources of continued improvement and, especially given, I think, Ray, your comment that $0.90 on every $1.00 that is not sustainable you expect $0.40 to $0.50.

You consider that the sustainable rate.

Can you sort of bridge the two for us?

Sure.

First of all.

This is the final year of our integration.

As we have mentioned many, many times the first two years were primarily focused at wringing out cost and expense reductions associated with all aspects of operating expenses and some tax benefit, as well.

The third year is the year of manufacturing and distribution.

So, a lot of the good work we did last year throughout 2005 to insource, to shut down the Austin facility, to rebalance where we make things, to negotiate tax rates in Switzerland and drive to a different legal tax structure in Puerto Rico.

Those are all things that are going to affect us even more so this year in gross profit and expenses associated with distribution.

And may have some spillover effect into 2007, as well.

We are -- one of the things that's sometimes prevents any acquisition from being combined quickly is the issue of systems.

And we've also mentioned that one of the many activities taking place this year is continuation of systems consolidation around the world, and the faster we complete those systems consolidations the more dramatic we can make the combinations that are facilitated by single systems.

We have those things going on, plus the effect of the way we run our business.

We do, as you know, have several large facilities rather than a number of small facilities, so the effect of scale matters a great deal in our business.

And the more volume we can put through facilities, and our SG&A structure is much the same way, the more we can continue to leverage the fixed absorption of expenses against a higher sales base, those things, and we can go on and on, but those are are some of the principal reasons we feel optimistic about our ability to continue to drive margin improvement.

Okay.

And then could you maybe -- I don't know if you can quantify this but the impact, the long-term impact of contracts.

Where your -- as you said, giving up some ground on pricing for -- in exchange for others and maybe one way to think this is the rough percentage of carve out technologies that offset?

Yes, I didn't realize you were going add the last part because that was going to be my answer.

I think one of the things you have to be careful of is as we negotiate with hospitals and we, in the past, in fact ,you go back a year and a half or two years ago when we were doing this, we gave up at the time if you look at what price was then, positive 2.5%, 3%, perhaps, you know at the time, we gave up something on that because we felt price was going to tighten down a bit.

Hard to be 1% to 2% smart on price, but we felt it was going to tighten down.

We gave up something on that on routine traditional primary hips and knees in order to balance our relationship with the hospitals.

We've got to work with them everyday too, and because we felt in the future it would prove to be a smart move, otherwise obviously wouldn't do it.

Although combined with that we carved out significant number of items and through a good selling effort convinced those same institutions that while we'll give up over here, we'll have longer agreements, we really want to be paid well for the things that we've really put a lot of R&D dollars development and so on into, and we did that.

And those carve outs, Dhulsini, vary from in dollar values and real value to us anywhere from, the highest one I've seen was 18% carved out, the smallest would be in the single digits somewhere.

I'm not sure the exact on the smallest.

We accelerated, though, the proportion of carve outs in all of those deals through our efforts in the give up on the other side.

The net effect on price that people are assuming, you know, where it is is offset by two conflicting factors.

One which you give up on ordinary primaries, the other which you gain on carve outs, then the question becomes how well can you sell the use of carve out products in the institution, and how will surgeons use that relative to traditional, but that's the answer.

We did it a long time ago.

I think we're seeing some of the benefits of that now, and, as you know, and we've talked about, we don't really have other than one, we are just finishing up.

We don't really have any major agreements to do this year anyway.

And HCA is complete.

Sure.

Okay.

So then your Trabecular Metal and Gender Solutions and all of that fits into the carveout strategy?

As does MIS, as does Crosslinked Poly, as will ceramic-on-ceramic.

Not in every single case, but the big things that we're well-known for, that people think of about Zimmer.

It's very rare that we don't get those carved out and then if we're fortunate we get a bunch of other things.

High Flexion we've typically, as an example, been able to get carved out despite our friendly competitors have inserted that into their new systems.

That's probably actually been helpful to them, us having done that.

Also getting back to the last point I made, scale, again, does matter as we look to negotiate contracts.

And the effect of scale on increased volume helps fund any discounts we may give to help drive the business through negotiation processes.

Great, thanks very much.

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

Good morning, gentlemen.

Good morning, Mike.

Wanted to clarify a couple items, one, Ray and Sam, it sounds like we might see more M&A activity in the next six months than what we've seen recently, and with that commentary that you made, Ray, how should we think abut the Company's ability to absorb these $100 million to $400 million transactions, not on the balance sheet but on the P&L relative to current guidance?

Two parts there.

