Zimmer Biomet Holdings Inc (ZBH) 2006 Q3 法說會逐字稿

Good morning.

My name is Luann and I'll be your conference operator today.

At this time I'd like to welcome everyone to the Zimmer third quarter 2006 financial results conference call. [OPERATOR INSTRUCTIONS] This presentation contains forward-looking statements within the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995, based on current expectations, estimates, forecasts and projections about the orthopedics industry, management's beliefs and assumptions made by management.

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

For a list and description of the risk and uncertainties, read the disclosure materials filed by Zimmer with the Securities and Exchange Commission.

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

This presentation also contains certain non-GAAP financial measures.

The 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 press release announcing our earnings, which may be accessed from the Zimmer website at www.zimmer.com under the section entitled Investor Relations. [OPERATOR INSTRUCTIONS] .

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

Sir, you may begin your conference.

Great.

Thank you, Luann.

Good morning, everyone, and welcome to Zimmer's third quarter 2006 conference call.

I'm pleased to be hosting this call to discuss a very good earnings quarter, with underlying revenue growth that was somewhat less than expected, but trending strongly in the right direction..

We indicated during our prior quarter report that we felt the second quarter was the bottom of the sales cycle and that remains our opinion today for good reason.

During the month of September, on a day rate basis, the Zimmer Americas combined hip and knee growth was more than 12%, while for the quarter in total, our entire Asia-Pacific segment grew by 11% in local currency.

Strong margins, focused metrics and ratios management, as well as near all time record cash flow production highlighted the period.

During the quarter, we again repurchased almost five million shares of Zimmer common stock and invested $314 million in doing so.

Although we will not comment specifically on the details until next quarter, Zimmer's new Gender Solutions female knee has been extremely well received, better than we could've realistically hoped for.

During the quarter, we have substantially and successfully completed on schedule, after three years, more than 3,000 milestones associated with the integration of CenterPulse.

Zimmer will derive an annual synergies benefit, an annuity, related to this acquisition of more than $100 million per year.

Our adjusted EPS in the quarter, excluding share-based compensation, grew by 17% over prior year, once again more than doubled the reported sales growth.

Joining me are Sam Leno, our Executive Vice President of finance and corporate services and Chief Financial Officer, and Jim Crines, our Senior Vice President of financial and global operations and controller.

We'll begin today's call with comments related to our third quarter 2006, including an update on operations and followed by a Q&A discussion.

All comments and comparisons are on an adjusted basis.

Further, all adjusted discussion excludes acquisition and integration expenses.

We'll focus most of our attention on constant currency revenues.

In light of the inclusion of FAS 123(R) share-based payment and our corresponding decision not to restate 2005, we'll try to provide as much apples-to-apples comparison to prior years as possible.

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

Consolidated sales for the quarter were $820 million reported, an increase of 8% to prior year, 7% constant currency and a little below expectations, but with the dubious distinction of having the smallest miss to the Street sales expectations in absolute dollars with the major orthopedic companies reporting to date.

But more importantly, the reported growth rates were materially above that of prior quarters.

Our sales growth rates for the first three quarters on a -- in 2006 on a per billing day basis were 2% in the first quarter, 6% in the second quarter and 8% in the third quarter.

Better still, our day rate growth globally in knees, on same basis, was 3% in the first quarter, 6% in the second quarter and 9% in the third quarter.

We have, however, admittedly been about one quarter behind all year in our forecast for sales growth, achieving in the third quarter our expectation for the second and expecting to achieve in the fourth quarter our third quarter goals, but the recent trends are encouraging.

The relative improvement is apparent.

Last year the third quarter represented 90% of second quarter sales, while this year the third quarter was 93% of second quarter sales, with Katrina and billing day differences essentially washing each other out.

Prior-year comps, although easier than the first half, were still 9% growth in the third quarter 2005 for Reconstructive Product segment globally.

We've been able to overcome country-specific strikes and government contractual issues in Germany, Spain, and Australia-New Zealand during the quarter, but we believe female patients in the U.S. business continue to wait for broader Zimmer Gender Solutions implant availability.

This issue, combined with spine trauma and an apparent declining use of Ceramic-on-Ceramic in favor of Metal-on-Metal accounted for timing of the 1% shortfall.

We are absolutely unable to supply Zimmer sets for all the Metal-on-Metal or Gender Solutions demand at this point in time.

Our dental business continues to be a consistent over-achiever in each geographic segment.

We will in total reset the bar and lower sales expectations slightly to 9% to 10% growth for the fourth quarter to both recognize the positive trends, but also to try to eliminate the repetition of being one quarter behind in the accuracy of our growth rate forecast, and acknowledge that, at this point in time, as hard as we work we simply in some cases cannot deliver set quickly enough to meet demand.

During the quarter on a constant currency basis, our three geographic segments -- Americas, Europe and Asia-Pacific -- all improved sequentially and grew at 6%, 7% and 11%, respectively, the latter showing exceptional strength in light of the new Japan pricing.

We believe on a weighted-basis for our combines and reserves markets, our 8% reported growth and 7% constant currency will prove to be at market growth for the quarter in Reconstructive, but trailing the market for the quarter in Spine and Trauma.

As mentioned, Recon sales grew 8% reported and 7% constant currency, about what was expected in an [arcave] measured against 2005 constant currency comp of 9% Recon growth globally and 10% Recon growth in the Americas during the third quarter of 2005.

For a little more granularity, we believe the global constant currency Recon market, based primarily on hips and knees and with about 75% of the market already reporting through this quarter at 7% to 8%, composed roughly of 7% to 8% volume and mix and zero to perhaps half a point of price.

Unlike the last two quarters, we do see a slight uptick in recent elective bookings domestically, and we can find no significant underlying future surgical demand decline or demographic trend differences.

Our latest strategic plan review of the served reconstructive market for the foreseeable future years remains unchanged, at 7% volume, 1% to 3% mix and little if any price, for an average market growth of 8% to 10% ex currency.

Surgeon capacity, operating room block time availability, and hospital profitability relative to other disciplines may continue to be issues to be managed, and occasionally may create some periodic, but not sustained volatility.

Zimmer hips in the quarter doubled last quarter's growth to 6% constant currency in a market growing at approximately 7%.

Given the releases of the Trabecular Metal Stem, the TMS Acetabular Revision System, the EPOCH® II Stem, as well as 510K approval for a Large Diameter Metal-on-Metal, we're comfortable with our current go-forward hip position.

Zimmer knees grew at 7% constant currency, with little benefit from Gender Solutions, and again a prior-year global comp of 12%.

Knees were clearly affected by both Japan pricing, where we are the new market share leader by far, and some future anticipation amongst the U.S. female population for broader availability of the Zimmer Gender Solutions brand.

The real issue for us is, when it is available, how much will Gender drive global knees over the existing base growth of 7% to 8%.

We believe the pent-up demand and sustainable interest, as the science is better understood, will drive visible, meaningful and measurable 2007 and 2008 growth.

This quarter the global knee market appears to be growing at about 7%, or the same as the current Zimmer results.

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

Zimmer's 7% constant sales increase globally was composed of volume and mix growth of 7% and slightly positive price.

Worldwide price has a 40 basis-point improvement for Zimmer in the quarter.

In fact, if you look at the last seven consecutive prior quarters, back to the beginning of 2005, global price, ex Japan, for Zimmer was positive 1.4%, positive 0.5%, positive 0.4%, positive 0.1%, positive 0.5%, positive 0.4%, and positive 0.8% this quarter, for an average of more than half a point positive over nearly two years.

In short, there's been very little price movement based upon our mix of countries, ultimately offset by corresponding and continuing strength in our gross margin.

In the same two years that price increases moderated at 1.5%, Zimmer has reported an increase in adjusted gross profit of well over 2% .

Our Bellwether America geographic segment was price positive, a gain at 1.8% versus 1.3% last quarter.

As mentioned at various times previously, the current 1.8% price improvement for Zimmer does, in part, reflect an earlier conscious decision to negotiate longer and better arrangements with key U.S. hospital groups and is, in fact, a 50% rate improvement from the positive 1.2% price gain domestically during all of 2005.

We believe that this will serve us well, not only now but in the foreseeable future.

The positive 0.3% price globally in the quarter is mostly about Japan, at negative 5.5%, as anticipated.

Expectations for prices to improve in Japan, certainly compared to our indications going into the year.

And we continue to see evidence that the combined affect of the FAC, or foreign average pricing, and the RZone, the annual Japan hospital price survey, for Zimmer will be a 2006 P&L impact of -3.7%, based upon our specific product mix and the April 1, 2006, start date.

It's important to keep in mind that the next installment of the scheduled Japan price reduction is January 1, 2007, not April 1st.

In spite of the government imposed reduction, Zimmer Japan is performing extremely well.

Without Japan, our Asia-Pacific segment is slightly positive in price, as expected.

In Europe, Germany has improved price to -3.1% from most of this year at -5%.

Iberia, or Spain and Portugal combined, registered positive price for Zimmer, as did France, Norway, Finland and Switzerland.

The UK continues to be an understressed price market, at -6.9% for the quarter; however, actual units of surgery have improved moderately with new budgets, at least for the time being.

Europe pricing total for Zimmer in the quarter was -1.6%, or slightly less than the prior four quarters.

If current trends continue in 2006, including Japan, UK and Germany at low to mid single-digit price reductions, global price for Zimmer, given our geographic weighting, will be better than our year-long guidance of -1.2% price, and is likely to complete 2006 cumulatively at even to slightly positive.

These are complex calculation given the variables, but we have excellent information technology for analyzing price and the implications of our negotiated agreements, as well as bi-country government policy changes.

I'll provide some detailed geographic and product sales analysis in a few moments, but the key to our CenterPulse deal was sustainable 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 continued prudent expense control.

