Zimmer Biomet Holdings Inc (ZBH) 2011 Q3 法說會逐字稿

Welcome to the 2011 financial results conference call. I would now like to turn the call over to today's host, Mr. Bob Marshall, Vice President, Investor Relations and Treasurer. Sir, please go ahead.

Good morning and welcome to Zimmer's third quarter 2011 earnings conference call. I am here with our President and CEO, David Dvorak, and our Executive Vice President and CFO, Jim Crines.

Before we start I would like to remind you that statements made during this call that are not historical may be deemed forward-looking statements. Actual results may differ materially from those indicated by forward-looking statements due to a variety of risks and uncertainties. Please refer to our filings with the Securities and Exchange Commission for a detailed discussion of these risks and uncertainties.

Also the discussions during that call will include concern non-GAAP financial measures. Reconciliations of these measures to the most directly comparable GAAP financial measures are included within the earnings release that was furnished in this morning's current report on Form 8-K. This information is also available on our website, www.zimmer.com in the Investor Relations section.

With that, I will now turn the call over to David Dvorak. David?

Thank you, Bob. Good morning everyone, and welcome to Zimmer's earnings call for the third quarter of 2011. This morning I will review our third quarter financial results, providing commentary on the year's progress to date and highlights from our performance. Jim will then provide additional financial details. As in previous quarters, I will state all sales and constant currency terms, and I will discuss all earnings results on an adjusted basis.

In the third quarter, Zimmer continued to deliver against our financial commitments. Sales improved year-over-year supported by above market performance in a number of international markets. Our third quarter and year-to-date results continue to reflect the benefits of recent product introductions across our portfolio, backed by investments in marketing and selling. Consolidated net sales for the quarter were $1.03 billion, an increase of 2.4%, and our earnings per share were $1.04. An increase of 8.3% over the prior year period.

Compared to the prior year, America sales were down 0.5%, while Europe, Middle East and Africa delivered growth of 6.7%, and Asia Pacific recorded sales growth of 7.1%. We believe we gained share in the quarter in a number of established markets in our Europe, Middle East and Africa and Asia Pacific segments. Over the last several quarters we have made strategic investments in these regions to improve operational and sales performance contributing to these impressive results. China and other emerging markets also continue to generate strong growth, reinforcing their long-term potential.

Turning now to the results of our product categories, knee sales for the third quarter decreased year-over-year 0.5%, reflecting positive be volume and mix of 1.4%, and negative price of 1.9%. While the knee market in the United States continues to be soft, our international operating segments delivered strong growth of 6.5% in Europe, Middle East and Africa, and 6.6% in the Asia Pacific region compared with the prior year. Globally, we are encouraged by increasing utilization of our posterior referencing and patient specific instruments. Strong sales were also generated from our mobile bearing knee, and from revision products including the rotating hinged knee. In Europe, we believe posterior referencing instruments are driving competitive gains. Additionally there is growing interest in patient-specific instruments, which delivered sales growth globally of more than 70% in the quarter over the prior year period.

Going forward, we are extremely enthusiastic about the product innovation pipeline we are pursuing within our knee franchise. This pipeline is populated with a range of technology innovations we believe will create significant value for patients, surgeons and hospitals in the coming years. We expect to begin to introduce these offerings in 2012. Hip sales in the third quarter increased 3.9%, reflecting positive volume and mix of 5.5%, and negative price of 1.6%. These results included strong above market performances in international operating segments with Europe, Middle East and Africa generating 6.5% growth, and Asia Pacific delivering 10.7% growth compared with prior year.

Globally, we continued to see steady adoption of our most personalized product lines including the Continuum and Trilogy IT Acetabular Systems, and the M/L Taper stem with Kinectiv Technology. Outside of the United States we are also benefiting from the increased penetration of hard bearing ceramic products, including the recently-launched Maxera cup and Delta ceramic liners used in conjunction with the Trilogy IT and Continuum cup systems.

In the third quarter, extremity sales improved 4.4%. Our Trabecular Metal shoulder system continues to perform well against a number of new entrants into this increasingly competitive space. To accelerate growth in our extremities business, we will be introducing new implants and instruments through the remainder of the year and into 2012, including products for upper extremities, as well as other anatomical sites. Our Dental business delivered solid sales growth of 9.2% in the third quarter. The Americas business generated growth of 18% , comprising organic growth of 4.6% as well as the contribution of existing Puros and CopiOs Allograft products distribution arrangement.

Slower growth in international markets resulted from temporary distributor inventory reductions, as well as suppressed procedure volume in certain European markets resulting from broader economic factors. New products including the recently-introduced Zimmer CurV Pre-shaped collagen membranes contributed strong sales in the quarter. Following positive feedback from clinical assessments, we are preparing to launch Trabecular Metal implants to the European dental market more broadly, expanding the application of this proprietary and clinically differentiated technology.

In the third quarter we again delivered above-market double-digit sales growth in all geographic segments in our Trauma business. Sales increased 14.2% over the prior year period, including stand out 21.4% growth in Europe, Middle East, and Africa. After several successive quarters of leading growth, Zimmer is back becoming on established player in the trauma market. With a comprehensive portfolio of innovative products, including the anatomically designed Zimmer Natural Nail family, and the NCB Periprostetic Plating System for complex fractures, our sales team are having success into driving business in Level One Traumatology centers.

Zimmer Spine business reported a sales decrease of 5.3% in the third quarter. The market remains a challenging one, but recently introduced products including the Pathfinder NXT Percutaneous MIS pedicle screw system, and TMS Trabecular Metal cervical Interbody Fusion device, provided encouraging sales performances. Internationally the Asia Pacific segment contributed sales growth of 11.7% compared with prior year.

In the third quarter, Zimmer Surgical and Other business category delivered 3.7% sales growth over the prior year period. We continue to gain share in a number of categories within the surgical market with bone cement and tourniquet product sales remaining strong. Moving into 2012, the full introduction of our Zimmer surgical power equipment line is expected to contribute to further growth in this business.

Turning now from our product category results, I would like to discuss several broad market factors. Reconstructive procedure volumes in the third quarter continued to be lower than historical utilization rates, and lower than demographic trends would indicate. This effect was particularly pronounced in the United States, where previously discussed factors including the impact of ongoing high unemployment and low consumer confidence contributed to softness. As these conditions improve, Zimmer is well-positioned to take advantage of normalized growth rates and procedure volumes. In the quarter we again experienced price pressure of negative 0.9%. As discussed in prior quarters, we have experienced a stable trend of pricing between zero and negative 1.4% for 14 quarters, at an average of approximately negative 0.8%. This trend is right in line with our expectations, and we are confident full year pricing for 2011 will remain at or near negative 1%.