Let let me answer them both.

Yes, we have been active, we're active now and we continue to be active.

We've told people, as you know, Mike, where the target areas are and the probable ranges.

We try to give people a range and then assume that covers off 80% of circumstances.

We're sensitive to the fact of people looking at the sales line and being very sales line focused right now, and as far as we're concerned, we're growing at market or better in the key markets we want to be.

And, frankly, are going to put our own pace on that top line, and we're sensitive people worry about the top line.

We think they worry about it too much.

Frankly, I could go out tomorrow if we wanted to and very quickly change that top line, but we're not going to do that, we're going do it smart, do it right, stay within our knitting and stay within the target areas.

And we'll live with the temporary abuse of the sales line perhaps not looking like what people would like it to look like.

We're not going make mistakes because of that.

We're going to run the business smart.

To answer the second question, I have no way of answering that, obviously, because you know, one deal might be accretive $0.01, and another deal, you know, might be diluted by $0.02.

We're high disclosure as you know, and we have the staff here, we have the people talent here.

I think one of our less understood skill set here, based on deals done historically by all of us, is the ability to effectively integrate deals and make money doing it.

We'll be more than happy to share the impacts with you as they happen.

I expect there to be multiple deals, but we're not going rush to artificially force the line when we feel we're doing well in most of the base areas.

Just to be clear on my question, Ray.

What I'm asking is if we're looking at a couple of different transactions small in size.

Can you absorb in the current guidance $0.02, $0.03, $0.05 of dilution?

I understood your question, Mike, but it's the same answer.

I can't answer that without telling you specifically which deals we're doing, and which ones we're doing in which order to whether they would net out to absorb against $3.40 by year end.

So I understand your question, but I have no way of answering it unless I knew precisely which deals, which order, and shared those with you and, obviously, I can't do that right now.

Okay.

Let me just try to understand this well then.

The sequential uptick in pricing in the Americas.

So, is that in part a function you took a little more pain in the first quarter of last year on some of the contracts that you signed and eased up on a comparison basis this year?

Maybe in some specific cases, but what it is it to do with is the language and agreements we negotiated over the last two years and where they come into play.

Some have escalators, some don't.

Some of the escalators are Jan. 1, some are April 1.

It's a mixed bag kind of answer I would have to give you.

It's a function of, no question, the negotiating we've done on major agreements and the work we're doing everyday.

I don't know -- I think there's still a pretty consistent price pressure there, I think hospitals are working hard to improve their profits.

As we've commented and as I've heard my counterparts comment.

It does seem somewhat lesser pressure in the last six months ago, but in our case it's just mechanical, it's mathematical, that's what we've negotiated and they're now flowing in.

Yes, Mike, also, it really isn't more pain that we took in the first quarter of last year because last year in the Americas the price increase was 2.4%, so the 1.6 was on top of the 2.4 from a year ago.

Right.

But you dropped from 4.2 to 2.4.

We all know what the drop off was over the first half of last year.

So I just wanted to make sure I understood.

What do you want us to be expecting over the balance of this year?

I think, as I said in the script, it's early.

We can give you theoretical examples, but as hard as we work at this analytically, I don't know that we're 1% to 2% smart.

But what I can tell you is right now if we stayed exactly, it's like the foreign exchange conversation, it's a point in time conversation, if we stay where we are now, versus the guidance we gave of minus 1.2% for price of the year, which was calculated by us in great detail, I can assure you, if we stayed where we are now and it extended through the year based on the mix of contracts I know about, the changes I know about, and the government, the countries we know about, we would be slightly positive in price as Zimmer.

Not industry, slightly positive price at Zimmer versus the guidance we've given of minus 1.2%.

But it's early and I'm certainly not going to put that in our guidance because I don't have sufficient data points at this time to be comfortable with changing the guidance on price.

As a reminder, even though Japan will be a bit better than we thought, it still occurs in the second quarter.

Just started April 1.

Okay.

Great, thank you, guys.

Okay, Mike.

Your next question comes from the line of Joanne Wuensch with Harris Nesbitt.

Hi.

Good morning, and thank you.

When we think about new products coming on line throughout the second half of this year for you guys, there's also a couple of your competitors that also have new products coming on line.

Does the growth come from those products being a higher ASP, does it come from physicians who are saying, hey, wait, Mr. Jones, we've got a better hip coming later in the year, I'll put it in then, or are the hospitals right now weaning down inventory and that's what aids the acceleration in the second half of 2006?