We have done so without the sacrifice of any key future personnel additions or technology investments.

In fact, we are active, as always, on both fronts.

Adjusted diluted earnings per share, inclusive of the share-based payment, for the third quarter of 2006, was $0.77 on $242.6 million average outstanding diluted shares.

During the quarter we utilized our share buyback program to purchase 4.8 million common shares, as measured by settlement, at an average price of $65.60 per share.

We utilized $314 million in cash for those transactions.

For the quarter, we delivered an adjusted diluted EPS increase of 17% over prior year, excluding the share-based payment, or just over double the rate of reported sales growth.

These results are $0.02 better than the First Call consensus EPS estimate of $0.75.

We are, frankly, mystified in some calculations that there's a belief that the share buyback in the quarter created over-achievement of adjusted diluted EPS, or missing EPS.

The fact of the matter is, when you account for the lost interest income and add back the average shares weighted consistent with our actual repurchase date, a positive effect of the buyback is only $0.002 in the quarter.

And therefore, our performance at $0.77 adjusted remains representative of our on-going operations.

The pattern of significant financial returns from the CenterPulse deal, reflected by both EPS and cash flow, combined with our own distinct earnings drop-through model continues.

Zimmer's gross profit margin in the quarter on an adjusted basis and excluding the share-based payment, was a near record 78.0%, up 50 basis-points from the previous quarter at 77.5%.

Favorable third quarter mix relative to both Japan and the Recon category accounted for much of the change.

The $30 to $35 million in remaining favorable CenterPulse integration synergies, as a long list of mix and cost reduction opportunities still in front of us for 2006 and 2007, we are confident in both the potential consistency and strength of our margins.

We believe that our gross margin is, once again, at or near the top for both the orthopedic industry and major medical devices.

The remainder of the P&L analysis will be on an adjusted basis, as usual, but excluding share-based payment effects in order to provide a more realistic apples-to-apples comparison to prior year with the repetitive clarification language.

SG&A expenses and total operating expenses for the quarter, as a ratio to sales, were very good, at 38.8% and 44.2% respectively, a 38.8% SG&A cost for comparable prior year and inclusive of increased legal commitments.

Year-to-date, SG&A and operating expense ratios at 37.8% and 43.1% respectively.

We continue to take expense actions to enhance our leading position as the low-cost manufacturer and low-cost distributor, while increasing long term key investments in such areas as orthobiologics.

Over nearly a three-year time frame, starting with the acquisition of CenterPulse and a fourth quarter 2003 of 40.9%, we had publicly targeted to reduce SG&A by at least 200 basis-points, with this quarter's performance continuing in that trend.

We expect that, with the expanding number of external and internal technology and biological relationships, our R&D ratio to sales would operate between 5% and 6%.

During the third quarter, R&D totaled $45 million, a $1 million or 1.0% increase to prior year and a current ratio to sales of 5.4%, or near the mid point of our normal range.

During 2006, we doubled our internal biological personnel and project-related investments.

We've signed an exclusive relationship with Revivacor for genographic transgenic person tissue products and even more recently committed $24 million to our new Warsaw-based R&D center that is near completion.

Recently we announced initial staffing of three new emerging technologies devoted solely to orthopedic applications for woven materials, sensor technology and drug device combinations.

Along with external research and intellectual property agreements, we continue to shift R&D dollars particularly to innovative investments that, in many cases are biological in nature and are expected to be accomplished through external acquisition.

In addition to biologicals, we continue to focus our business development acquisition activities on dental, spine and hospital productivity consulting targets, for the most part in the $100 million to $400 million range for each potential purchase.

We are dedicated to paying the right price for a company with valid intellectual property, and we insist on legally-compliant business practices being in place.

The total operating expenses for the quarter at $363 million represent an increase of 6.8% to prior year.

Our 44.2% operating expense ratio to sales was a 40 base improvement over the third quarter of 2005.

For reference, in the third quarter 2006, actual acquisition integration costs were $5 million and were $10 million year-to-date due the first quarter credit related to a gain on sales of the legacy CenterPulse's Austin facility amongst other items.

We are expecting acquisition and integration costs for the year 2006 to be approximately $14 million.

Adjusted operating profit in the quarter reached $277 million.

Consistency matters.

This the eighth consecutive reporting period that we've produced at or more than $0.25 billion in operating profits.

Our operating profit to sales ratio at 34% in the quarter continues very strong and is up 100 basis-points from a good third quarter 2005.

During the quarter we believe that we have continued to deliver one of the highest operating margins in medical devices.

As previously mentioned, the Zimmer contract that we have today was modeled during the late 1990's turn-around to register approximately $0.40 to $0.50 of operating profits for each new sales dollar.

In the third quarter of 2006, with CenterPulse substantially complete, we have recorded approximately $28 million more operating profits on approximately $57 million more in sales, or near the top of our normal range at about $0.49 of operating profits on every new dollar of sales.

EBITDA in the third quarter continued to register at 40% or better of a ratio to sales and up 140 basis-points from the same quarter prior year.

Adjusted net earnings in the period continued very strong at nearly $200 million, with an industry-leading 24% net margin ratio to sales and also up 140 basis-points from the same quarter prior year.

Our third quarter 2006 tax rate improved from full-year 2005 by 130 basis-points to 28.3% and, therefore, our year-to-date EPR is 70 basis-points better than the 29.4% recorded in the third quarter of 2005.

We are equally mystified that forecasted permanent reductions to tax rates some how don't count for performance.

The effect of a tax change from our prior quarter is $0.004, and therefore, the combined effect of tax rate and share buyback is $0.006, not the $0.02 or $0.03 quoted in many analysts reports.

We believe that we can continue to make substantial progress, while simultaneously raising the performance bar on each line of our P&L.

While sales acceleration can be fairly measured against prior-year comps, and first half lack of new products, in part due to our resource allocation for Gender Solutions development, the third quarter sales growth rate is still realistically about two to three months behind where we would have liked to have been, but the run rates are simply very positive.

Just as the third quarter was an improvement from the second, we expect the fourth quarter to improve upon the third.

The simple fact remains, we have delivered solid sales growth and even better trends, combined with about the Street earnings and cash flow again this quarter.

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

Cash generation remains fundamental to our story and our strategy.

Every company has their argument about what's important, and as you know, we like cash.

We had another terrific operating cash flow quarter, beyond the favorable end of our expectations, registering $286 million and up 23% over prior year.

Measured against net earnings, these results demonstrate a 156% to cash conversion ratio from net earnings.

In three years of combined operations with CenterPulse we will have delivered some $2.75 billion in cumulative operating cash flow.

Free cash flow in the quarter was equally outstanding, at $223 million, and at the end of the quarter we had $278 million of cash and equivalents on hand.

A number worth noting, year-to-date we have generated over $600 million in free cash flow.

During the fourth quarter of 2005, our board of directors authorized a $1 billion common stock repurchase program through year-end 2007, giving Zimmer another option to increase shareholder value.

As noted during our opening remarks, we utilized $314 million in the quarter for settlements and commissions to purchase a little under five million common shares.

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

In the third and fourth quarters we have been and will be active in assessing and negotiating transactions that fit within our previously announced strategy.

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

Our third quarter combined working capital statistics continue to perform well and consistent with the large number of second half new product launches under way.

Our combined inventory days are 310, a little over last year's third quarter but inclusive of nearly $20 million of new inventory builds for the TM Stem, the EPOCH® Stem Metal-on-Metal, two new shoulders and, of course, the Gender Solutions knee.

We expect a 20 to 25 day drop in inventory days for year-end 2006.

Our trade receivables collections provides support for our strong cash flow production.

In the third quarter, we delivered excellent global trade receivables at 59 days, consistent with our prior quarter, and under our target of 60 days.

The Americas made a nice two-day improvement in the quarter to 39 days.

We continue to operate our payables days at 62 and in excess of our receivable days.

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

For the third quarter, worldwide Reconstructive sales increased to $676 million, an 8% reported increase over prior year and 7% constant currency growth.

Knees grew at 8% reported and 7% constant currency, while hips grew at 7% reported and 6% constant currency.

We expect the global Recon market to be up about 7% to 8% constant currency in the third quarter.

And as we indicated earlier, Zimmer should be equal to the markets growth.

Let's take a look at each global product category and geographic segment more closely, first some products in the knee category.

On a worldwide basis in the quarter, knee sales for Zimmer increased by 7% constant currency versus prior year to $338 million.

From a brand point of view, our NexGen LPS Flex continues its strong three-year trend, with a 45% constant currency increase to prior year in the quarter.

After over two years, we are still seeing very little direct impact from the two new competitive knees systems with respect to any [atrile] change in operating room units with market share.

LPS Flex and CR Flex femoral components sales alone are approaching $60 million in the quarter, but are still only a little of 30% of our own Zimmer knee femoral mix.

The premium we receive in the market for Flex, inclusive of Gender, remains an exceptional mix opportunity.

The legacy CenterPulse NX knee, well regarded in mobile bearing circles, delivered excellent growth at 16% constant currency.

Our new Uni, the industries first high-Flex single compartment knee, increased unit sales by more than 30% to prior year.

Offsets to these strong knee performances are reflected in several center pole specialty needs and old Zimmer brands that we continue to aggressively save down.

Our new MIS [Stemtibular] plate for assembly inside the patient quickly jumped from an early launch to third quarter sales of over $5 million, up 100% from prior year.

Highly crosslinked Prolong polyarticulating surfaces have more than quadrupled last year's units.

Prolong was released more than three years ago as the only new generation knee polyarticulating surface without free radicals, and, therefore, without oxidation risk.

And the only surface with the FDA-approved label, resistant to delamination.

It still is today.

No other products, including the new competitive releases, can make these combined claims.

They are strictly old technology in sheeps clothing.