Consistent with prior quarters, recently introduced innovative products continue to deliver strong sales and premium pricing. This is especially true of products featuring Trabecular Metal technology across our portfolio, many of which contributed double-digit sales growth. Supported by increased investment in R&D and sales programs, we believe a regular cadence of new product and instrumentation offerings across the portfolio will drive future performance. Investments in growth drivers including innovation are made possible by the ongoing progress of our business transformation programs, which contributed to improved cash flow in the quarter. In line with our strategic agenda, we continue to emphasize disciplined deployment of this cash and capital to return value to our stockholders.

Before I turn the call over to Jim, I would like to address one further topic. While we don't consider this to be a material matter for disclosure purposes in order to be appropriately responsive to inquiries we received, I want to provide an update regarding a recent FDA inspection in Warsaw. As you know, medical device companies are subject to periodic FDA inspections. Zimmer has had more than a dozen such inspections across our facilities globally since 2007. In the third quarter the FDA completed a periodic inspection of our Warsaw manufacturing site. As a result of this particular inspection, we received a number of observations in a Form 483. We have not received a warning letter relating to the inspection. While 483 observations are not uncommon across the industry, we take all observations very seriously as part of our commitment to quality. We have already addressed some of the observations, and we are executing a plan to resolve this matter appropriately. As would normally occur, we expect the FDA to conduct a reinspection to confirm that our actions have adequately addressed the observations.

Zimmer is committed to a strong culture of quality. This is a core value that our global organization embraces, we will continue to drive operational excellence throughout the Company and quality system enhancement initiatives are an integral element of that agenda. And as evidence of our commitment in this area, one of our other US facilities was inspected by the FDA within the past two weeks, and this inspection resulted in no observations. Except as necessary we don't plan to comment publicly on the results of inspections by FDA or other notified bodies in the future.

With that, I will now ask Jim to provide further details on the third quarter and our guidance.

Thanks, David. I will review our third quarter performance in greater detail, and will then provide an update regarding our fourth quarter and full year 2011 guidance. Zimmer's total revenues for the third quarter were $1,031,000,000,a 2.4% constant currency increase compared with the third quarter of 2010. Net currency impact for the quarter was positive, increasing revenues by 4.5% or $43.1 million. Favorable currency contributions were driven mainly by our Euro Japanese yen and Australian dollar denominated revenues. Our adjusted gross profit margin in the third quarter was 75.8%, this represented a sequential improvement of 80 basis points over the second quarter, and a decline of 150 basis points compared to the third quarter of 2010. This reduction resulted primarily from the impact of foreign currency hedging losses.

The Company's R&D expense constituted 5.9% of sales in the quarter, which represented a 6.6% increase when compared to the prior year period. R&D expenses continue to rise in line with or ahead of reported revenue growth. Our product development and clinical programs represent key drivers for accelerated growth. We believe the market will continue to reward innovations that provide value across a broad spectrum of stakeholders, including patients, clinicians, and hospitals. Our ongoing efforts in Research & Development focus on meeting this fundamental challenge.

Selling, General & Administrative expenses were $444 million in the third quarter, an increase of 8% on a reported basis,in line with our prior guidance and comments regarding seasonality, SG&A expenses represented 43% of sales for the quarter. Legal costs, increased bad debt expense, and a higher mix of revenues from developing markets, offset savings from our transformation initiatives within the quarter. SG&A expenses were also negatively impacted by foreign currency translation, which added approximately $19 million in the quarter compared with the prior year quarter. We continue to expect SG&A as a percentage of sales to be approximately 41% for the full year, down over 50 basis points from prior year.

Special items accounted for $8 million of expense in the quarter. This included cost associated with our global transformation, quality excellence and restructuring program, as well as integration costs related to the Beijing Montagne Medical Device Company, and SoPlus Power Equipment transactions and third-party distributor acquisitions in the Europe, Middle East, and Africa segment. Adjusted operating profit in the quarter amounted to [$276.4] million representing a profit margin ratio of 26.8%. This ratio is flat relative to the prior year third quarter, reflecting a lower gross margin ratio due to hedge losses as previously noted.

Net interest expense for the quarter totaled $11.7 million compared to $14.2 million in the third quarter of 2010. This change reflects the continued benefit of having swapped a portion of our fixed rate debt to a floating rate. Adjusted net earnings were $197.2 million for the third quarter, an increase of 2.4% compared to the prior year.

Adjusted diluted earnings per share increased 8.3% to $1.04 on 188.8 million average outstanding diluted shares. These adjusted earnings per share are inclusive of approximately $0.05 of share-based compensation, at $1.01 reported diluted earnings per share increased 5.2% from the prior year third quarter, a reported EPS of $0.96. Reported diluted earnings per share for the third quarter include special items charges and inventory step-up net of tax.

Our adjusted effective tax rate for the quarter was 25.6% which represents a decrease of 90 basis points from the third quarter of 2010, resulting from a higher mix of earnings and profits from low tax jurisdictions. As a consequence, we now anticipate our full year effective tax rate to be between 26% and 27%. Our reported effective tax rate for the quarter was 25%. As indicated in our earnings release, in the quarter we acquired 10.1 million shares of Company stock, at a total purchase price of $549 million, market conditions provided us with an opportunity to accelerate repurchases, and add a modest amount of leverage to our balance sheet. The repurchases were supported by $375 million of borrowings on our senior credit facility.

Our strategy for capital deployment is built on a foundation of maintaining a conservative capital structure. We use leverage to both support strategic growth initiatives such as acquisitions, and to acquire Company stock opportunistically. At an enterprise value of less than 7 times EBITDA, and with our leverage ratio at less than 1 times coming into the quarter, we saw a compelling opportunity to accelerate share repurchases and acted on it. In the current low interest rate environment this action provides the added benefit of lowering our weighted average cost of capital.

Year-to-date, we have repurchased 16.2 million shares at a total spend of $906 million. As of September 30, 2011 approximately $299 million remained authorized under a $1.5 billion repurchase program, which expires at the end of 2013. The Company had approximately 180.4 million shares of common stock outstanding as of September 30, 2011, down from 197.4 million as of September 30, 2010.

Operating cash flow for the quarter amounted to $350.6 million, an increase of 9.5% from $320 million in the third quarter of 2010. This improvement resulted from an element of our restructuring and transformation programs directed at driving greater efficiency in our field inventory deployments. Net receivables increased $828 million from $758 million in 2010, or 9% over the prior year period as we discontinued receivables factoring in certain European markets. Inventory decreased sequentially in the third quarter of 2011, and adjusted inventory days on hand finished the quarter at 348 days, a decrease of 32 days from the third quarter of 2010. Depreciation and amortization expense for the third quarter amounted to $90.9 million.

