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Zimmer Holdings Inc. (NYSE:ZMH)

Q1 2008 Earnings Call

April 24, 2008 8:00 am ET

Executives

Paul Blair - VP IR

David Dvorak - President and CEO

Jim Crines - EVP of Finance and CFO

Analysts

Bob Hopkins - Lehman Brothers

Joanne Wuensch - BMO Capital Markets

John Crawler - Piper Jaffray

Tao Levy - Deutsche Bank

Mike Weinstein - JPMorgan

Michael Matson - Wachovia Capital

Matt Miksic - Morgan Stanley

Jason Wittes - Leerink Swann

Kristen Stewart - Credit Suisse

Michael Jungling - Merrill Lynch

Bruce Nudell - UBS

Bill Plovanic - Canaccord Adams

Philip Lezlie - Thomas Weisel Partners

Paul Blair

Good morning, I’m Paul Blair, Vice President of Investor Relations for Zimmer. I would like to welcome you to the Zimmer First Quarter 2008 Earnings Call. Joining me today to host this call are David Dvorak, President and Chief Executive Officer and Jim Crines, Executive Vice President of Finance and Chief Financial Officer. This morning we'll review our performance for the first quarter, present an update to our outlook for 2008, provide you with report on some key initiatives, and conclude our discussion with a question-and-answer session.

Before we get started, I would like to point out that this presentation contains forward-looking statements, within the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995, based on current expectations, estimates, forecasts, and projections about the orthopaedics 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 risks and uncertainties, see the disclosure materials filed by Zimmer with the Securities and Exchange Commission. Zimmer disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. This presentation also contains certain non-GAAP financial measures. A reconciliation of such information to the most directly comparable GAAP financial measures, along with other financial and statistical information for the periods to be presented on this conference call, was included in the press release announcing our earnings, which may be accessed from the Zimmer website at www.zimmer.com, under the section entitled Investor Relations.

A rebroadcast of this call will be available from approximately two hours following the conclusion of today’s call through the end of the day on May 4, 2008, and can also be accessed from the Investor Relations section of the Zimmer website.

At this time, I would like to introduce David Dvorak, President and Chief Executive Officer of Zimmer.

David Dvorak

Thank you Paul, and good morning everyone. Today I would like to review the overall results for the quarter and address the progress we are making in furtherance of the strategic priorities we previously outlined. First, let’s review our first quarter results.

Consolidated sales for the quarter of $1.059 billion, were up 11.5% over the prior year first quarter, 6.2% in constant currency, and we delivered 6.1% growth in adjusted earnings per share. We are pleased with our earnings performance and cash flow generation in the first quarter. Our sales results, when adjusted for a reduction in billing days in United States, and the negative impact of the previously announced actions at our Ohio-based orthopedic surgical products operation, reflect performance in line with our expectations. The continued weakening of the US dollar has favorably impacted our top line growth, and as we’ve pointed in the past, our hedging program essentially neutralizes the impact to our bottom line.

During the quarter, we generated operating cash flow of $243 million and we used $144 million to repurchase 1.88 million shares. Jim, will discuss these results and changes to our stock repurchase program in greater detail later in the call.

The market opportunity for our products continues to be strong across all three of our major geographic segments, and we continue to believe the market for our core reconstructive products is growing at mid single-digits on a per share basis with mixed benefit opportunities adding to 1% to 3% for new devices that address unmet clinical needs. Our first quarter sales performance was well balanced and consistent with this view of the global orthopaedic market. I will now turn to our updated guidance for the full year 2008.

We previously explained that we developed our guidance taking into account our assessment of the market and the ongoing opportunities and risks that could cause and impact our performance. Our outlook called for top-line growth for the year of 10% to 11% net sales on a reported basis. As we indicated in our fourth quarter call, sales will be driven by new product introductions and further market penetration by key products launched in 2007 and this year, as well as the positive effect of a weaker broad.

Our guidance for top-line growth remains in the 10% to 11% range on a reported basis. The previously announced impact on OSP revenues is expected to be offset by the positive effect of a weaker dollar. In addition, as the year began, we projected earnings per share of between $4.20 and $4.25, based on those expectations. We've maintained that guidance today, after taking into account the negative financial impact we'll experience as a result of loss sales, inventory losses and remediation costs in our OSP business. We have also now factored in the anticipated positive financial impact of a number of other planned actions that Jim will describe in more detail, which are expected to offset the negative impact of the OSP situation.

On our fourth quarter earnings calls, Jim and I previewed a number of significant infrastructure initiatives that will position us to respond to the growing medical needs of an aging population. Cheap among these are the investments we're making to ensure that we maintain state-of-the-art quality systems and processes in all of our business operations globally.