An excellent peer-reviewed research project that I just read, published on page 1,005 of this month's Journal of Arthroplasty compares the effects and outcomes of products that retain free radicals, specifically Crossfire, brought to you by the same folks that have free radicals in their X3 today; same technical issue, same potential problem, same old story , Trabecular Metal tibial trays have continued to take share.

TM tibial trays alone reached $10 million in sales this quarter.

We over-achieved our 2005 annual target of $100 million in total Trabecular Metal sales.

As a data point of interest, during the first nine months of 2006, Trabecular Metal product sales have already totaled more than $110 million, a great mix contributor.

There has been excellent progress on the Zimmer Gender Solutions female knee.

Gender Solutions continues to be in the hands of our surgeon-developers and a select group of key clinicians and consulting surgeons.

The early feedback on fit and function has been filled with a series of proverbial light bulbs going on, usually followed with, why didn't I think of that?

We have introduced the media and patients alike to the "The Blue Ladies," two mature funny friends created by R. O. Blechman, of the New Yorker Magazine fame.

They are wearing Zimmer process blue dresses and are equally blue in mood, due to their painful knees.

In print, TV and magazines, they will travel the world, starting with their first stop in a museum, to educate fellow suffering women on the new Zimmer implant that everyone is talking about.

Speaking of exposure, we have benefited from 656 media placements and over 100 million Gender Solutions media impressions since June.

We have placed over 500 sets in surgeon's hands to prepare for a 2007 that will require a starting point alone of over 1,200 sets.

Europe is scheduled to launch Gender Knees late in the fourth quarter.

Dr. Robert Booth, Chief of Orthopedics at the University of Pennsylvania, and our national spokesman, just returned from standing room only receptions for Gender Solutions in Sydney, Australia.

We have now test marketed various aspects of our direct-to-patient campaign in: Birmingham, Alabama;

Lincoln, Nebraska;

Harrisburg, Pennsylvania; and Toledo and Dayton, Ohio.

We will move to our major metropolitan area plan as part of our New Year's celebration.

In knees we're only looking at one statistic in the fourth quarter, and that is a target of 7,500 or more Gender Solutions Knees implanted during the period.

That will tell us that, even without a full release, we have both a game-changer and a blockbuster on our hands, and by definition, a product that is capable of doing 10,000 units in the first quarter of 2007 with unlimited availability of products in the Americas only.

Let's switch to hips.

On a worldwide basis in the third quarter, hip sales were $278 million, up 7% reported and 6% in constant currency.

Porous Stems and MIS appear at this early stage to be receiving new life from the TM Stem, EPOCH® Stem and Metal-on-Metal, along with our new anterior lateral, posterior lateral and anterior supine MS techniques..

We are very encouraged with our targeted hip brands and new combined Company.

Our enthusiasm is based on the potential breadth and impact of both MIS and entry surfacing, Trabecular Metal, Metal-on-Metal, advanced polys and the continued flow of economic data for [inaudible] MIS.

Zimmer Fiber Metals and M/L Tapers, and along with the new TM and EPOCH® products are the stems of choice for our MIS hip surgery.

In the third quarter, these stem families grew by over 25%, bringing the combination this quarter to more than $34 million in sales and an anticipated annual run rate to begin 2007 of $150 million per year.

And Acetabular Cup, Trabecular Metal Modular and Durom® continue to perform well.

Trabecular Metal Cup sales have increased over $16 million in the quarter, a unit increase of over 25% from prior year.

The Durom® Cup and Stem, including the LDH Large Diameter hip, doubled sales in the quarter to almost $11 million, more good news on Durom®.

And as noted recently, we have received our conditional approval from the FDA to proceed with our U.S. resurfacing IDE.

Ceramic-on-Ceramic gains were relatively small, and we believe that in the market in general, they are on the decline in favor of large head Metal-on-Metal or highly crosslinked polys.

Premium-priced longevity in Durasul® highly crosslinked polyethylene liners units increased by almost 10% again, and when annualized delivered over $100 million per year in sales.

In the future [colerated] mechanical lineal, vitamin E, or other polytechnologies exclusive to us may well be the true second generation offering.

We've also been very pleased with our performance on PALACOS® and other bone cement products.

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

New platform products, including the Trabecular Metal Hip and EPOCH® Composite Stem for MIS -- TMS Acetabular Revision, new techniques like Zimmer anterior lateral, posterior lateral and anterior supine, bigger Metal-on-Metal heads and a new antibiotic bone cement are expected to make significant growth contributions.

In extremity products, the new inverse and reverse shoulders, along with Trabecular Metal Shoulder Stems, contradicted to our growth worldwide, a solid 18% constant currency increase for the third quarter.

Total Zimmer extremity sales grew 16% in the quarter, and based on year to date sales trends, are annualizing at almost $80 million.

To complete our reconstructive discussion, Zimmer Dental had another very successful quarter, with sales of $42 million, up 20% reported and 19% constant currency, in both cases a full four point run rate sequential quarter improvement.

The Dental business showed solid performances in all three geographic segments, with the Americas, Europe and Asia-Pacific up 19%, 10%, and 35% in constant currency, respectively.

Dental implants increased by over 19% constant currency, while Dental regenerative graft sales, including our new biological graft, Puros®, were equal strong, up 20% in growth.

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

We're particularly pleased with the Americas market figures at almost 20% growth gain and the implied inability of internet mail order implant sellers to penetrate the market without providing world-class advanced implantology education and live interoperative support.

Congratulations to our Dental team.

On a worldwide basis in the third quarter, Trauma sales grew 9% constant currency to $48 million.

The global Trauma market, in general, appears to be at low to mid double-digit growth, and we will need to make more progress.

However, we've only going deliver new products and this 9% growth is still above our year-to-date growth.

With expanded field releases of our new locking and universal plates, as well as MCB, our plate and screw sales in the quarter increased by 10%, but were held back by the continuing decline in compression screws of negative 12%.

With the introduction of legacy CenterPulse's [Cyrus] Nail to compliment Zimmer's ITST, IM nail sales increased by 33% to an annual run rate of $50 million and a huge improvement.

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

But we will need to be consistently at mid double-digits to be market competitive.

Our Zimmer Spine division sales increased by 10% constant currency, a little less than less quarter, with sales $42 million.

We are pleased with this continued double-digit sales growth, although with tougher Dynesys® comps and a temporary registration issue with our pedicle screw system in Japan, we are under market.

Excluding Spine biologicals, it's true that the spine market is growing at about 12% or closer to 15% with biologicals.

Cur cage sales did increase to $8 million, but our strongest story, once again, is seen as our Dynamic Stabilization System.

Sales reached almost $13 million in the quarter, and despite the major comp anniversary, we're still up 18% over prior year.

Dynesys® continues to grow into well over a $50 million brand, and when combined with almost $4 million of spinal Trabecular Metal, these two technologies delivered some $17 million in sales in the period or more than double the contribution of cages.

A major decline in the quarter was solely related to a pedicle screw registration issue in Japan that is expected to be temporary until early 2007.

As we're noted several times, the combination of Trabecular Metal, Dynamic Stabilization MIS and additional pedicle screw technology and biological acquisitions should create a globally competitive spine business.

In orthopedic, surgical and other products, sales increased slightly from prior quarter, but declined versus last year by 4% to $53 million on constant currency basis.

Obviously, Orthopath's declining by $7 million to prior year took its toll, as we phase out this distribution agreement.

We expect this decline to affect sales growth negatively by at least $7 to $8 million each quarter in 2006.

This assumptions already implied in our guidance provided and through the end of February, 2007.

Fortunately, our Japan and [inaudible] in the powered tool business helped offset Orthopath, with growth of 16%.

Zimmer and Brasseler U.S. have entered into a five-year U.S. distribution deal for large and small-bone powered surgical instruments and disposables, including a Zimmer-branded blade.

Our first five major U.S. distributors are receiving product training during the fourth quarter and we expect a successful rollout in 2007.

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

Nearly two-thirds of our R&D investment spending relates to innovative products and platforms, with a real bent towards economic value-added and improved patient quality of life.

At the end of the third quarter, we're managing 116 active new product development projects.

We currently have 29 active hip projects, 24 in knees and 21 in trauma.

We are launching 12 major new products in the second half, and a grand total of more than 20 new products in the period, with the most significant, of course, being Gender-specific knees.

We can now state with real experience 20 new product introductions or 12 major product introductions in a single half is too complicated, particularly in the summer.

During the quarter, we completed our initial analysis of Gender hip data, with a large number of statistically significant differences between men and women.

We plan to utilize our proprietary two-dimensional CT scan to three-dimensional implant designed intellectual property to create scientifically supported female hips.

In the near term we will also initiate early evaluation of ethnic hip and knee construct differences.

During the quarter we also signed for the exclusive ownership rights to intellectual property from the University of Tennessee and the Patel Institute for advanced sensor technology usable in major orthopedic implant applications.

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

That number should easily exceed $700 million in 2006.

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

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

New product sales for the third quarter of 2006 were just under $200 million or a record 24.3% of sales.

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

Zimmer Americas had a better quarter, with some limited ability to sell Gender knees and early utilization of Metal-on-Metal sets, but ultimately we continue with pent-up demand for both.

Pure price was successful again, improving to 1.8% from 1.3%, sequentially.

Americas revenue for the quarter was $502 million, the third time we have reached the $0.5 billion mark and up 6% over prior year.

The Americas reconstructive growth in the quarter was up 8% and delivered $405 million and a nice sequential run rate growth improvement of two full points.

We believe that this 8% growth is just slightly below market.

But with 12% prior-year comps and many more new products still to deliver in the second half, we remain comfortable with our strategy.

As we stated earlier, we are better off than expected, relative to Recon growth rates.