No, there's no inventory effect at all because surgeries are booked and it's in many cases carry in, carry out, so there's no inventory implications to be considered.

In terms of competitive product, new product releases versus ours and whether it's in effect mix in ASP versus share.

It's a lot of mix opportunity for us based on good clinical stories, there's no question.

What we don't know, if I take two or three examples, the Trabecular Metal stem is, we've just, obviously, just released it to developers, so it's a little hard to tell.

They really love it because they helped work on.

It's off to a very fast start.

It's doing very well on ASP and we have taken some competitive situations where a competitive surgeon was using Trabecular Metal, for instance, on revisions but was not using it on primaries, and now we have the chance to take the primary stem.

EPOCH II is the same example, it's full coat composite, it's a very unique stem, it's going to be dynamite for MIS as well.

In the case of gender, that's tough to say, we'll see where the gender battle goes.

It's clearly a higher priced product not because we particularly marked up gender but because it's 100% Flex.

There's no non-Flex offering.

We think gender is going take share and we think it's going to take share with a higher price component because of Flex, but that's what the battle is all about.

The fun begins when all of those come out and we'll see who takes what from who.

We remain -- I read a couple reports quickly this morning about, gee, now it's even more back ended.

We don't view the world that way, nothing has changed in the products that are are coming out.

They're going to be great products and, obviously, we feel good about those numbers, but there's a high mix concentration, the question is can we get the double whammy?

Can we have a higher mix concentration and more GP dollars along with market share taking?

That would be the obvious ideal.

Also, Joanne, back to the inventory question briefly, we own all of the inventory in the channel right up to the time it gets implanted, so title doesn't pass and revenue doesn't get recorded by us or our competitors until the implant is made.

So there is no inventory in the hospital that the hospital owns, it's all ours.

That's on hips and knees, that's just to be for the spirit of full disclosure, that's not necessarily true on trauma, obviously, where we do keep material there because of the emergency aspect of it.

Okay, switching topics slightly.

You said there were a number of acquisitions that could have hit, but didn't hit in the first quarter.

How do we think about why they didn't and why they might in the second?

It's just timing and negotiations and valuations and bankers and, you know, it's -- there's nothing magical to it.

It's all of the usual things we, our big fear as you can tell from us not buying back stock was not about, gee, they may spread out but rather the opposite.

It was all about whether we thought they would all come together at a much closer space in time.

You can't, we've done, as we've told people, Sam and I have done over 200 acquisitions in 35 years.

You can't rush acquisitions and expect it to work.

So there's nothing magical about it at all.

Okay, thank you very much.

Your welcome.

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

Thank you, just a couple quick ones.

Good morning.

On the M&A side, should I take your comments to mean that the likelihood of larger deals is slim to none in the next 12 months?

No, you should never take that.

That's not what I said.

I think what we're saying is that we, and we say this all the time, we try to give people a range to give context.

What I didn't say in the script, and we always say to people is, if we go out and do one for $600 million, as an example, and we've said 100 to 400 don't place 25 phone calls and say you lied to us.

We're not able to get it that close.

We're trying to give people perspective on the areas and types of deals we would do.

Okay.

And secondly, could you just remind us of the timing of, or your outlook for the timing on ceramic-on-ceramic and the large diameter heads?

It's out of our hands completely now.

We've done everything.

We had five plant reviews, two plants which were not ours, obviously, CeramTec is involved in this.

We are complete on the plants.

We've answered all of their questions.

We have filed all of the paper work, and we would hope, because it's not in our hands, it's with the FDA, but we would hope to begin marketing in the third quarter, in the summertime, but I'm hesitant for the last 20 years of my life to ever make a prediction specifically because it's simply not something we control.

But generally if things proceed as planned it would be in that time frame.

For both?

For both although the -- you mean both metal-on-metal and ceramic-on-ceramic?

Right.

We would hope so.

Certainly the ceramic-on-ceramic should be first given filing times.

Then lastly, on the hospital consulting side.

I do hear from our contacts in the hospital world that you guys are really out in front on this and, at this point, alone and I understand how it can help improve hospital margins and I understand how it can help improve your margins, but do you really think this is something that can lead to better revenue growth outlook for you guys, and market share outlook, or should I think about it more just in terms of margin?

Well, I think, I think we have to be careful here.

HMI and any consulting do, in and of itself, is an attractive revenue business, and attractive profitability business.

So just separating it for the moment.

We see that.

It will improve our revenues by that very fact.

The linkage fact is to the extent that you can link, in some cases, not in all cases, but in in some cases, the productivity to specific areas we've work on, published on and have beta sites on, such as MIS.