Free cash flow in the third quarter was $273.1 million,$16.7 million higher than the third quarter of 2010. We define free cash flow as operating cash flow less cash outflows for instruments and property plant and equipment. The quarter's change in free cash flow resulted from a lower seasonal inventory build, as we burn off excess field inventory that is being redeployed as part of our operational efficiency efforts. Capital expenditures for the quarter totaled $77.5 million, including $43.7 million for instruments, and $33.8 million for property, plants and equipment and software. Cash outlays associated with investing activities during the quarter include $2.6 million for product distribution agreements.

I will now provide an update to our guidance for the full year 2011. In our earnings release this morning we announced that the Company is updating its full year sales and adjusted EPS guidance, narrowing our prior adjusted EPS guidance toward the top of the range. We now expect full year revenues to increase between 2.3% and 2.7% in constant currency when compared to 2010. In the fourth quarter we anticipate market conditions to remain challenging due to the economic environment. Assuming currency rates remain at current levels we expect foreign currency translation will increase our reported full year 2011 revenues by approximately 2.5%. On a reported basis, our revenues are new projected to be between 4.8% and 5.2% above 2010 results. We expect our gross margin ratio for the full year to be in line with our prior guidance of approximately 75%.

Taking into account our current revenue expectations, additional share repurchases, and a slightly lower effective tax rate, full year 2011 adjusted diluted earnings per share are now projected to be in a range of $4.75 to $4.80. To arrive at GAAP earnings per share, you should subtract total charges for certain claims and special items of $120 million to $130 million pretax, or approximately $0.33 to $0.37 per share. Finally, please note that our guidance does not include any impact from potential acquisitions or other unforeseen events.

David, I will turn the call back over to you.

Thank you, Jim. Improved sequential performance in a number of international markets, as well as the positive contribution of innovative and proprietary product introductions across the portfolio, were the foundation for our solid performance in the third quarter. Looking ahead, we are not waiting for broader economic conditions to improve to deliver increased value to our staff stockholders. Our goal is to deliver at or above sustained market growth in each of our geographic segments and product categories.

To achieve this goal we will maintain a rigorous focus on our strategic priorities, which include a commitment to product innovation, an ongoing emphasis on emerging markets, and disciplined sales and capital deployment. We also will continue to pursue opportunities for further external development where potential targets can deliver meaningful returns in a reasonable time frame. Our current portfolio comprises the industry's most comprehensive clinically successful and customizable products. We are confident that we can continue to create value for all stakeholders with these offerings. The performance of our global sales teams in the last several quarters demonstrates what can be achieved when the industry's leading musculoskeletal solutions are delivered with strong sales execution.

At Zimmer we are focused on meeting our financial commitments into the future, and to delivering both short and long-term value to our stockholders. Now I would like to begin the Q&A portion of our call.

(Operator Instructions). And your first question comes from the line of Adam Feinstein with Barclays Capital.

Thank you. Good morning, everyone.

Good morning.

So Dave, just your comment just about the utilization trends as being weaker than what you would view as normalized in population growth and such. So clearly managing costs is a big goal in the current environment with lower revenues. You guys have talked about your cost saving plan, the $50 million in gross savings. Maybe just give us an update and maybe just talk a little bit more about opportunities there?

And then at the same time just also wanted to get your thoughts you are talking about utilizing the balance sheet and you guys bought back a lot of stock in the quarter, so as you think about additional opportunities going forward just wanted to get your thoughts in terms of the opportunity for additional stock buybacks, and other uses of free cash flow?

Adam, this is Jim. I will take a stab at answering that question, at least with respect to the restructuring and transformation programs. As we said before the benefits from these programs estimated at $100 million on an annualized basis, with $40 million to $50 million as you pointed out to be realized in 2011. We are on track to realize the $40 million to $50 million of savings in 2011.

We as we have said before expect the benefits to be some what evenly distributed between cost of goods and selling, general and administrative expenses, and at this point I would tell you although we are now anticipating to be spending less in 2011 and our beginning of year contemplated, and our expectations with respect to the savings are unchanged. We are effectively getting a higher return on the capital we are investing in restructuring and transformation and to give you just the specific details on the adjustment to what we are planning on spending this year, some of the background as to why our forecast on spending has changed, certain of the initiatives including those pertaining to manufacturing and distribution include potential changes that are still under evaluation.

So as I said, some of the costs we had anticipated occurring in 2011 are now expected to be deferred to 2012. We are now projecting to record pretax charges of $55 million to $60 million within the 2011 operating period related to restructuring and transformation. And as well, as we previously indicated we also anticipate recognizing approximately $15 million to $20 million of integration costs related to recent acquisition. That is $70 million to $80 million in total compares with our guidance at the beginning of the year of $90 million to $100 million. Lastly, I would tell you that we are very excited about the opportunities we have to enhance the profitability of our business through the initiatives, the work we have completed to date validates the assumption that we can create value for our stockholders through programs that focus the organization on achieving operational excellence.

Great. Thanks for the detail. And then just on the additional stock buybacks, or just uses of free cash flow, just wanted to get some updated thoughts there since you guys have used up most of the repurchase?

Sure. And this is Jim again. We do typically return approximately one-half of our net income to stockholders on an annual basis through share repurchase programs. We havealso used leverage opportunistically to acquire shares. Just to give you an idea in how we think about that, in evaluating the opportunity we give careful consideration it our leverage ratio to ensure that we remain within rating agency guidelines for investment grade credits. We also seek to maintain available capacity within those guidelines that will allow us to execute on strategic acquisition opportunities when they arise, and we are interested in acquisitions that fit with our focus on musculoskeletal health, and have the potential to create value for our stockholders. As I indicated in my prepared remarks, with the enterprise value trading at less than 7 times EBITDA, we saw a compelling opportunity in the quarter, and decided to act on it.

Okay. Thank you very much.

You are welcome.

Your next question comes from Bob Hopkins with Bank of America.

Hi, thanks. Can you hear me okay?

We can, Bob, good morning.

David, first question for you. It looks like looking at your numbers, and the numbers that others have reported that the global hip and knee markets got worse on a comp adjusted basis in Q3, and you are lowering your top line constant currency guidance by 50 basis points, and that suggested things might have gotten worse as you exited Q3. So is that a fair assessment that things in your view are getting worse? And any other color you can provide on what you are seeing especially in US knees would be very helpful. Thanks.

Sure, Bob, I don't think that we see things getting worse. I think that the projected slight pickup in light of what we anticipated to be off of easing comps in the second half of the year, really didn't materialize to the same degree that we expected at the beginning of the year in Q3. And so we are sort of projecting that out in Q4 as well as part of our guidance. But the overall market doesn't look like it slowed down in both those categories to us, Bob. I think that if anything the hip market looks like it picked up on a global basis, and probably the knee market ticked down.