J&J, BioMed and Stryker -- the latter two with major new knee system releases with full distribution -- are only collectively growing combined hips and knees domestically at high single-digits in the quarter.

In our Americas Reconstructive category, knees had a growth 6% growth to $225 million.

NexGen® LPS and CR-Flex, new new high-Flex Uni Trabecular Metal tibula component, and the new MIS Stem tibula all made substantial contributions to Americas knee performance.

Hips in the Americas increased 8% to $141 million, and at market, with domestic hip growth figures likely at 8%.

We are reasonably satisfied with the hip growth in the quarter, even though it's only at market.

Given the new stems, our bone cement growth trajectory, Trabecular Metal, Acetabular Revisions Systems,and the full launch of large head Metal-on-Metal, we are, in fact, well positioned.

Americas hip performance benefited from MI porous stems, Trabecular Metal Cups, and highly crosslinked poly.

Our dental business in the Americas grew at 19% in the quarter to $27 million.

The Americas operating profit in the third quarter of 2006 was $265 million, for an excellent operating profit to sales ratio of 53%.

Let's take a look at Europe.

We continue to be pleased with the underlying constant currency sales growth and the traction being gained, relative to what appears to be a more difficult 2006 European medical device market.

We believe that we are clearly growing Europe above market levels.

In the third quarter, European revenues were $197 million, up 7% constant currency, and up one full point sequentially in run rate from prior quarter.

As mentioned previously, price decline in the quarter for Germany improved, and this along with the previously described countries contributed to our -1.6% price for all of Europe.

We still expect to see a new DRT-like tariff system in France -- still probably mid single-digit negative -- very late, if at all, in 2006, and some price improvements in Iberia and Italy and, hopefully, the UK.

Reconstructive implants in Europe delivered sales of $175 million in the quarter, an increase of 6% constant currency.

European hips were negatively effected by German and UK pricing changes from rotating German and Spanish hospital strikes and surgeon disenergies.

But despite all these circumstances, stayed, much to our surprise, in positive territory at 2% constant currency growth.

Knees grew a solid above-market 9% constant currency.

Positive gains in the quarter reflect the continued acceptance of both Durasul® and longevity highly crosslinked poly, some early [impactivement] on the invasive instrument deployment to the growing acceptance Durom® and Trabecular Metal, as well as ongoing market share gains for the NexGen® and NX Knee brands.

Many of Europe's country businesses performed well in sales growth versus the competition.

South Africa, Sweden, Russia, the Middle East, Eastern Europe, Portugal and Belgium all grew constant currency sales for the quarter at double-digit or better.

We are pleased to report that, as expected, our Zimmer UK business rebounded a little after government-imposed budget constraints.

Italy, Spain, Netherlands, Germany, Switzerland and Austria all remain solidly in positive territory.

For the quarter, Europe delivered operating profits of $70 million and operating profit to sales ratio of over 36%, a 160 basis-point increase over third quarter 2005, and far from the 25% ratio to sales during our first full quarter combined with CenterPulse.

In Asia-Pacific, revenues in the third quarter were $121 million, an increase of 11% constant currency and up on a sequential run rate basis by eight full points.

These are extreme good results, considering Japan's -5.5% price in the quarter.

We believe that the Asia-Pacific Reconstructive market the growing at mid single-digit rates in local currency.

And as a result, net of the synergies of periodic geopolitical disruptions, we appear to be taking share.

Japan's constant currency growth rate in the third quarter was 9.2%, dramatically above market.

In the third quarter, our combined Asia-Pacific businesses delivered $econstructive growth at an excellent 10% constant currency to $96 million in sales.

We expect Trabecular Metal tibula components, the NexGen® CR Flex knee and the strength of the CenterPulse natural knee will continue to improve Asia-Pacific's new performance, this quarter up a surprising 12% in constant currency.

A new Japanese ECMJ hip, some hoped-for Trabecular Metal regulatory approvals and MIS-driven expansion will help to further grow our hip performance, with this quarter rebounding to 6% constant currency.

While our ental business is small in Asia-Pacific, it did delivered another very strong 35% sales increase.

Several country constant currency growth rates were good, with Korea and India both at 25% or better.

Japan, despite a negative five -- 25% price, as mentioned, had a solid 9% constant currency growth in a market that now, with 2006 pricing cuts doesn't grow much over 2% or 3% in volume and mix alone.

The Zimmer Asia-Pacific businesses delivered $54 million in third quarter operating earnings and a very solid 45% operating profit [inaudible], up 160 basis-points from the third quarter of 2005.

While that covers the key components of our business in what I believe is record time, Sam, I know you have your usual elaborations, but let me deliver one additional fourth quarter aspiration, along with my previous wishes 17,500 Gender knees implanted.

If we can deliver a 10% growth with the high end of our current guidance for the fourth quarter as a ramp to fiscal 2007, then we are where we need to be.

Sam, what are you thoughts?

Thanks, Ray.

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

We include a breakdown of price, volume mix, foreign currency and constant currency contributions to both geographic and product sales growth in our 10-Q each quarter.

In the interest of time, I will not cover that level of detail now; however, that information will be available in the Investors Relations section of our website immediately following this conference call.

In the third quarter, the contribution of foreign currency to sales growth was 0.7 of a point or $5 million.

And as of Monday of this week, the U.S. dollar had changed only modestly against most major currencies as it compared to rates in effect three months ago, when we conducted our second quarter earnings call.

If the U.S. dollar holds at current levels for the balance of 2006, the contribution of foreign currency to sales growth for the fourth quarter should be favorable by about 1.6% or $13 million.

This level of contribution from foreign currency is already incorporated into our latest sales guidance.

Effective January 1st, we adopted FAS 123(R), share-based payments, using the modified perspective payment method.

And in accordance with this adoption method, we did not adjust our historical financial statements to reflect the impact of share-based payments.

The adoption of this new accounting standard reduced earnings per share in the third quarter by $0.05. in order to understand the comparisons to prior year, I will identify the dollar amount of this new accounting standard on each line of the adjusted P&L.

For cost of goods sold and gross profit, we had a $3 million impact, or approximately 0.3 point in sales.

Research and development $2 million, approximately 0.3% rounded to sales.

SG&A, $12 million, 1.5% of sales.

Operating profits, $17 million, 2.0% to sales.

The tax effect is $5 million or 0.6 of a point in sales, and net income $12 million, 1.4% to sales.

Our acquisition and integration line this quarter was $5 million.

Since the acquisitions of CenterPulse and Implex, we have spent $325 million on acquisition and integration costs. $227 million of those costs were expensed to the P&L.

Although the vast majority of the integration activities aer behind us, a few items still remain and should be completed in 2006 with some spillover into 2007.

Some of those items include continued IT systems conversion, continued manufacturing in-sourcing and some warehousing consolidations in a few countries.

The only debt we have in the books is $101 million in Japanese debt, because it carries a very low interest rate.

And with our continued strong operating and free cash flow, we have accumulated $278 million of cash in the balance sheet.

Subtracting out the $101 million of Japanese debt, we have a positive net cash position of $177 million. interest income in the quarter was $600,000 compared to $2.1 million of interest expense in the third quarter of last year.

In the quarter, we recorded $100,000 in minority interest income related to one of our small European subsidiaries.

All references to our effective tax rate will be on an adjusted basis.

Our ETR for the quarter was 28.3%, which is 130 basis-points below the full year of 2005.

Year-to-date, our ETR is 28.7%, and assuming that's our year-end, the R&D tax credit is extended retroactive to the beginning of the year.

As it has been in past years our full year tax rate should be close to nine month year-to-date effective tax rate. capital expenditures for the quarter were $63 million, consisting of $31 million for additional instrument sets and $32 million for all other property, plant, and equipment fixed asset additions.

Our expected full-year capital expenditure estimate is approximately $255 million, consisting of $125 million in instruments and $130 million in all other PP&E fixed asset additions.

Depreciation expense is $38 million, and as a result of the CenterPulse and Implex acquisitions and the related $596 million of amortized or intangibles recorded at the time of those acquisitions, amortization expense in the third quarter was $13 million.

On December 15, 2005, we announced that our board had approved a share repurchase program, authorizing us to repurchase up to $1 billion of Zimmer common stock through December 31, 2007.

In the third quarter we repurchased 4.7937 million common shares at an average price of $65.60 for a total cash outlay of $314 million.

To date we have repurchased 9.9515 million and an average price of $63.79 and we have $365 million of our $1 billion authorized repurchase program remaining.

Foreign currency rates today are very consistent with those that were in effect when we provided sales guidance during second quarter earnings call.

Sales growth in the third quarter, however, was not as strong as we anticipated because the contributions from our new products are taking a big longer than expected to realize.

And as a result, we are lowering our sales growth guidance for the fourth quarter to a range of $922 to $932 million, which represents an increase of approximately 9% to 10% growth over prior year.

This is one percentage point lower than range in our previous guidance.

Our previous Q4 guidance for adjusted diluted earnings per share was $0.99, and given the strength of our margins, we are reaffirming this previous adjusted earnings-per-share guidance.

In summary, during the third quarter we continued to demonstrate our ability to generate excellent earnings per share growth under a variety of different business conditions, and we exceed First Call consensus, as well as our previous guidance, by $0.02.

In addition, we began to roll out a number of new and exciting products, including to name only a few, our NewGen® Knee System, Trabecular Metal Primary Hip Stem and Acetabular Revision System, Durom® Acetabular Cup with Metasul® Large Diameter Heads; and our new inverse and reverse shoulder.

New product sales were approximately $200 million in the quarter and represent a 24% record of consolidated sales in the quarter, and this is three points higher than the 21% recorded for the full year of 2005.

Our dental business was up 20% over prior year, and this is the seventh quarter in a row of double-digit sales growth in our Spine business.