We believe it can drive revenue.

But the hospital, or hospital group, has to have confidence in the fact that HMI and anything we do is independent.

The work they do is independent.

They're recommendations are.

And that the times it does link revenue to us is because that's -- because we've done great work on MIS and we can prove it, and certainly not tying the two together.

The other comment I would make, Bob, is we will start to now be much more comfortable going after large hospital growth and multiple hospital programs.

Such as working with HCA than we could have been in the past because we had great data, great products, great ideas, but we didn't have the infrastructure to execute the sale of the consulting out in the marketplace.

So I think that has changed, as well.

The other thing you have to think about is not just consulting it's integrating.

It's exposing HMI to things like BRIGIT, as an example, where we think we can dramatically reduce operating time and reduce costs by eliminating instruments.

So it's also introducing HMI to the things that are at Zimmer that are unique to us, and that they can feel comfortable proposing and not losing their credibility.

Is there any way you would like to think about the revenue opportunity from a consulting business alone when we look out two or three years?

I would like you to think of it being a lot higher.

Is this, could be a $50 million business or is it a $500 million business?

Just to frame it broadly?

It's, I don't think it's a $500 million business.

We have not completed work where we probably want to do guidance, but I think it's multi-million dollar business for sure, and then it depends whether we do incremental acquisitions and patch them together, but it's certainly a multi-million dollar business for sure.

Great.

Thanks very much for your time, guys.

Your next question comes from Milton Hsu with Bear Stearns.

Good morning, Milton.

Good morning, guys.

Ray, just one question.

Given your comments about the end of the first quarter, could you give us a sense of how things are tracking in the beginning of the second quarter and going to the second half of this year?

I understand that sometimes the initial uptake of these new products is variable.

What gives you your confidence that everything's fine?

On your first question, I'm just going make, assume that you and Katherine are now dating, and I'll skip that entire question altogether.

On the second part, it's the sheer number, we have not had, and when I say number I don't mean absolute number, you can release lots of things and they can be small.

Our confidence level is based upon distributor input from the field.

We've had to go way higher on Trabecular Metal stems, example, I mean we've had to go way higher on production of Trabecular Metal stems, example, than anything that was in the original marketing plans because the distributors came back and said, hey, we're not going to be anywhere close.

We're in back orders if you stay with this current production plan, and it's based on the type of products they are, the clinical story, the mix story, the marketing excitement in the case of gender, which I realize is more fourth quarter.

I'm appreciative of the hockey stick and you guys can all come back and say I told you so, and I'm sure you will if the fourth quarter doesn't look like what we say it will, but I honestly believe we've got this nailed right, and I believe those products are so different in their uniqueness and in their quality compared to many of the new products.

In fact, one of the reasons our R&D is, perhaps looks light is not because we don't have a net growth in huge things, it's because we're externalizing some of those great technologies and we're eliminating a lot of the "me too" stuff that we've traditionally done and gone with things that will change the patient and change our revenues.

I'm here everyday and look at it.

That's about all I can tell you.

I have confidence in it and we've been pretty good at, in general, at hitting our numbers.

And just a second question for Sam, and I just want to make sure I understand this correctly, the first quarter, there was a $1.8 million, I guess, benefit from the -- I shouldn't say benefit, but maybe gain from the acquisition integration and other.

Last year we backed that out to get to $0.75.

This year if you include it you get to the $0.82, but if you exclude it you get to the $0.81.

The only reason I'm asking is because I guess it has an impact on the second quarter guidance, if that's $0.81 to $0.82 because the first quarter was $0.01 better because of that.

We back it out whether it's positive or negative.

It's the first time it's been a positive number, but it's $0.82 within or without.

It doesn't matter.

It's small enough that it just doesn't matter.

All right, maybe I just got to look at my numbers.

All right, thanks, guys.

Let me add, Milton's gone there.

But let me add the point, too, because as we look at guidance for half.

So it's up $0.01, down $0.01, that guidance is done at the beginning of the year, we don't see anything different in the half, particularly, one way or another. $0.01 on $1.74 over six months is not a reflection we think the second quarter is worse, it's a reflection of balancing between the first and second quarter, between the two.

And the kind of launch investments and now we know where we're at on DTC and gender and we know what we're doing in the second quarter.

So I realize we live and die by penneys, but in our perspective there's no real difference there.

I would also comment, too, because I had a couple of quick calls if it is helpful to people on the second half, on the $0.76 and people said, well, you've changed your guidance substantially.