The size of our US knee business is large, and a bit more emphasized than some other companies I suspect. So that step down in even tens of basis points in the US market, we are going feel the effect of that. But nothing about that changes our view as to the longer term prospects of the business, these procedures will come back, and I think that people are just being pretty careful across the industry at projecting when there is going to be a pickup in the procedure rates, but we know those cases are out there.

I guess I was referring on a comp adjusted basis given how much easier comps are. Putting that aside though for a second, just in terms of what you hear from your sales organization especially in the United States, and the different metrics that you can look at in terms of backlogs or conversations with physicians. Is it your view in the US that things are not getting worse in Q3 versus what you have seen in Q2?

I don't think that there is a material difference from what we have been dealing with in the prior couple of quarters, or even the prior year, Bob. I think people were anticipating a strengthening and that really didn't materialize. On a relative basis there might be a bit of disappointment in that regard. But I don't think that things are materially turning down in procedure rates at this point in time.

Okay. And then just one for Jim. Thanks for that, David. This quarter you didn't have much in the way of operating income growth. You did have good EPS performance based on the buybacks. My question is, how long can that continue, where you can continue delivering high single digit EPS growth based on buy backs or lower tax rate, versus not seeing much in the way of operating income growth? Just trying to get a sense for how sustainable you feel high single digit EPS growth is, if the current environment doesn't get better?

Sure, in fact as you pointed out our updated guidance implies little to no leverage at the operating profit line. Keep in mind to-date in 2011 we have seen very strong results out of our international markets. Much of that coming from emerging markets where we are continuing to invest, and expanding our local presence mostly in the form of direct sales channels, and just given the stage of their development those markets tend to have higher operating expense ratios. So there will be opportunity going forward as we establish more critical mass in those markets to get leverage. There is certainly opportunity to see leverage return to the P&L notwithstanding what we are doing on the restructuring and transformation front, as we see growth restored in our biggest market here in the US. That opportunity, frankly, is pretty significant. If we can get back to mid-single digit growth in the US market, we will have some significant opportunity to see leverage return to the P&L.

As I said, we are also really excited about the opportunities we have to enhance profitability through the operational excellence initiatives. We are making progress. These involve some pretty significant changes to our business model, and we are still in the early stages at least with respect to the operations side of the business including distribution and manufacturing. You should know that we have hired in new talent with we believe the necessary expertise, in things like Lean Six Sigma principles and quality excellence. We have engaged third parties as well to assist in what is an enterprise-wide drive to transform our manufacturing and distribution facilities and processes. Not only do we expect to get greater efficiencies in manufacturing and distribution, which will lead to lower costs, but we also expect to achieve a state of quality excellence that goes well beyond compliance with regulatory standards.

Thanks for the comments, guys. Appreciate it.

You are welcome.

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

Thank you, I want to follow up on Bob's question to a degree. If we look at the last five years Jim, you guys have generated I am thinking through 2011 here, you have generated $4 billion in free cash flow, and you will end up having returned $3.6 billion or$3.7 billion in share repurchases over that period. Obviously an incredibly high amount. I think I would speak for everybody in the call and say the amount you bought back this quarter was absolutely a strong statement. People like what you are doing with your cash.

If we say that under the assumption that the environment doesn't get better any time soon and that your revenue growth is continuing at maybe this 2.5% to3% level, because of what your end markets are doing, is what we have seen in 2011 is really as much as anything what we saw this quarter, this big buyback, this we are going to try and take 2.5% to3% revenue growth, and if the markets aren't giving us better we are just going to return our cash to shareholders, is that what we should expect going forward, just that? And I am talking about the whole mixture of okay if our revenue growth doesn't pick up, if our end markets don't pick up, the best thing for us to do is to continue to buy back our stock until it does?

I would tell you, Mike, that is not the way that we think about it. Our strategy has several elements to it. But at a high level, we believe, continue to believe that there are opportunities for growth, and so we continue to invest in a pretty aggressive way in innovation. And I would tell you we are really excited about the opportunities we are going to have to drive, take advantage of growth, as we more normalized growth as we see that return at some point to the developed markets, but also drive share gains with some of the investments we are making in some new and innovative technologies across all of our product franchises.

There is certainly another element to the strategy that focuses on the business model and with where we have opportunities to drive operational efficiencies, and we think those opportunities are pretty significant, and that will lead to enhanced profitability, and then finally there is another sort of element to the strategy which we are focused on with your question. We are committed to returning some of the free cash flow that we generate. That commitment will remain in place, but we are also interested in deploying capital towards acquisition opportunities as I said when they arise. So I wouldn't want people to think that we are not looking for opportunities to deploy capital towards acquisitions. We are going to be disciplined. We talked about how we think about that. We had some pretty high hurdles that we have put in place internally, including benchmarking acquisition opportunities against share repurchases, but we think those opportunities are out there, and hopefully we will get a chance to execute on some of those opportunities in the short to medium term.

Thanks. I think I am pushing on it a little bit and Bob and some others were as well, in part because markets are doing what they are doing this year. There is only so much you can do about that. So as a result your top line is growing 2.5% to3% and you are trying to grow your operating margins, but obviously that is a challenge given the mix of growth that you are seeing within your businesses. So you are turning let's call it 3% to 4% EBIT growth, maybe it is 4% into 10% EPS growth this year because of the 6 points you are getting from share buyback. So the level which you buy back stock going forward dictates whether you are a mid-single digit EPS grower, or a 10% EPS grower, so that is the I think the sensitivity from everybody on the call and on the Street. So everybody is applauding the buyback this quarter but kind of wondering what is the right formula going forward?

Well, Mike, I think that one of the things that we are very focused on is ensuring that we take full advantage of the growth opportunities that we have, and as you said there is a bit of at this point in time, and I don't think it is a forever thing at all that is an externality in the way of the procedure rates. You even saw a bit of uptick on the hip side sequentially from Q2 to Q3 of this year, and I think that is a sign that those procedures are still out there. I mean the economy didn't get healthier, consumer confidence didn't improve, but the need that those patients had broke through that barrier, and we saw a little bit of an uptick.

I think the same thing will happen in knees and it is just difficult to predict which quarter it will begin to occur but those patients are still out there. In the meantime, we want to make sure that we are positioning the Company to take full advantage of the growth opportunities that we have within reconstructive, but as well the emerging businesses, fine dental trauma, surgical and the emerging markets, and we are breaking through, making good progress on those investments, and I am quite confident that you are going to see improved top line performance in all of those areas as we move forward.

We have got the right product pipelines. We are strengthening our distribution channels. We are focused exclusively on this musculoskeletal space, where we think we can just out compete people even in a slower market, and you can see where that is happening even in big categories like hips. You can see it happening where we have smaller market share in smaller categories like trauma, and as we get all of those cylinders firing, we are not going to have to rely on the growth numbers that you articulated to be able to sustain that earnings per share growth performance.