Continued strong margins, coupled with strong asset management, contributed strong operating cash flow of $286 million in the quarter, which was 56% more than our reported net income.

Operating cash flow and free cash flow increased 23% and 32% respectfully, and 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 ETR is at an all-time low of 28.3%, and we repurchased almost five million shares of Zimmer common stocks during the quarter.

Our third quarter sales grew faster than our second quarter, and our fourth quarter is expected to grow faster than the third.

Finally, to reiterate one of $ay's earlier points, our aspirational goal is to enter 2007 from a fourth quarter launch-pad of double-digit sales growth.

Our fourth quarter 2006 sales call be held at 8 a.m. eastern standard time on Tuesday, January 30, 2007

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

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

[OPERATOR INSTRUCTIONS] Our first question comes from Matt Miksic with Morgan Stanley.

Hi, good morning.

Thanks for taking the call.

A question on the components of growth for Q4.

Sam, you gave a 1.6% FX based on current rates, I guess.

And I just wanted to get an idea if that's the FX contribution, how are you thinking about price sequential improvement again.

Is there a mixed component to growth?

Can you help us understand that a little bit?

I can comment on part of it and then you can jump in.

Matt, it's Ray.

First of all, the new component -- or the new product component, I should say, is accelerating and it's accelerating considerably now.

Now, we haven't done a good job of forecasting.

We're off by two or three months here, and that's our fault.

However, the actual rate of growth in new products -- and you tell by the ratio of total sales and the acceleration and the fact that we just haven't been able to keep up at all on sets for Gender and Metal-on-Metal -- so the new product component of it -- and those are high mix content items.

Both Metal-on-Metal are very, very high-mix, high-margin, and Gender, of course, has Flex built in, so that, along with the other new products that we're trying to get out in time.

I'm not expecting price to be much different.

I would be very happy if price in the U.S. hung in at 1.8%.

That's a much better number than any of us expected.

And then the volume growth we've talked about, so that should get us to the number.

But, you know, it's our fault.

We haven't -- we've been off on timing of the forecasting and probably should smack ourself for that, since we knew we had to start all those product releases in the summer.

But what's done is done.

Be that as it may, we still think that the run rates are attractive and going in the right direction.

Okay.

So I'm coming up with something in the neighborhood of 7% to 8% volume and mix.

Is that in the right range?

Well, I think if you assume we want to get [[aspirationally]] to double-digits and you know what our guidance is and you back out price as described without change, sure, I think you get right around those numbers.

And I haven't sat here and done it on paper, but I think that's right.

Okay.

And then you mentioned the sets.

You're at -- what was it -- 500 so far, and you're hoping to get to 1,200.

Can you talk about what's the difference between -- it seems like the Gender knee set is something that you can move a little quicker on.

Is there something different about this roll out, given that it's built on top of the NexGen® platform?

Well, it's implants and provisional sets, because we shouldn't mix up instrumentation.

The instrumentations relatively similar.

The ability to get out the sheer number of implants and provisionals required to do the inter-operative test, has been -- it's not that it's a challenge. t's just the demand for our -- exceeds our capability to do it, and it's not done on the same equipment as standard NexGen®.

And then, Metal-on-Metal, it's just the same story, except that's both instrumentation and implants.

And we just have a demand that exceeds our capability.

We've got people working overtime, et cetera, et cetera, but we can't get there as quickly as we wanted -- or as much as we might like to.

So, we're turning them out as quickly as we can.

Right now, we have a lot of sales reps complaining because they're -- at 10:00 at night they are swapping sets with each other to try and meet a surgery the next morning, and we've got more turns right now -- turns being the number of times utilized in instrument sets per month per surgery -- we've got more turns on those two items now than I've ever seen in any new product.

So it's a challenge right now, frankly, but we're going to get there by year end and stabilize this and have the number of sets out there that we need to start the new year.

One last question, if I can?

You mentioned surgeon desynergies in Europe.

I think that we've heard that before.

Is that annualized any time soon or is that sort of like an ongoing thing?

No, a lot of it was earlier, and it does annualize for the most part in the early parts of next year, so we do get rid of that as a comp calculation issue.

But it's still there through the end of the year.

Okay, great.

I'll jump back in queue.

Thanks..

Our next question comes from Katherine Owen with Merrill Lynch.

Thank you.

Good morning.

Just wanted to follow up on the question regarding the capacity.

I just want to make sure I understand that it's -- the Metal-on-Metal and the Gender Solutions are the two products right now where you're capacity constrained, and but for that, the revenue would have come in where you would've expected it in the quarter.

Is that what you're saying?

I think there's four things.

I think that's exactly true.

And I think to that you have to add that we underperformed in Trauma and we underperformed in Spine.

The Spine one is a Japan registration issue.

We would've been fine in Spine.

That was the surprise.

We had some paperwork that has the wrong language descriptions on it, and we need to redo all that.

The Japanese government doesn't allow that.

So that was a surprise.

That stung us in Spine, was unexpected.

Trauma, we're underperforming the market right now and need to be a better job in new products.

Failing those two and as you're suggesting, if we could have got an unlimited number of sets, we would have been fine.

But that's if, if, if we didn't do.

The fact of the matter is we didn't.

And then just a second question.

One of the things that we saw at NAS was how big the physician-owned spinal companies have become.

It's probably approaching 15+% of share, now, of the spinal market.

Can you help us think, why couldn't that or wouldn't that happen on the Reconstructive side, where a trend that was barely noticeable a few years ago in Spine has become such a big component?

And then, switching and looking at Recon, why wouldn't we see physician-owned reconstructive company?

I think there's a number of reasons.

The size of the wall you have to climb to capitalize and equipment and put in place on hip and knee, even in the France's and the Germany's where you have a lot of one-off kind of hips and knees that are supported by three or four surgeons, you don't see the amount of it that would equate to anything near that size market.

I think spine is a very rapid change, highly innovative, has a lot of unique products.

I will also tell you -- and I read numbers higher than that, actually.

I think the answer's probably somewhere between15% to 25%.

I will tell you, I think you're going to see -- because we are part of that exercise, if you will -- you're going to see that a lot of these people do not have freedom to operate under intellectual property.

And you're going to see that they've been trampling on intellectual property -- not all of them, but a lot of them -- and you're going find that, while we've under the radar in the past, some of the big spine companies -- and in fact, us included in some cases -- in partnership are going to not let those people operate under the same easy rules they've had in the past.

So I wouldn't count on -- first of all, I think the government frowns upon those setups, in general.

Secondly, I wouldn't count on the fact they're all going to have freedom to operate and sell their products like they have in the past.

Okay, great.

Thanks.

Our next question from Bob Hopkins with Lehman Brothers.

Thanks and good morning.

Good morning, Bob.

Two things.

First, I'm trying to understand the degree to which the Gender Specific opportunity can be additive to growth.

So you suggested over the next two quarters you'd have 17,500 implants done.

Can you give us a sense as to the degree that you're going cannibalizing your own knee systems, what ASP benefits might accrue?

And then secondly, can you give us any evidence -- now that you've been out with this for a little bit -- from a marketing perspective how we should think about the potential of this product to allow you to gain share from your competitors, which, as you know, historically's been hard to do in orthopedic?

Before you turn the 17,500 into guidance, I termed it an aspiration, so I don't want you writing it up as guidance.

Yes, I'm not going to disclose -- the premium for Flex is substantial and historic.

We've had Flex actively in the marketplace for more than four years, so we understand it's about 30%, as I've often disclosed, of our existing femorals now, and it is a substantial premium.

To that, we are actually getting a premium for Gender on top of that, which I don't know if that's going to stay or no,t or whether we just revert to a straight premium.

So you have a number of situations by which you make a lot more money.

One, you convert existing surgeons simply to Flex first, and convert them to Gender afterwards.

You convert existing Zimmer Flex surgeons to Gender, which we get a premium, and they will tend to get stronger units incoming, because of the marketing programs we've put together.

And then obviously, the big conversion and the one you asked about last is converting competitive surgeons.

We have already converted several competitive surgeons to this product line because they understand the science and we've taken them through it.

There's not a lot of products out there that are going to convert substantial amounts of people between manufacturers.

It's a sticky industry.

It's not just not the nature.

I think Trabecular Metal has been one for us.

I think MIS has been one for us.

And I think Gender will be, if we can effectively communicate the science and not have people get caught up in that sizes will [solve] it or this is just a size.

So, the onus is on us to deliver the science story.

If we can deliver it, this will move market share, and there's not many orthopedic products that I would say that about, ours or other peoples.

Just given the events that you have now, let's say, take this first quarter aspiration of 10,000 units, just ballpark what percentage of that do you have confidence in at this point could be new surgeon implants versus cannibalization of current surgeons -- current Zimmer surgeons?

Oh, of the first quarter 10,000?.

Yes.

Oh, it's going to be very little competitive, because the -- you know, it's more to do with politics and commitments we have with people.

We have so many committed Zimmer surgeons that want to convert to this that in any given city or town if we -- even though we make a lot more money on the conversion of a competitive surgeon, we would be in a political nightmare if we started handing it out first to competitors.

We'd like to from an economic point of view, but it's simply not practical.

So I would tell you the percent of the 10,000 is very small.

Okay, and then just one last question. [Straman] has a conference call, I think it was yesterday, where they suggested that they wanted to get much more aggressive in the U.S. when it came to dental, implying that might be through acquisitions, or at least that was my interpretation.

I think I know the answer to this, but it sounded like your comments that dental remains very strategic for you.

I just wanted to get confirmation of that?

Well, it's very strategic and I read very quickly the [inaudible] outline and I thought maybe it was somebody else's interpretation.

But I thought they specifically said that they would look to mid to large acquisitions which, frankly, surprised me.

Again, I'm not sure if that was written by them or that somebody else's interpretation.