We didn't change our guidance, we changed yours.

We had given the half and we've simply adjusted and refined it down to quarters for you now as we do each year at this time, based on the normal proportion and what we see in earnings relationships based on last year.

So Sam's comments on 21% to 22% in the third quarter, and 28% to 29% in the fourth is not us changing our guidance, it's us adjusting your interpretation of the half numbers that we gave you, and refining them for you so now you know what you can feel comfortable with, obviously, there's no change in the total.

Just from a process working together point of view we want to make sure everybody's comfortable with that, that we're not changing second half guidance.

I'm not sure what the individual [softside] models look like, Milton, but if you were to, if we were just to leave the street were they were I would guess the models would show some sort of spike in margins in Q3 and margins decreasing in Q4 as a result of that.

Which wouldn't make any sense.

Okay.

All right, thanks, guys.

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

Thank you, good morning, guys.

Good morning, Steve.

Ray, any update on a potential OrthoPAT replacement?

Yes, not enough to put in the script but, or I would have obviously -- I'll give you a sentence on it.

We've narrowed it down.

We're not going do it internally although we continue to play with some component technology there.

We're looking at two opportunities, both of which at this point would take us out to the beginning of the New Year, and one of which is our primary choice, in part, because it allows us to make some components for them, as well.

In addition to selling and marketing the unit.

We think it's got characteristics and potential capabilities, at this point in time, our assessment that perhaps exceed OrthoPAT, as we know it today, and we get some vertical integration in the manufacturing.

I don't think -- I promised to update people when I knew for sure, and I still don't, I don't think there's much possibility we'll see anything in '06 because we've decided to modify it and make it into everything we want as opposed to rushing to market.

If that changes, I'll certainly tell people.

Okay, great, and then Ray, in terms of the second half growth acceleration, how should we think about the relative contribution of the new products versus the anticipated FX swing and the easing comps?

You mean in their relative -- those -- we haven't published.

We wouldn't publish the new product dollars or percents.

You already have foreign exchange and comps available to you.

If you're asking me to connect those three dots together by giving percent of new products and dollars, I've got that here but that's not something we would put out publicly.

In other words, do you still build in somewhat conservative contributions from the pipeline in the the back half?

No, I don't think they're conservative, you guys are tough to follow, we have seven people complaining we have a hockey stick that's out of sight, and you're asking me if I think it's conservative.

It's hard to know which way to go here.

They're our best shot on what we know today at where we believe we will be, and we have confidence those third and fourth quarter numbers are good ones, but I wouldn't break it down any further than that.

Fair enough.

And lastly, in the U.K., just a lower performance there.

How much would you say is the lower access to elective surgeries overall versus the sales synergies you talked about, and what is your outlook on the potential improvements on those two issues there?

Well, I'm told, I'll give you what I'm told.

I don't know the details myself, but I can tell you from the analysis.

It would seem to be in our case sort of four or five points of growth and we've got other things we need to work on there.

We've got new product introductions, we've got sales force stuff, we've got our own surgeon things.

So, of the issue I'm told that it's in that neighborhood for the quarter, I'm also told that that goes out of effect April 1, and the government will reenergize the budgets and I haven't had that confirmed yet, but I presume that's the truth.

Great, thanks, guys.

Your welcome.

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

My questions have been asked, thanks.

Thanks, Ben.

Your next question comes from the line of David Lebowitz with Thomas Weisel Partners.

Thank you very much for taking my question.

You had mentioned earlier in the call that when the ceramic hip comes online later in the year that it could recoup some sales that might have been going to other competitors in ceramic hips?

Could you quantify what type of impact that would be and if it is incorporated into guidance?

It is in the third and fourth quarter guidance, yes, I can answer that.

I won't quantify it specifically, but I will tell you that the -- we recorded on -- we don't but distributors, obviously, watch it on a by surgeon, by hospital basis, we get a cumulative effect reported to us here by distributorship.

I will tell you when you add up the onesies, twosies by surgeon like they do, and you consider the incremental mixed value of ceramic-on-ceramic, and you add it up for 26 distributors, it's a healthy amount and these are all for the most part 100% Zimmer surgeons saying I like that in a specific situation with this 55-year-old.

We don't lose any of the other the business but we lose that or we lose it on a metal-on-metal on a large head if in the surgeon's opinion that's his best decision.

So, it adds up to -- I can say more than $1 million, several million dollars.

I won't quantify it, but it's surprisingly more than you would think, even though it's onesie, twosies, primarily because of the unit value of the sale.