You couple that with leaning out the operational expenses as Jim has been discussing, to fund some of those initiatives in the interim period, and still provide nice growth and earnings per share, and be responsible about what we are doing with the cash and capital deployment. As you emerge from this period and procedure rates tick back up, you will have a leaned out P&L, the right pipeline and a global distribution channel to push those products through. I think you are really going to like the results.

Great. Thank you, David.

You are welcome, Mike.

Please remember analysts allowed to ask one question and one follow-up question. Next we have Derrick Sung with Sanford Bernstein.

Hi, good morning.

Good morning.

I wanted to turn to the product cadence for your hip and knee lines in the US. I guess if I look at the growth pattern around your US hip growth. We saw a nice accelerating kind of through the back half of last year into the early part of this year as a result of your new products. That seems to have slowed down a bit And we have seen kind of a steady deceleration in growth over the last few quarters. I am wondering on the hip side are the new products now starting to contribute less and less to your growth, and is that kind of what we are seeing on the hip side?

And then on the knee side, you talked about turning new product introductions into next year or in next year. How long does it take for those products traditionally it has taken at least six to nine months to see an impact for those new products in your numbers. I guess what I am wondering is next year, do we kind of see a period where you are not seeing as much contribution from your new hip products but the new knee products still haven't rolled out yet, and kind of getting a period of a little bit of below market, or no longer above market growth? Maybe you can talk us through that a little bit. Thank you.

Sure, Derrick. I think on the hip side as we said in the past, we felt that we had the right stem portfolio going back a couple of years, and continued to innovate in that regard. But we have some gaps on the cup side, and we feel really comfortable with what we have done to put out the right solutions on the cup side. We continue to see traction with those products. Admittedly our performance in Q3 was a bit of a step-down on the hip side, and we would expect that to come back and strengthen in future quarters. I don't think that there is anything of any significance in the way of a product gap that creates a barrier to us performing very well in the hip category within the United States market.

And you can see that we are doing well with those products OUS. We are growing up into double-digits in Asia-Pacific with those products. We are finding terrific traction with all of the products that are US-based in Europe. But then we also have some unique products including the Brevius stem and the Maxera cup that are specific at this point in time largely to Europe. So I feel very confident that we have the right portfolio of solutions in the hip category at this point in time, and there is no reason that we shouldn't be able to sustain our at or above market performance in that category going forward, which is a trend break for us relative to what had been going on in prior years within that important category.

On the knee side we have talked about some of the instrumentation gaps that we had and developing more contemporary solutions in that regard, and then availing the posterior referencing oriented surgeons to the next gen knee system with these PRI instruments, and I think that launch has gone well. I think that PSI is going to continue to deepen its penetration rate, and as I said we grew PSI revenues over 70% in the third quarter. So I think that we have the right ancillary products in the form of instruments.

With respect to the knee portfolio. And then obviously we have a couple of the very best performing knee systems available globally with the next gen, the NK2 system, and then we also have the NX system over in Europe. These are excellent knee systems. They are broad-based platforms. They offer a lot of patient-specific capabilities, so they are very customizable in the hands of the surgeons, and we are going to continue to support those platforms moving into the future.

I would also tell you that we have some technologies within that portfolio development pipeline that will build on the legacy of those great systems, but we believe will take the offerings to a very different level and be truly differentiated solutions in the marketplace, and you will start to see some of those solutions as they get cleared in 2012 hit the marketplace. So in due time we will give you more information on that front, Derrick, but we feel like we have a very solid knee portfolio currently, and we believe that we are in a position to step ahead of others as 2012 progresses.

Great. Thank you. That is very helpful. And as a follow-up, can you give us an update on the Gel-One launch? We understand there was that temporary retraining order issued this quarter. Are you still on track for a sort of near the end of this year launch for that product, or is there any now risk to that product in your mind as a result of some of the IP litigation that you are going through?

Sure. The temporary retraining restraining order was extended out, and now we are heading towards a preliminary injunction hearing before the year is out, Derrick, on that, and so we won't be launching the product before that preliminary injunction hearing is held, and the matter is resolved in a preliminary way through that process. And then we are anticipating the underlying case go to trial some time next year. It could be in the first half of next year. But those schedules can move around some.

So the most likely is a scenario is that the product won't launch this year, and then we will have to wait to see the outcome of the preliminary injunction hearing later on this quarter, before we understand what will happen in 2012 with respect to that launch. But again, we believe that we and Seikagaku are not infringing the patents of Genzyme in that case, and we intend to vigorously defend our position in that case.

Thank you very much.

You are welcome.

Your next question comes from David Lewis with Morgan Stanley.

Good morning.

Good morning.

Good morning.

Just two quick questions. First Jim I apologize if I missed it. Gross margins in the quarter were a little stronger than we were expecting. Could you just walk through the components?I think you talked about mix but specifically sequentially mix and currency and the impact that had on gross margins?

I would tell you that it really depends on what you are comparing it to. Comparing it back to the prior period, the third quarter of last year we actually saw gross margin step down about 150 basis points, and really nearly all of that is attributed to the hedge losses that are running through cost of goods. And that is in line with what we anticipated coming into the year, and in line with the guidance we have provided for the full year.

I will say that with respect to the full year guidance of 75%, given the strength this quarter and the way that things are playing out by quarter, it does imply a bit of a step down in gross margin in the fourth quarter, which can be attributed to somewhat higher unit costs, as a consequence of pressure on volumes as we anniversary out of some large pipeline inventory build that took place in 2010, and also recognize or realize the effects of the higher mix of revenues from international markets, where our devices are generally sold at lower average selling prices and consequently our gross margins are a bit lower.

Thanks for the clarification, Jim. David, maybe more of a strategic question. I know you have been getting a lot of outlook and strategic questions on this call. For the last eight or so quarter there has been pressure in the recon markets. You remain convinced, as you mentioned with the hip business this particular quarter that those businesses can recover. But as you think about your strategic planning, obviously I am sure you take more than a six or 12-month view.

As you think about your strategic planning what are you running the business to, in terms of your M&A strategy as it relates to spending levels, as you think about three to five years now what is your updated outlook, in terms of what the recon business can grow?Are you thinking about a low-single digit business,Mid sizing the digit business,are there still hopes this could be an upper-single digit business, because we can't predict when the markets recover, but I imagine you are thinking strategically about what these markets could grow at, I was wondering if you could share with us your thoughts?

Just to keep that assumption centered, we think about it as a mid-single digit growth market upon normalization. And the timing of that is difficult to predict because you are really relying on some form of positive momentum in the macro economic climate to cause people to become more confident, that if they are in jobs they are not going to lose their job while they are out getting one of these procedures, or to get enrollment rates back up in the US, as it relates to the unemployment levels, et cetera.