But if that's directed at other people then that's fine, but dental is a strategic keeper business for us that we're very, very pleased, and frankly continue to become more and more enamored with.

And then, finally, any update on the DOJ process with the original set of issues back from, I think it was March of '04?

No, there's nothing -- nothing there to tell you, anyway.

March of '05.

Yes, March of '05.

Thanks very much.

Okay.

Our next question comes from Steven Lichtman of Banc of America Securities

Thanks.

Hi, guys.

Ray, can you talk about your view on why you think we're seeing a move from Ceramic-on-Ceramic to Metal-on-Metal from docs?

I think it's a combination -- I don't know that it's so much negative on the Ceramic-on-Ceramic.

You hear -- and I will tell you this as anecdotal, so I'm not challenging anybody -- but you hear antidotal issues back to some of things that have been heard in Europe for many times, the squeaking issue.

When they go -- they don't break very often, but when they do go, they create catastrophic damage. it's not like the sort of gradual decline of a poly.

You hear some of this sort of traditional chatter about Ceramic-on-Ceramic, so that may be part of it.

But I think more than anything else, Large Head Metal-on-Metal performance characteristics -- whether it's ours or other people's -- combined with the positive characteristics of antidislocation, I just think Metal-on-Metal is coming of age for most of the companies that have it -- including us now.

And that's weighing against the other obvious alternative of alternative bearing, if you take out highly crosslinked poly, and I just think it's becoming less of a contest, frankly, maybe in part, too, because of some of the downside anecdotal [inaudible].

But, I will tell you, we are -- as you can tell from my comments on sets -- we're overwhelmed with Metal-on-Metal demand, and we are underwhelmed with Ceramic-on- Ceramic demand.

OKay.

And then I'm wondering if you could give us some more color on you comments about expected trends in European pricing, as we exit this year and into next year, in terms of France and then also on the upside, Iberia and hopefully UK?

What do you think are going to be some of the trends?

If you give a little more color, that's be great.

Yes, I think it's going to end up wash out where we are now, for what it's worth.

I don't think the price is going to change very much.

But I think what we will see -- at some point we're going to see this French tariff change.

When I don't know, because they keep delaying it.

I think if you put that in place, if Germany stays where it is and the UK improves slightly, when you wash all through I think for us -- now again, I'm not speaking for anybody else but us, because it's a product mix, country mix weighted -- but if you look at our mix, I think it's going to stay about where it is because we have very large German and French businesses, with Italy being the next largest, that's positive.

Spain being the next largest, that's positive.

And then the UK,. it's hard to tell what's going to happen with the NIH there.

So I think when you wash this through for Zimmer, we're going to end up about a point to a point and one-half negative, and that's kind of where we've been running now, although the mix of countries will be different.

Okay, and then lastly on number of selling days, I think you touched on in the third quarter the impact was a wash versus Katrina from last year.

Can you quantify a little bit more in terms of what the impact was this quarter, and then in terms of the number of selling days next quarter and what the impact may be?

When I look at our average U.S. business day and -- for days of the week, because, obviously, the days of the week have very different [inaudible].

I look at the average week and I look at what we pronounced that we lost in Katrina, those are basically a wash in the quarter, plus or minus $0.5 million.

So, the people that using Katrina as a calculation and saying, gee, these guys didn't grow very much because they had $6 or $7 million in hand, that's really not accurate at all.

It's kind of like the tax and share buyback argument.

I don't think people are using the right calculation. if you look at the fourth quarter, I think as has been mentioned in a couple of other calls, there's an extra day -- the U.S. being our predominant business, there's an extra day we'll pick up, but the extra day, unfortunately, is at the end of the year and it's in December.

And the extra day doesn't help you, because the problem is when it's at the end of the month in December, you'll run into holidays, and if you're lucky you'll get a third of a day or a half day's billings out of that.

So I would tell you the fourth quarter is meaningless, even though it's technically a little extra.

And I would tell you the third quarter's a wash because the day offset -- at least in our case offset potentially what we believe we lost in Katrina.

So I kind of think we're even money in the second half relative to sort of billing per day rates, if you will.

Okay, got it.

Thanks, guys.

Our next question comes from Ben Andrew with William Blair.

Good morning.

Good morning Ben.

Just wanted to check in on a couple of things.

You talked about European pricing.

Can you give us a sense of what we should look for from volume and separately a mix dynamic as best you can over the next year?

Now you're talking Europe?

Yes, Europe.

Europe, Europe only.

We think it's going to be about a five or -- this is not our guidance or speaking of Zimmer.

We think it's going to be about a 5% mix -- 5% or 6% growth market in the sort of main hip and knee.

Obviously all the companies have different mix of countries over there, so it kind of -- I'm speaking just raw market because of the different country mixes and so on.

It's been a tougher market this year than I would have expected, not so much in price but in units of surgery.

I think it's been a little tougher European market this year.

Eucomed, which is the European version [Absomed], actually produces for the participating companies -- including all the big companies -- the actual units of surgery done by those companies on a per -- I think a per quarter or per monthly basis.

In any event, we have pretty accurate data as to what's going on over there, so that's probably a good number.

So, five to six market growth, that includes minus one at six or so percent price?

Yes.

Yes.

And then, obviously, we would like to be better that that if at all possible.

But I would suggest -- again, I'm talking primarily hips and knees.

Don't include spine or other things in there.

I'm talking primarily sort of basic Recon.

Sure, as is there any mix baked into that, or is that just sheer volume?

There is mix now -- mix into that in our case, but you also have to remember much like in Japan, in a lot of the countries you don't get full value for mix.

Some things you do, some you don't.

We have places where we do extremely well do Trabecular Metal.

We have other places where we get very little for it.

Same with crosslinked poly.

So, Europe you have to be a little bit careful by country basis when you're starting to look at mixed calculations.

Okay, and then on the gross margin side, may be a question for Sam.

Talk about the specific opportunities over the next 18 months to continue driving that higher.

Well, as we mentioned, we still have some spill over into 2007 of manufacturing insourcing.

And the way the manufacturing cost reductions work is to the extent that you can reduce costs in any specific day or month, you don't actually see the benefits appear until some 270 days later, when the [inaudible] inventory gets burned off.

So, a lot of activities that we have in place this year to improve product costs, we actually won't see until next year, rolling out later in the year, as well as the specific activities that take place early in the year.

That's one area.

Volume given the size of our plants, we have essentially three large plants here in Warsaw, [inaudible] in Puerto Rico.

Volume plays a good role, so we get good leverage on volume, and that helps us.

Mix as an issue, as Ray pointed out, with all the new products we have coming out.

That's helpful.

Price has not been the drag that we thought it might be, so that is not a take away, as we thought it could be for this year.

So that's helpful.

So just a variety of things.

Like hedges.

To the extent that we can continue to focus of excess amounts of inventory, that falls into there.

We record our hedge contract settlements and cost of goods sold, and depending on which direction the dollar goes against foreign currency, that's either a benefit or a drag.

Royalties plays a role.

If we are benefited by selling more products at a lower royalty rate, that helps us.

The flip side is also true.

If we sell products with a higher royalty rate, it goes against us.

So there's a lot of things that could go either way, depending on the mix of product.

I think that new products -- if you look at the new product mix, it's Gender.

It's Flex.

It's inverse reverse shoulders with Trabecular Metal.

It's Trabecular Metal Stems Acetabular Systems.

It's EPOCH® composite technology.

These are all mix loaded new products, and if we continue to run at 20% to 25% new product content to total sales and continue to drive down and aggressively phase out the older products, which, frankly, were less mix related, if MIS continues to go up as it has been, it attracts by definition porous stems and high mix knee products.

So you'll really get a lot of benefit if you manage the individual content of your sale.

Just a quick follow up on that.

If you look at that new product mix and the 20% to 25%, specifically Gender, what is the royalty dynamic as best as best you can explain it for us?

The relative dynamic on Gender?

Gender and some of the other new products that --

Nothing unique in it..

It was -- I think when we did the press release, we listed the 13 developing surgeons who worked on it.

It has -- you know, they have burden rates that we keep within targeted and specified ranges, so there's nothing special about it.

Okay, thank you.

Our next question comes from Milton Hsu with Bears Stearns.

Hi, good morning guys.

Hi, Milt.

Ray, can you just talk about the potential for penetration of Metal-on-Metal hips in your population or as a percentage of your units?

I mean, can you get to about 30% where some of your competitors are?

We don't have the targets that are that high internally, so I don't know.

I read the follow-up -- or listened to the follow-up on Wright yesterday, and I know they have -- I thought I heard them say a number like 70 something percent.

I know that [inaudible] was somewhere in the 30's in Ceramic-to-Ceramic.

We don't have targets that high, but I would tell you if we get up into those kind of numbers that -- you know, it's back to Ben's question -- the mix and profitability impact is huge.

We've always tended to think of alternate bearing, and not highly crosslinked poly, but ultimate bearing the context of Ceram -- Ceramic Metal-on-Metal, and settling in somewhere around 8% to 10%.

But admittadly, these companies right now are running a lot higher than that.

But that's -- we don't have any internal targets that are near that.

Okay, and then any plans for longevity large diameter head that would maybe address some of the concerns that some surgeons out there may have about Metal-on-Metal couplings?

Yes, that's a good one that we want to have.

There's limitizations in the head sizes.

I think that was going back to Bill Harris's original work at Massachusetts General and his development of highly crosslinked poly and then believing that the large diameter head in,combination with the poly, would give you the least debris and the least possibility for dislocation.

So, yes, absolutely.

Okay, and just two quick ones.

One bigger picture, which is Japan.

With all the cuts we've seen over the last ten years, do you think we're approaching a rate where the MHLW may eventually slow down and say that their pricing is on parity with where they want it to be?