And just the sheer number of Zimmer surgeons and size of our U.S. operation.

Okay.

I'm drifting over to Trabecular Metal.

Clearly, you're making an increasing investment in the area and it's been doing well for you thus far.

Can you comment on the competitive dynamics of this area?

It seems that some of your competitors, certainly with porous titanium, beginning to make a little more noise and what do you think about this technology versus TM?

I think when they're ready they should let us know, we'll have a Pepsi/Coke challenge, and we'll set the parameters.

We built the original one.

So we'll measure all of the parameters we have in performance characteristics while the Pepsi/Coke challenge and we'll see who walks away happy.

That's what I think.

Okay.

One more question on Spine.

It seems that you mentioned earlier and correct me if I'm wrong.

A total disc replacement that you just introduced in Europe, and in the past you've kind of deemphasized TDR and pointed much more towards nucleus replacement.

Is this an overall change in approach or just expanding?

No, not at all, David.

What I've said specifically is I would not invest or put a first generation lumbar disc into the United States, or into North America.

That's what I've clearly said.

The Swiss folks and our Centerpulse folks developed this or started development long before the acquisition.

They felt very strongly about it.

They argued in favor of it for Europe and they want the opportunity to grasp that market and prove their point.

We've supported them on that and they've now done that and this work was primarily down by Legacy Centerpulse, not by Zimmer.

I have not changed my opinion one iota relative to the U.S. marketplace.

I believe where Zimmer should be is in MIS Spine dynamics, stabilization, and second generation cervical discs, so there's no change of any kind.

Okay, thanks for taking my question.

Your next question comes from the line of Robert Faulkner with JMP Securities.

Thank you, and good morning.

We can just talk about the overall market a little bit.

It looks, as you said, or by our calculation, about 7.5%, 7.7% growth for the U.S. recon market.

And which I believe is what we've long, or at least I've long considered about unit growth.

I'm wondering what the underlying dynamics are that you see or believe are happening with respect to price and mix?

Is price positive and mix negative?

Or is unit volume below what we have traditionally anticipated?

Well, I think if you're looking just at the quarter.

There has historically been in the long-term trends for investors here, people in the business.

Obviously, the demographics and all of that stuff are terrific and people have done inordinate amount of work on calculating that.

In fact, at the AAOS there were some surgeon researchers that put out work that had astronomical increases, which we happen to agree with, out over the next several years.

But there is occasional cyclical activity here.

There's occasional lowered electives.

I'm not sure I understand the reasons for that.

It does happen periodically, I don't think there's anything, we go back over and over the numbers, there's nothing here.

I'm not talking for Zimmer now, I'll speak for the sector as best I know it.

I don't think there's anything here we're seeing.

There's some deceleration certainly from higher numbers we've seen in the past.

I don't think there's any movement down to 4% or 5%.

I don't think there's anything, there's price we talked about.

I think price is, I said many times, is going to be somewhere between plus two and minus two.

Hard to tell where.

I'm not seeing that much in mix issues.

We're anniversarying some mix issues, whether it's us with Highly Crosslinked after eight years, or whether it's, Stryker's probably the best known situation more recently with ceramic-on-ceramic, these things happen, but other new mixes will come to take their place.

Unit surgeries, I think I talked to a lot of surgeons every quarter as does everybody and a lot of, obviously, HCA as an example, there were slightly less elective surgeries and more hip activity in the first quarter.

I don't know that means anything.

Frankly.

The underlying demographics are still strong.

I'll tell you what we use internally, as I've said so many times.

We use 7% in units on a go forward basis strategically, and somewhere between 2% and 3% in mix.

We use zero for price and we don't care about foreign exchange.

When we look at ourselves in the primary implant areas, not Spine, but the primary implant areas, we see this marketplace as a 9 to 10 go forward with price and foreign exchange as variables.

I don't see anything new, Rob, I know several people believe this is going to go something lower than it is.

I don't get it.

I don't have any data that says that and I don't believe it.

Can we drill down on knees, specifically, it looks like -- I was expecting a bounce back from hurricane--kind of a tempering of actual implants in the last half, but knees slowed down quite a bit more than I had expected.

Do you see anything going on there?

It looks like around 8.5%-ish for the market, again around unit volume?

No, I don't.

I still think knees is going to prove to be 10-ish over a long period of time.

It depends how things like gender and not just us but new topics like that create excitement.

It doesn't matter how the competitive companies approach it.

We like our approach but all these topics create interest, and they attract people to get surgeries.