There is no doubt in our mind that when you do the demographic analysis, that you can look at something in mid-single digits, and you are make some assumption to get there as to what kind of a mix benefit you will have if you innovate properly, and you are doing things that are going to improve patient outcomes, but also being responsible and acknowledging the cost pressures that are on the customers. I will feel confident as well that you are going to be able to offset any sustained price pressure with mix opportunity. I think that is an appropriate way for us to think about this market.

Is there a catalyst you can think about that would lead you to believe that mid-single digits is not appropriate, and low-single digits is appropriate? If that were to happen, one is there a catalyst for that?If that were to happen are there changes you can and will make to operating structure and capital deployment according to that change in growth?

Well one of the things that we are going to consistently do David is examine within the musculoskeletal care space, the portfolio ensure that we are overdriving our investment in the higher growth areas, and there are subsets of the space that are high growth areas, both by product category and geography, and that is a lot of what we have been doing this year, most of that effort has been funded by the transformation initiatives as we repurpose dollars and redirect people towards those opportunities. That is one thing that we can do.

And then, of course, there is going to be a constant effort on our part on the inorganic growth side. We generate a lot of cash. Our preference would be to redeploy that cash in external development, and acquire our way into adjacencies that make sense within the musculoskeletal space, and ensure that we are attacking those high growth areas to put ourselves in a position for sustained growth, and to get the top line up even in a difficult market. I think that is doable. At the same time we going to be very disciplined and responsible about how we price those deals, and which ones we go after to make sure that we are going through all of that effort, and doing all of the work, so that it redowns to our stockholders benefit.

Great. Thanks, David. Very helpful.

You are welcome.

The next question from the line of Charles Chon with Stifel Nicolaus.

Thank you very much.

You are welcome.

I would like to dig a little bit in the strength outside the US, especially in hips and knees. You spoke to how new products and instruments are driving the relative outperformance there. Is it really just that, or is there more to the story? Because you speak to infrastructure buildout, and I am wondering if you could be a little more specific on what the Company is doing there?Acquiring local distributors?Moving into regions that are being overlooked by competition?What is the margin profile file on the incremental growth outside the US?

Sure, Charlie and this is an area that we have I think done a better job of focusing on strategic planning efforts and then our annual operating planning efforts have shined a brighter light in some of these areas, where we either had, were underrepresented relative to our global market share in profitable developed markets, or we are underinvesting in emerging markets that provided us with significant opportunity. So there are places where we have decided to go direct and do forward acquisitions of distributors, because those are markets where we want to have more control, more direct control in the future, and they are markets that we feel are very attractive.

But more importantly, we have put more feet on the street in accordance with where we saw opportunities. I think that the OUS channels are doing a nice job of picking up on the opportunities they have for the emerging business markets that we have, meaning spine, dental, trauma, and surgical. They are attacking those opportunities and they have an infrastructure and channel that allows them to go after those opportunities and expand our market share there, and then the emerging geographic markets have been a point of emphasis.

We did a transaction in China with the Beijing Montagne deal last year. That integration is going well. We are continuing to grow our legacy business in that same jurisdiction. A whole variety of strategies that we are executing relatively well right now, and you can see the returns that we are starting to develop in those markets.

How much would you say that emerging markets constitute of your OUS revenues, and how quickly is that segment growing?

It is a double-digit grower, in the scheme of the overall revenue base, it is not a big percentage. So we are growing at a very rapid rate off of a small base.

Okay. And my second question is just on the US knees. The more the market really, I can appreciate the dynamics related to some of these macro issues are impacting the market, but we have also in recent years seen an increase in competition, including customized implant solutions, robotic based implants, which may not be as well understood when just looking at the numbers from companies that report results each quarter. Wondering do you think the perceived market softness could be masking to a degree some of these increasing competitive dynamics, and for Zimmer as a market leader in knees, how do you guys contemplate these competitive issues?

I think that there is some level of traction on that front, but we have visibility to those numbers in at least some of those instances, and can estimate out in other instances, Charlie, that cause us to believe that there is a pretty clear view as to the market. I think there has been a procedural slowdown. It has been more profound in knees than it has been in hips over time. We have sort of seen that play out across the global market, as well as between those two major product categories.

I think that on your broader question, we are going to continue to innovate in this space, and I referenced that in my prepared remarks. We are not going to get specific about how we think the market is going to respond to the different offerings, or what our specific strategies are in that regard, but I would tell you that I believe where we are headed is to take ourselves to a place where we are providing better patient outcomes in a cost-effective manner, so I am very confident in our ability to compete against some of those threats that you were referencing in the knee category going forward.

Great. Thank you.

You are welcome.

(Operator Instructions). Next we have Joanne Wuensch with BMO Capital Markets.

Thank you for taking my question. One of the things I get from investors a lot is what about price in orthopedics, it is remarkable how consistent the price for your products in terms of price pressure has been. Do you have a view on why that may be so stable?

Well Joanne, there have been different geographic segments contributing to that price pressure sort of at different paces and times, and so we have had a pretty good experience in the European markets. We have significant market presence and share in those developed markets. There is negative price pressure in some of those markets. There is still some opportunity in other markets, and our price performance there has been somewhat augmented by some of the forward acquisitions we have done within that channel.

The lumpiness that we see coming out of Asia-Pacific is largely driven by the largest market there Japan, and so we go through the two-year cycles and then get a year break as that anniversaries out, and then head back in for another two-year cycle, and that has been the pattern for an extended period of time. Within the United States it is more the case where it has been outlier pricing coming back, gravitating towards a mean.

So we have more statistical visibility to that one than you do other areas that might be driven by central pricing controls because of a national healthcare system or austerity measures coming out of a centralized healthcare system. So in this case obviously it is the product of negotiations with at a lot of customers, and the trend that we have seen that has been most forceful, has been instances where there have been outlier pricing on the high side, and they are pushing that pricing back toward something that is much closer to the mean. And over the course of the last several years, we can see that subset of our customer base on the high side getting cut down substantially, and that gives us a level of confidence that as we gravitate back towards the mean the ongoing pricing risk in the future should wane over time.

That is helpful. My second question is, the division that received the 483 letter from the FDA. Can you tell us which one that is, and/or do you see any products that are pending regulatory approval in it? Thank you.

Sure. It the is Warsaw operations, Joanne. That is predominantly the reconstructive business. We do have products that are in the 510K process from that facility. We in fact just received a clearance within the last couple of weeks on a pending product in that case. So again, what we are committed to addressing the substantive matters pointed out and the observations, we are deeply committed on the quality side, and I will tell you that the organization understands that there is no higher priority. Plus the foundation of our core values, and we will work hard and make sure that we get that area right.