And then the last one on manufacturing, any plans to outsource as -- to try to met the demand for Metal-on-Metal?

On the first one the answer I would give you is that the government has repeatedly stated that once they get to the market basket they're satisfied with -- and that had to include some European countries, and we know we're now using that basket -- but they have also looked at one and one-half times that foreign average pricing basket in orthopedics as being an acceptable place to be.

And to the best of my knowledge, the companies -- all of us collectively in orthopedics -- are there now or very close to it.

So unless they change the rules, that would suggest that they focus their attention on other part of medical devices or other areas of healthcare that far exceed that.

So theory would suggest, yes, but as with anything else with the Japan government, I can't give you a very refined answer.

Metal-on-Metal is not going to be outsourced.

We have the capability to do that and catch up.

It's not our capacity that was registered as the problem.

It's the demand that took us by surprise.

That's perhaps our own fault or we didn't even see that opportunity.

A great deal of that is produced in Switzerland.

That is an operation [inaudible] that we want to expand,and as you know we are contrarian when it comes to outsourcing.

We like controlling our own margins and, particularly, the quality of our own product when it's highly tolerant like this is.

Plus, our product is a very different product. it's a rock-high carbon that doesn't lend itself as well to some of the opportunities outside the business.

It's better that we control it.

Yes, the manufacturing process is unique enough that, even if we wanted to outsource -- if we had a sudden spike in demand -- we probably couldn't -- we couldn't anyway because anybody we'd outsource to would have to buy the same equipment that we would have to buy, so there would be no time advantage to try to outsource.

Great.

All right, thanks.

Our next question comes from Tao Levy with Deutsche Bank.

Hey, good morning.

Good morning, Tao.

Just one quick question.

On the gross margins front, obviously there wasn't too much on an impact there from the rollout of the new hip products this quarter.

But over the next couple of quarters, do you think that some of the pricing benefits that you'll see will be offset by just lower ramp up volumes with the new technology?

Just repeat that.

There's a lot of background noise wherever you are, Tao.

I missed about half of that.

Give me the quick version again.

With new product launches, is that going to negatively affect your growth margins as your ramp up?

No.

No, it doesn't negatively affect our margins.

We roll it into the inventory as we guild the inventory.

But the margins on the kind of products we were talking about, as I described earlier, far exceed, in general, our average margins, so you're bringing stuff out that, even if you had a ramp up to it or you had negative variances, the variances would be rolled out through the inventory.

And secondly, you're dealing with margins that are starting out far higher than the average, anyway.

Thanks.

Our next question comes if William Plovanic with First Albany Capital.

Great, thank you.

Good morning.

Morning, Bill.

Just some clarification in terms the launches, so in Gender Specific you have 500 sets now, you want to have 1,200 by the beginning of year, is that correct?

That's correct.

And then to give us a frame of reference there, what -- how many NexGen® sets are out in the market at this point?

A little under 5,000, I think.

I'd have to go check the number, but I think that's it.

So when do you think you would be at a point similar to the NexGen® with the GSF?

You mean when will we have 5,000 sets?

Yes.

Well, in order to have 5,000 sets, you'd have to have the same sales of Gender that you have for NexGen® and same number of turns and surgeries, so probably quite a while, since we wouldn't have 100% penetration of, you know, Gender to total knees.

Okay but you think the 1,200 sets could support full launch and all the demand that's out there?

Well, it'll support full launch in the U.S.

It wouldn't support full launch on a global basis.

What I'm looking for is we'll have some sales.

Obviously, we just released it in Australia and Canada, a little bit, and Europe will be late first quarter.

So in that 10,000 we probably have some non-U.S. sales.

But I'm looking for that 10,000 sales -- units as an indicator that we've got a blockbuster.

The 1,200 units up there of sets, as long as we keep a high turn ratio, which means you've got to have them in metropolitan areas or areas you can drive them quickly.

You've got to be able to turn them over early.

As long as we do those things well, those sets will serve us well.

But getting from the 500 -- we originally thought we would need 600 or 700, we now need 1,200 -- getting to that from where we are now through the end of the year, is -- we're going to have to go hard and go after it.

But we can do it.

We've just been surprised by the demand, frankly.

Okay, so you're saying you have the 500 now, it'll take you until the beginning of next year to get 1,200.

It's not likely that maybe December 1st you could have that 1,200 in the field?

Oh, no.

No, that's not going to -- that'd be great but that's not going to happen.

Okay.

And then, in terms of the alternative bearing, the Metal-on-Metal, how many sets are out there now for that and when would you expect to have that fully up and launched?

I don't have that number in front of me off the top of my head, but we expect to have it fully launched to service U.S. requirements fully again by the beginning of the year.

We thought we would -- obviously you can tell from our forecast, we thought we would be in great shape on Gender in terms of set, returns and meeting demand by October and that's just not the case.

So it'll be the beginning of the year, but you know, that doesn't mean we're not going to do well on both of them in the fourth quarter, as they start to begin to really turn.

But it's going to be the beginning of the year before we can get all the stuff -- everything done we need to do.

Right, and then lastly in terms of the Ceramic-on-Ceramic.

With that you mentioned demand isn't as high as you expected, so you have enough sets to support that demand, so really in the alternative bearing, the bottleneck is really more the Metal-on-Metal, rather than the Ceramic-on-Ceramic.

Is that a fair statement?

Well, I think it's fair to say we probably have a few more sets than we need in Ceramic-on-Ceramic.

It's not that it hasn't been what we thought it would be.

It's been quite a bit less and the Metal-on-Metal has been way more.

The net effect of the two together for Zimmer is higher than we anticipated, but the weighting on that is virtually all Metal-on-Metal. it's surprising the decline that we think we're seeing in Ceramic-on-Ceramic, and we think it's the market.

I don't think it's anything to do with us.

Okay, and then in terms of crosslinked poly and the knee, what percent of penetration do you think you had in the quarter?

We don't disclose that, but it's still fairly small.

I think it's in the teens.

We have disclosed it in the past, but just for time reasons I don't put all the data in any more.

Right, I understand.

And then, lastly, the contract that you signed with the hospitals last year, you mentioned they're long.

How long are those contracts?

Well, obviously HDA is five years.

It's the longest.

And the shortest I think -- we may have one left at two years, but a lot of them we went from one and two years to three -- three years.

Next year we've got two mid-sized agreements to do out of many, many mid and large-sized ones.

So we don't have a lot to do next year.

Great, thank you.

Yes.

Our next question comes from Mike Weinstein with JPMorgan.

Thank you, Can you hear me okay?

Yes, good morning, Mike.

Good morning.

First maybe a couple of housekeeping items.

Just want to make sure we've the right data here.

First on the tax rate, you're assuming, obviously, the extension of the R&D tax credits, Sam. if they don't get it done in this congress and it slips into next year, what would the impact be?

The impact on our full year tax rate is about a bit shy of 0.2 on the rate.

Okay.

So it's not a huge number.

No, it's not a big number.

And then the selling days, which seems like it's something where you have to track every quarter with you guys.

Last year in the third quarter you had one less selling day in a lot of countries versus the third quarter of '04.

Where in the third quarter of '06 do you have one less selling day than the third quarter of '05?

The countries go up and down all over the place in Europe, particularly in Asia.

But we usually work off the big countries plus the U.S., and that washes out to about a single day in the third.

And then as I said, in the fourth quarter, yes, there's an extra day, but I don't think when there's an extra day in December it's meaningful, at least that's been my exposure to this industry after ten years.

Technically it's an extra day.

We don't use it very much in our own internal forecasting for the reasons I've already described.

Is it unusual that you would have back to back years basically with one less fewer selling day in the same quarter?

Oh, I can give you one, Let me give you an interesting one for the first quarter of '07.

Japan, four less billing days.

The reason being that the Japanese celebrate holidays on the day they occur and every single one of those holidays occurred on a weekend in 2006, and every one them occurs on a business day next year.

So there's huge peculiarities and ups and downs on a bi-country basis, which you have to work your way through.

Got you.

You know, it looks like, as I look at this quarter and the -- just relative to that is what we were thinking.

Europe did okay.

Obviously Asia-Pacific [inaudible] did better than expected.

But America volume mix being up 4.3%.

That's really average, probably below what it was in the first half of the year, despite the product launches.

As we look at the fourth quarter, is the pick-up you're expecting -- most of that coming from the Americas?

It is.

It is.

And it would seem your new guidance is reasonable enough.

You mentioned you're going to have a little bit easier comparison, because you have a little bit -- you had a little more hurricane impact the fourth quarter of last year than you had in the third quarter.

You're going to have the extra selling day for whatever that is worth.

And then you're going to have your capacity issues on Metal-on-Metal.

It'd obviously be a lot bitter -- should be better if Gender Specific rolled out more.

So it would seem to be, from an organic basis, what you're describing here, your growth for the fourth quarter you're saying is basically 7.1% to 8.3%.

That would assume it's relatively reasonable, probably conservative to get to the upper end of that ramp?

I wouldn't say conservative, because we've been wrong all year.

We've been off by two to three months all year long, so we don't like being off on our forecast.

We're happy with where the run rates are.

We're happy with what we're doing.

But we don't like missing sales numbers.

And we've been off -- we haven't really be a quarter off.

We've been off two to three months all year long and particularly, we thought we would get more done in the summer, and we sh -- again, I said we should smack ourself for that.

You should know better, thinking you're going to get things done in the summer.

But we thought we would be further ahead on an absolute quarter calendar billing basis than where we are, even though we like the run rates.

So I think what we're trying to do, as I said in the commentary, is first of all, recognize that the trends are better, which they are, But also trying not repeat missing our sales numbers.

So the combination of those two things suggested that we ought ta bring the number down by 1%.

And that's as simple as that.