There's four studies out right now that are really interesting that says the biggest problem with orthopedics is not products or any of the things we are talking about, but it's the underutilization by those who should be getting the surgery, and the numbers are between 10% and15% of the population.

I talked to a number of surgeons who said we had such a soft winter this year that people didn't want to go in as they normally do in the bad weather or before Christmas and get surgery done because -- I mean you get all of these combinations of anecdotal things.

But the fact of the matter is it's an underutilized surgery, it's an elective that is incredibly important to quality of life, and there's no underlying change in demographics.

So we're going to get ups and downs, and as I said we saw more hip, now this is just us,

I don't know about our competitors, but we saw more booking of hip activity than we've seen in some time and knees were a little softer.

That's different than it has been for several quarters.

Is that meaningful?

I doubt it.

And finally, a housekeeping detail, where is bone cement in the product categorizations?

Where is bone cement?

Yes.

We manage it at OSP, but it's in hips.

Okay.

So it depends on what you're asking.

We manage it as a product line at OSP along with delivery accessories because they're components, it is recorded and revenue based in hips.

Great, that's the question I was asking.

Thank you.

Your next question comes from the line of Michael Matson with Wachovia.

Hi.

Most of my questions have been answered, but one thing that would be helpful, you talked a little bit about the spine market and sort of a slow down there, and I was just wondering what you think is causing that, and if you're sort of sensing that hospitals are now approaching some of the spinal implant products with some of the same things that they've done in the hip and knee market to try to control price and mix and things like that?

Thanks -- it's, at least in our case, it's not price.

I can't speak for other people, but it's not price related.

The 14% growth we had in what I believe is about a 13.5% to 14% growth market is a serve market.

For us it's an instrument or metals market so I've taken infuse particularly out of that and I believe the market's growing at about 14.

In our case, obviously, dynamic stabilization was terrific and cages haven't changed.

What is different is pedicle screw systems and [peticardy] we didn't get the release out on our new Optima system as aggressively as we would have liked, so on our relative smaller base than some people we could have just as easily been at 20, or 21.

I think there is some lightening down for whatever reasons.

It could be anything, a little bit in the instrument procedures in the first quarter, but I don't think it's anything, you know, anything meaningful, and as I say in our case, we try to compare ourselves to market, and as long as we're at or better than market I don't get too concerned about it.

All right can that's great.

I guess I was more focused on kind of the broader market.

I know you guys are the smaller part of that.

It's tough for us to tell.

Again, for us price was not a negative contributor to Spine in the quarter, but I don't have other people's price data.

Yes, I understand.

All right, and then in terms of the, you talked about the hip growth in Europe and one thing that I didn't hear you mention that I think you talked a little bit in past, and I was wondering if it had any impact in this quarter was, I think you mentioned that some of your products were being knocked off by European companies.

I was just wondering has anything changed there?

Have you been able to stem that?

Or anything there?

Yes, no, I think that's less of a factor now.

We put together a pretty aggressive.

They're still trying to and people do try to knock off the CLS, the [Spaterno], and the Alloclassic and they always will.

I think it was less of a factor because the growth rates in those two product lines were above market in the quarter.

I've got to assume the knock off efforts are a lot less effective then they have been and they never were totally effective.

I think Europe in hips this quarter has a lot more to do with the fact that we thought we would do a better job of sort of, if you will, inserting -- we should know better by know, but inserting our best U.S.

MIS technique over there and we found out once again that's not a good idea and we're putting in anterior supine which is for [MIS] which is much better acceptance.

I think that's hurt us.

The U.K./Germany I talked about.

The other thing is we had relatively lower export shipments relative to hips in the quarter than we expected, and some of those shipments have moved out later on.

So, I don't think there's anything special in European hips.

It's 5% constant currency growth, that market is probably growing at 6%.

It's not a big change and the 5% isn't a lot different than we've had.

I think the difference is we had expectations of a little better performance, our own personal ones, as opposed to where the market is.

That's all I got, I appreciate the answers.

Thanks.

Your next question comes from the line of William Plovanic from First Albany Capital.

My questions have been answers, thanks.

Thanks, Bill.

Your next question comes from the line of Jason Wittes with Leerink Swann.

Hi, thank you.

First off, just wanted to know how it works with your female, or your gender-based knees?

In the fourth quarter, does basically a light switch go off and everything becomes a gender specific knee, and at the same turn everybody gets sort of pushed, who wants to use Zimmer product gets sort of pushed into using a high flex knee, as well?

Is that the way to think about it?