I also want to emphasize that our objective as it relates to quality isn't just regulatory compliance. We have a vision for quality excellence that is integrated into our operational improvement initiatives. So we are on a journey from where we started several years ago to the Promise Land, and the Promise Land for us is world-class quality excellence in that category, and obviously a by-product of that is going to be regulatory compliance. But that isn't the extent of our objective, or the end destination for us.

Thank you.

You are welcome.

Your next question comes from the line of Rajeev Jashnani with UBS.

You have spoken quite a bit regarding the mix of geographies that are contributing to growth, but also putting some pressure on margins, and you have also discussed some of your Lean initiatives. I was just wondering if you could talk about the net effect of the factors as it relates to the Company to show leverage on the gross margin side, as well as on the SG&A side over the intermediate term?Thanks.

Sure. As David indicated a couple of minutes ago in response to a question, the revenues at this stage revenues from what we defined as the emerging markets for our business still represent less than 10% of our total revenues, and those again are markets that are growing in the area of 15% to 20%. At the outset they are markets that because of the investments that are being made in the early stages of developing those businesses that are operating at lower EBIT margins, lower gross margins and lower EBIT margins than our total consolidated margin, but over time we intend to run those businesses in a way where we are driving them towards an EBIT margin that is very much aligned with what we realize today when you look at our consolidated P&L.

We know we can do that. We have seen that in the way other markets have developed outside of the US. And we get there even in the event that average selling prices are lower and gross margins are a bit lower. We get there by setting up the business model in a way, the service model if you will such that we are spending less money say in sales support than we do relative to our higher priced markets. In the short-term it is putting enough pressure I guess on EBIT margins that it is offsetting some of the savings we are seeing on the restructuring and transformation initiatives. Over the long term, we expect to get positive leverage as our percentage of revenues from those markets increases.

Great. That is helpful. I apologize. I am going to try to push you on this a little bit more. I know it is difficult to put a fine point on it, but when do you see better leverage coming out of those markets to drive better leverage for the organization overall? Is that something that you would care to try to put --

We do it our strategic, well sure, we do our strategic planning out five years, and our expectation and understanding how much more revenue is going to be coming out of those markets is that at a consolidated level, we expect to see increased profitability over that five year strategic plan.

Thank you.

You are welcome.

Your next question comes from the line of Kristin Stewart with Deutsche Bank.

Thanks for taking the question. Just wanted to follow-up on price if you could give us the US, EMEA and then Asia Pacific, and then any color that you might have on what to expect next year with Japan, since I guess the price cutbacks will roll back in come April?

Sure, Kristin. Americas was minus 1.5% in the third quarter. Europe was positive 0.4%. And Asia Pacific was minus 0.8%, for an overall blended total of minus 0.9%, which is bang on where we were in the prior two quarters of fiscal year 2011.

With respect to Japan, as you said, the expectation is that some time in the first quarter we would see pricing revisions coming out from the FAP process, and that those would become effective the beginning of April. All one can do at this point because it is early enough in their process is speculate about what that might look like, and I think that if you were looking for a number to put on that, I would say something in the mid-single digits reduction in price, just because that is kind of the pace we have been on over the last couple of rounds. And I would think that would get blended in over the course of a two-year time period, which has been consistent with what has transpired the last round or two.

Got you. And you mentioned earlier that Europe pricing was augmented by some forward acquisitions. Can you just maybe explain that?Is that why EMEA was up 40 basis points?

This is Jim, Kristin. That is the case. Some of what is contributing to the positive price we are seeing out of EMEAs are these distributor acquisitions. Some of the emerging markets that have allowed us to capture margin that was previously captured by independent stocking distributors, and that is, and the way we are measuring price that is being reported as positive price.

Excluding that was EMEA kind of flattish then? I can't imagine that declining that much?

We haven't provided that detail, and I think that is probably, that may be a fair assumption, but again I haven't done the math, so I can't tell you exactly what that is.

Okay. And then just on the 483, and thanks for being forthcoming with that. Just wanted to get a sense for what the next steps were?You mentioned that the FDA was going to be coming back to inspect. Do you have a sense of timing, because this may just be a little bit of an overhang, and trying to understand kind of what the path is going forward, and I guess what the potential risk could be if it does escalate a little bit further?

Sure. So this is an area that we are going to maintain a lot of focus on, and not just it is a relates to the Warsaw operations. These end up being learning experiences that we translate across the global operations, to ensure that we are doing the right things, and making sure that we are continuously raising the bar on our standards, and formed by views of Best-in-Class in any of these areas. So the work can become relatively expansive because obviously what we wouldn't do is just address an observation as it relates to the particular instance that has been identified. We will take those earnings across the Warsaw operations, and then of course, review the same area across other operations on a global basis.

Some of the observations are a bit more straightforward to address than others. I think that we have made substantial progress I would tell you on all of the observations at this point in time. We believe that we have substantially addressed probably a majority of the observations, but that doesn't mean that there isn't significant work yet to be done to fully address all of the observations, and so we will be on that path. We met with the FDA to discuss our, this is after we submitted our written response for the observations. Had a discussion with them. Understand what their expectations are. And are providing periodic reports to them voluntarily, so that they understand what our progress looks like on a month-to-month basis.

And to I would expect that the reinspection would occur in the coming months, but wouldn't be able to pinpoint a particular date at this point in time. So as needed we provide more information on this. But I do think that it is important for people to understand that we are going take any observation that we get, whether it is from the FDA or a notified body or our own internal audit process very, very seriously, and we take these observations very, very seriously, but one should also conceptualize a bit the number of Form 483s that go out, and understand the context in which we are operating. So we believe that these quality systems, robust quality systems aren't just important because we want to produce good products. We believe that those quality systems are important because those practices are just fundamentally good business, and so our commitment is 100% on this front. And we will make sure that we get it right.

Alright. Could we be facing I guess additional spending levels going forward, just kind of broadly as you adopt some of the changes across all of your facilities from the sounds of it?

Those initiatives--

It seems like you guys have been doing that for quite some time already?

We have been and I would tell you those quality initiatives are so integrated into our operational improvements that is really where we would capture those going forward. So as part of the transformation initiatives, and in the past several years we have been making substantial investments in this area. So that our guidance would contemplate anything that we need to do in that regard going forward, Kristin.

Okay. Thank you, guys.

You are welcome.

Your next question comes from Matt Miksic with Piper Jaffrey.

A couple of questions. But just if I could a clarification. I was hopping back and forth between a couple of calls. The letter is a 483 letter, it is not a warning letter, is that correct?

That is right.

Or are we talking about the same thing?

They aren't the same thing and it is a Form 483 with observations listed.