Understood, but the commonality for the last three quarters in the revenue shortfalls has really been principally in the Americas.

I mean, every quarter that's where you end up comings in light.

I know you always talk about your product launches and your execution, which is what you can control.

But the reality is that the market hasn't been there, and the market hasn't really picket up in any appreciable way over the last three quarters.

Is that a fair statement?

Not up until -- yes it is, up until recently, but I think there's an up-tick recently in surgical procedures, Mike, so I'm not sure that's necessarily totally true.

I would agree with you on the first seven, eight months.

That's not just a function of easy comparisons versus is hurricanes from last September?

I don't believe so, because I think -- I'm talking about surgical units in the operating room as opposed to the other components we're talking about here.

So as I said in my commentary, we stay pretty close to that market on a daily base, and I think there is a slight up-tick in surgical units that I hadn't seen over the few months.

I don't think that's necessarily a benefit to Zimmer.

I think it's a benefit to the market place.

I think it's true for everybody.

Thanks for taking the questions.

Our next question comes from Joanne Wuensch with BMO.

Hi, guys.

Can you hear me?

Yes.

Good morning.

Throughout 2006, we've been hearing about acquisitions as sort of always out there bubbling out.

I think even at the beginning of this year you've held back from repurchasing shares because you were looking to make shows acquisitions, and they really haven't come to fruition.

So, I'm sort of curious what's holding back?

Two things.

Probably more than -- well, three things.

And we are -- we are very ac -- as I said in the commentary we are very active right now in the negotiating with people.

We intend to continue to be.

We would like to get closure on these things, believe me, just as much as I'm sure people are tired of listening to it.

But the fact of the matter is we have -- as you know, we've done a couple hundred deals between Sam and I in your careers, and we hope most of them have been reasonably sensible.

We are very focused on price and making sure you get price right.

The reasons deals fail is either integration is lousy or you paid too much, and we don't like either of those things, so that's one thing is price.

Secondly intellectual property -- and it's kind of like the question that Katherine asked on physician-owned spine -- there is so much what I would call IP abuse out there, it's just amazing.

And we will not buy a business that we believe does not really have the freedom to operate within its own intellectual property.

In fact, it's treading on other people or will be proven to be treading, so that's number two.

Number three, we are finding business practices and compliance issues that are unacceptable to us and are inconsistent with our own compliance program.

And unless we feel they are minimal and very changeable, that's a block for us.

So between price, IP and business practices, it's -- you know, we could go out and close deals tomorrow.

We have lots of money.

There's lots of targets out there.

But if they don't meet those three requirements, we are not going to do it.

We just -- you know, whether it's age or experience, you get patient and maybe people any think we're too patient, I can't help that.

We're not going to go against what we believe is the right thing to do.

Are you thinking something in the smaller size, or Is there another CenterPulse [inaudible] organizational change are in the mix?

No.

I'd love to do another CenterPulse because I think we're capable of integrating those kind of business pretty well.

But the ones in the target mix right now are sort of roughly between a $100 and $400 million in purchase price each.

Okay, and then just on a final question.

You've been talking about sort of being -- first, it was the quarter two to three months behind all year.

That being said, looking into 2007, are we looking at a double-digit revenue top line?

We haven't given guidance.

In fact, I was surprised nobody asked why we haven't given guidance, although I noticed not everybody did.

It's sort of sporadic this year.

We're not done our budget for three weeks, is the simple reason why we're not giving guidance.

I would love to have a double-digit target for next year.

I think we'd be happy with that because we can leverage big earnings from it..

As you heard both Sam and I in the commentary, we would like to have a double-digit ramp, if you will, the fourth quarter to go into the new year, but we've got another three, three and one-half weeks to go on budget.

So [aspirationally] my answer is yes, but I can't give you guidance yet.

Thank you very much.

Okay.

Our next question comes from [Eric Snyder] with Sanford Bernstein .

Good morning gentlemen.

Morning, Eric.

On the hip and knee side, particularly in the U.S., I think a little bit of follow-up to where Mike was going.

What do you see on the unit market, just recent history and sort of progress on that front?

I haven't seen anything different, Eric, than we've seen for some time. we've had some down -- and Mike's right -- we've had some down trend here in units lately, although my assessment of that, having talked to a lot of people, has got a lot to do with things other than real demand and other disciplines.

Getting block operating time and some declining margins in hip and knee, which I think is creating so much that block time shifting and all those kinds of things.

But I believe the ultimate demand for patients -- assuming people aren't going to be left waiting for long periods of time -- I still see is around 7% or so, 6.75% is what we have in our strategic plan for units, and that includes 0.75 of a point of baby boomer, [bolus], if you will, passing through.

About 6% for all other areas and then I think you have to go company by company, because we see mix at 1% to 3%, but it's going to vary a lot by company and depends on their new products.

So I'm no different than where we've been for a long time, and I don't see any statistics or data that suggest we should be any different.

Okay.

And on the SG&A side, you set a target a couple years out back in '03.

What do you think the potential trajectory is on SG&A going forward?

We haven't set a specific goal, but we'll continue to bring it down numbers of basis points each year.

We'll continue to expand margins.

I mean we still have -- one of the questions that inevitably comes is, can you continue to get leverage?

You can certainly get leverage if you do acquisitions, because you can build it in.

But can you continue to get leverage without acquisitions?

We want to do acquisitions, but we also believe we can continue to get leverage in our existing P&L, with or without acquisitions.

In order to get that leverage, margins have to go up, SG&A has down, and you have to keep working on your tax rate and perhaps on share buyback, if the price is right.

We have to do that and there's room to do it.

And, Eric, you may have -- others may have heard us describe our planning process.

But every year -- and we're in the midst of the planning process now -- a very intentional part of our plan process is to grow increased gross profit, grow it at a faster rate than sales and grow SG&A at a slower rate than sales.

That's just fundamentally baked into our plans.

That's it.

Thank you.

Okay, thanks, Eric.

Our next question comes from Michael Matson with Wachovia.

Hi.

This is actually Vincent Colicchio for Michael Matson.

Morning, Vincent.

Morning.

Just a quick question.

What do you think the impact of the Gender Solutions knees is going to be in terms of the directed consumer spending on SG&A?

The impact in '06 is going to be somewhere close to $2 million, which is already assumed in our earnings guidance.

The impact at this point -- we haven't -- we're doing the Americas budget a week today actually, so I haven't seen their final number.

But I know the preliminary number that we've guided people to is $7, $8 million for the year next year, but that's got some Europe and Asia in it.

Okay, and then just a tick quick second question.

What's driving the increased legal expenses?

Just the combination of battles we're initiating.

People coming at us with a couple of things, the DOJ workload, et cetera.

There's a number of things, and we went through that with people in the last quarter and said you can expect increased legal in there for some increase or flattening.

As it turns out we were equivalent to the ratio last year.

But we told last quarter, VInce, we would be increasing legal in the third and fourth quarter over our historical run rate and that has been the case.

And we expect it to be the case for a couple of quarters, including this one.

Okay, great.

Thanks for taking my questions.

And our final question is a follow-up from Matt Miksic with Morgan Stanley.

Hey, [Tinako's] going to get on here with a follow-up, but thank you.

So just to be clear one more time on the Gender.

I think I've asked you this question before, but I think earlier in the call we were talking about percent of competitive procedures I think it's Q1 for that 10,000.

And just looking out, I mean we could talk about the potential to convert surgeons.

I think you have done that in a couple of cases.

But, just in terms of unit share driven by direct to consumer and driven by the other media work that you're doing, do you still see this as a share gainer on a unit base, whether or not you're able to convert a large number of surgeons?

Yes, we see it as a share gainer in units of surgery basis, and we see it as a substantial gainer in dollar market share, which is how most of the calculations are done.

Because if that person was not doing Flex or Gender prior to that, there's a built-in premium in the vast majority of the cases.

So the answer is yes, yes.

Although you will not see -- to reiterate, I don't expect to see a great deal of competitive conversion first quarter, because, again, it would put us in a very political -- a tough spot politically in some of those cities with existing high-ends and their surgeons.

So, that'll be more over time.

Sure, and just turning -- I don't know if I missed this, but turning the quarter -- the corner in January 1 in Japan pricing. that down shift now from the current negative to something else, can you help us understand that?

Yes, it's less negative.

I think it's 3.2 instead of 3.7, but I'll have to go back and have a look at it.

So, Japan is a beast in the first quarter.

You've four less billing days, as I was telling Mike, and we've got the down shift in price January 1 instead of April 1, so -- and that's just the wa -- I mean, we have the largest business in Japan, but clearly it affects everybody the same way.

But Japan is brutal in the first quarte,r but there's nothing you can do about it.

That's right.

April 1, obviously is this year's price decrease in Japan, anniversary's out.

Yes, yes.

Okay, great.

Thanks.

And at this time I would like to turn the call back to Mr. Ray Elliott for any closing remarks.

I think that's fine.

I think we've done our commentary.

I do want to reiterate just in a -- it's perhaps housekeeping, but I read some of the reports early this morning at 6:00.

Let me just reiterate again, because it's really, I guess, disturbing to us to see people thinking that the over-achievement in EPS is, in fact, gained by $0.02 or $0.03 of tax and share buyback.

That simply isn't the case.

When you go back and look into those calculations -- some of the data that you wouldn't have available I recognize -- it's $0.006 and the operational performance at 76.5 or 76.4, if you want to look at it that way, or 77, is, in fact, true operational performance.

So I would just ask each of you to go back and just look at that again and understand the calculation as those events actually occurred.

Other than that, we appreciate it.

We will try and get our forecastings, obviously, better on the sales, but the trends are good and we appreciate the time you've spent with us.

Thanks.

This concludes today's Zimmer third quarter 2006 financial results conference call.

You may now disconnect.