No, not really because we will continue to offer, obviously, the standard NexGen knee today or the Natural-Knee, as an example, will continue to be offered.

The program will be targeted, obviously, at women, and if women, and/or the surgeons doing the surgery request the gender knee they will be forced into Flex because there is no other thing available.

But we're not automatically turning any switch.

This is in the hands of consumers, and it's in the hands of Zimmer surgeons, so there's no sort of automatic force.

The only difference is that if you put in gender, you will be putting in Flex.

But for your other knee lines you have an option whether to put in Flex or not, you're saying?

For the LPS, yes, absolutely.

Okay.

And terms of the rollout itself, in terms of timing, I guess you've indicated fourth quarter.

Is that a gradual launch or starting now and eventually building up to fourth quarter?

How should we thinking about modeling that?

Well, it can't start at all until the 510-K comes back,, so we're hopeful that will be anytime in the near future.

We then have rollouts in trainings and all of the usual stuff to do.

We need to get it to the developers and designers and key clinicians first.

The DTC we're doing always has a lag impact.

You never sort of do something and then the next day it comes into place.

So the reason it will roll out from the 510-K forward, not from today.

We're presuming given how we've scheduled rollouts and DTC and all of that the primary impact will be in the fourth quarter.

If we get early surprises that are favorable so much, so better, but we haven't planned it that way.

Okay.

That I appreciate.

Finally, what was the -- what were bone cement sales this quarter since it is lumped into hips, apparently?

We don't break it out.

That's too much information from the folks that we got it from, amongst others.

So we'd be happy to tell you but we're not telling them.

I can't do that, we can't tell either.

Fair enough.

Can you -- well -- I guess --

It's not a material impact on our size of hip business, if that is where you're going.

That's where I am going.

Okay.

Fair enough.

Thank you very much.

Your final question comes from the line of Scott [Thoma] with Edward Jones.

Thank you for taking my call.

Just a couple of quick clarifications.

On the U.K. issues that are going on there, I think the issues with the NHS are fairly well known, have they put a moratorium on things for the quarter, have they tried to slow things down, is it something you would expect to start seeing normal type of procedure growth as we move forward, is this a one-time issue where they tried to slow things down, or is this something we should expect to see going forward?

They've done a number of times over the years.

It was a first quarter, I don't know when the exact announcement came out, it was in December, I think, but it was a January to end of March moratorium on incremental.

It doesn't mean they weren't doing any, obviously, there were hip and knee surgeries.

But it was a budgetary restraint move on incremental hips and knees that my understanding is over April 1.

They've certainly done this in the past, at some times, if the government over there would forgive me, they've done it at times to shorten lines during election periods, and they've occasionally let the lines grow up after that, by the look of things, but there's no ongoing on this that I'm aware of.

It's a single budgetary one quarter adjustment as far as I know.

Okay, thanks, that helps a lot.

And finally just one final question.

Stryker in the past had noted that whenever they are coming out with some of their new products, they did note a little bit of slow down from their sales just because of anticipations of the new products coming out.

Is that possible in some ways where you see in the first quarter, as well as the next quarter, you're expecting the ramp up anyway, but aside from that, maybe some slow down in the sales as you expect the ramp up to come on and that's why we might see the sales being a little bit lighter right now?

Yes.

I have a tough time following that in many cases because unless you're having the surgeon move the surgery out, if you're doing a hip, you've got to put a stem in.

Unless somebody was for some reason actually moving I never followed that in hips and knees because unless you're artificially moving out a specific patient, now maybe what they were referring to, for instance, on ceramic-on-ceramic if you've got a 50 or 55-year-old that you really can have wait three or four months because you specifically want to use that product, I can understand that, but on routine hips and knees, I don't know -- maybe a little bit, but I would be hard pressed to really think that's the case and have it have any real effect on sales.

Well, thank you so much for taking my call.

Okay.

Thanks very much.

I would now like to hand the the call back to Mr. Ray Elliott for closing remarks.

My only closing remark is that Sam just put the ticket in front of me and we failed again, it's two hours and five minutes.

So once we give up.

We appreciate it.

We're sensitive, again, I'll repeat what I said with Mike Weinstein, we're sensitive to your views on the top line.

We're not going to rush acquisitions, but clearly that top line can and will grow as we integrate in businesses and as the new products come out, and we would reaffirm our comfort for the strength of those products for the end of the year and the relative underlying strength of the hockey stick.

Appreciate the good questions and all of the time you've put in.

Thanks.

This concludes today's conference call, you may now disconnect.