Okay. So maybe a few steps down below the severity of say a warning letter for a facility, just for clarification. One question on some of your emerging markets. You talked a little bit about, you mentioned Montagne in China, and also your legacy operations there. Could you talk a little bit about how those two businesses are sort of developing together, has one helped the other and if so, how? In particular, I am curious about the development of the knee market in China?

Sure, I would tell you that the legacy Zimmer business, Matt, has been focused on the premium price segment within that market, whereas Beijing Montagne's business was more focused on the middle market side from a pricing standpoint. That company had been predominantly focused on the hip side, had developed products, and is beginning to do more on the knee side, but most of that business historically had been hip focused. And so we like the fact we are going to have product offerings appropriately positioned for the different subsets of that growing market. And I would also tell you there have been some significant benefits to better understanding the distribution channel that had been built out by Montagne prior to the acquisition, and figuring out how we can further leverage that distribution channel, even in instances on the premium side of the market.

So there have been terrific synergies. I think that the team has done an excellent job of integrating that business and executing year one's business plan, and they have done it at the same time where they have not lost momentum on the legacy business. So we feel good about the progress that we have made particularly in the last year or two within that important emerging market.

Okay. And then just for clarification, maybe growth in that market. Do you feel you are growing above and below market, and maybe just to sort of benchmark it for folks, what do you think that orthopedic market in China is growing, either in your sort of legacy top tier, or in the middle market, whichever you are willing to talk about would be helpful? And then I have a follow-up on trauma.

It is a double-digit grower and going to be a sustained double-digit grower in our eyes, and we are getting all that growth, and we believe then some at this point in time relative to market growth, Matt. And just in magnitude it a $1 billion market or so, that is going to become a $2 billion market in a couple of years. So none of these businesses in a market like that are going to be all that impactful on the consolidated results in the short term, they provide nice growth and you can see some of that growth coming through and positively impacting the geographic segment results on the top line, but in due time I think that they will have a similar impact on the consolidated results of the Company, and hence our focus on them.

Great. And then on Trauma and maybe Dental also, both have been performing well. If you could talk about your view there on what has been working for you in Trauma?Is it products, is it distributor strategy?And then sort of similar question on Dental. What is working for you there, how much of what you are showing is a result of the healthy market, and how much is what you are showing maybe the result of some of the products you are rolling out?

I think that in neither instance is it all that complex as it frankly isn't in this business. We have done a good job of innovating in both of those categories, and providing meaningful innovation in the eyes of the customer. And then at the same time concurrent with the investment that we have made in execution on the product development side we have been investing on the sales channel side, and then getting those two things aligned you can start to see the results that we have produced, and if you focus on the trauma side, again this was a plan that was developed five-plus years ago, we have been executing that plan, and we knew that there were no short-term solutions to some product apps that we had, but sustained that investment and executed in getting the new products out the door, and the Zimmer Natural Nail line puts us in a very competitive position with these anatomically contoured nails within the intramedullary nail subset of that market, and we had a very competitive plate and screw offering in advance of that, so we put those two things together, and then enhanced our investments and focus within the sales force on a global basis, and you start seeing the results that we have been seeing for the last three quarters now. So the key is to keep that pipeline flowing on the product side, and to continue to make smart investments on the sales and marketing side, and sustain that growth going forward. But it as business that I feel very confident that we going to be able to maintain that momentum with respect to.

And the Dental? In particular, I guess you have shown yourself to be interested on the strategic side there. It doesn't seem like that has been what is driving your growth here. Is that still an interest and maybe talk a little bit about the market?Thanks.

Sure. And this is a market that we like as well. It provides a bit of a diversification relative to the payers that we see in most of the other businesses, because it is more private pay generated. That is its strength, and that is this market's weakness, and when the economy was facing the downturn in the early stages, obviously this is a market that got hit harder. Even now you can see although it is stabilized over the last year, you can still see some lumpiness in the market performance. We saw it OUS in a more significant way in Q3 than we did within the United States market, but we saw it somewhat in the United States market as well.

So again, in a stable economic environment this is a very underpenetrated market. This is a solution that offers clinical and aesthetic benefits. You have to have the customers with the wherewithal to trade up and buy a better clinical and aesthetic solutions, so it is going to be a bit more cyclical directly in accordance with what the general economy is doing. We like the space a lot.

As you said in an external development world, where we could find a way to get more market share through inorganic growth we would want to do that, but we going to be disciplined about that, and I think that particularly because of the potential volatility of this market in accordance with the general economy, we are going to be disciplined about how we grow that business, and I think that we have a terrific team and have executed very well, and we find the right opportunities we will augment. If we don't we are going to keep investing internally in this business, and I think our leadership team there with continue to have success going forward.

Very helpful, thanks.

You are welcome.

We have time for one additional question.

Your final question comes from Larry Biegelsen with Wells Fargo Securities.

Good morning, thanks for fitting me in. Just two questions here. First what do you think procedure growth is for the US knee market in the third quarter, and the second quarter? And is it decelerating? I am wondering if the mix benefit from patient specific instruments are masking very weak procedure growth there. And my second question is on extremities. For you guys it has been a little bit below market for a couple of quarters. What is going on there and has the market slowed, and what is your expectation going forward? Thanks.

Sure. Good questions. I tell you that on the US knee side I don't know that the market has changed dramatically. I think that they are on a dollar basis could have been a step down of 20 to 30 basis points, from negative 1 point something, to negative 2.0 or 2 point something. And I think that most of that is procedure based, Larry. I don't think that across the broader market, we are in a big mix benefit period. I think that there is probably some mix opportunity that some are enjoying, the patient specific instruments in that space is an area that probably most are getting some benefit from, but there aren't a lot of new system launches that would be driving benefits, so I think that your operating environment where pure price is probably minus 2 for most, or at least lower single digits negative, and so that is how we see that space at this point in time.

With respect to extremities, we continue to do very well with our Trabecular Metal solutions within extremities, so the majority of our business, and the majority of that market at this point in time is shoulder focused, and we have some product portfolio development efforts that are ongoing to address other anatomical sites, and so that is part of the answer for us. And then shoring up our upper extremity offering at the same time is part of the answer for us. But I think that market continues to be healthy, it may have stepped down a bit, but I don't think all that much, I still think on a global basis it is a low double-digit grower, and I think it will continue to be, primarily because there is meaningful innovation going on in that space to provide better solutions for patients than what they have had in past years. So we continue to like the extremities market, and you are going to see us continue to maintain a focus on that market in our product development plans.

Thanks guys.

You are welcome Larry. So with that, I would like to thank everyone for joining the call today, and for your continued support for Zimmer. We are glad that we could finally find our call coordinator whose name began with Z for today. We look forward to speaking to you on our fourth quarter conference call that is scheduled for 8.00 AM on January 27th, 2012. So with that I will turn the call back to you Zatanya.

Thank you again for participating in today's conference call. You may now disconnect.