Our ongoing commitment to quality will be unyielding, as we continuously improve our quality systems. To that end, our infrastructure investment plans for 2008 are, in part, directed at opportunities to enhance quality systems across our entire manufacturing network, and to ensure the quality systems and practices in all divisions meet or exceed our standards, as well as those of agencies that regulate us.

As a result of this endeavor, in the first quarter we initiated a comprehensive remediation effort at our OSP division Dover, Ohio including voluntary product recalls of certain OSP products, voluntary and temporary suspension of manufacturing and sales of certain products, facilities equipment and procedural upgrades, enhance quality training for OSP employees and appointment of a new divisional president.

While we're clearly disappointed by the OSP situation, we believe the actions we've taken demonstrate the seriousness with which we take quality systems' matters and we're keeping the FDA informed of all of our actions.

Now, I'd like to focus on and provide details regarding the progress that we've made early in 2008 and the other key priorities that were highlighted on our fourth quarter call. One of our priorities is to meet or exceed our stated goals for financial performance. Our updated guidance demonstrates that we'll take necessary steps wherever possible and within the interest of our stockholders to offset the negative impacts of unplanned events to the best of our ability.

Another key priority for Zimmer is to make investments in manufacturing facilities operations, and very importantly, our employees, so that we're prepared to serve the healthcare market of the future, generating positive returns for years to come.

During the quarter, we took a significant step in assuring that our global manufacturing network is ready to meet growing demand. We announced and began to work on a new Zimmer facility in Shannon, Ireland and are making additional investments across our global manufacturing network. The Shannon project also reflects our intention to geographically diversify our manufacturing base. These investments, combined with our other operating infrastructure initiatives, comprised an ambitious program to build our business globally.

Over the last seven months since entering into our resolution agreements with the US government, we've considered carefully what it will take to shape the future growth of our industry. As we shared during our fourth quarter earnings call, this process has let us to move beyond the requirements of our resolution agreements to create what we believe is a more sustainable model for growth, based on practices that reduce potential or even perceived conflicts of interest involving physician collaborators.

Our most urgent priority is to continue to develop products that are best-in-class in terms of the benefit they deliver to patients, the difficult problems that they solved across the clinical continuum and their quality. We need to fulfill this mission in ways that broadly inspire confidence and trust. That's why we have chosen not to incrementalize these efforts. We want to go through this transition once in a comprehensive manner across our global enterprise.

Last week, we publicly communicated the strategies we've established at this stage which create fundamental changes in product development, surgeon training, educational and charitable funding and transparency. Taken together, they create a new model to aggressively reduce potential or perceived conflicts of interest, while preserving the best of the collaboration that drives innovation in our industry.

Finally, before I turn the call over to Jim, I want to note that in March, we were informed by the US Department of Justice, Antitrust Division that they have closed their investigation that was first announced in June 2006. We are very pleased that the DOJ's antitrust investigation is closed, and that neither the company, nor any of our employees were charged in connection with the investigation.

Jim will now provide further details on the quarter and our 2008 guidance. Jim?

Jim Crines

Thanks, David. I will review our performance in the quarter in more detail and then provide some additional information related to our guidance.

Sales of $1.59 billion for the quarter represent an increase of 11.5% reported, and 6.2% in constant currency. These results reflect an estimated loss of $6.5 million in OSP product sales as well as the effect of one less billing day in the US On a day rate basis, and excluding the impact of the OSP matter, these results are in line with our expectations for the quarter.

A weaker US dollars compared with prior year, added 5.3% or $50 million of revenue in the quarter. As expected consolidated price was flat for the quarter, and the Americas pricing contributed six-tenths of a point of growth in the quarter, in Europe, price was half a point negative. Germany, Italy, Sweden, France and UK reported low single digit reductions in average selling prices while other markets in Europe were flat to slightly positive. Asia Pacific results include negative price of 0.9%, driven by negative 2.8% in Japan offset by flat deposited prices in other Asia Pacific markets.

Turning to our revenue growth by major product category, worldwide reconstructed sales increased to 11.8% reported, 6.3% constant currency with the billing day difference in the US accounting for nearly a point reduction in growth. Knee sales improved 6.7%, reflecting lower mix benefit associated with the NextGen Gender Solutions Knee compared to prior year first quarter. Knee pricing on a global basis was flat for the quarter. Flex knees accounted for 49% of our knee units on a global basis, slightly ahead of our last two quarters.

We are still early into the launch of our Gender Solutions Natural-Knee Flex as well as our NextGen mobile bearing knee. Unit sales of these two systems accounted for less than 10% of our knee units on a global basis in the quarter and represent an important opportunity going forward. In addition, our new gender solutions Patello-femoral Joint System is now broadly available and we're also launching a Trabecular Metal Tibial Tray for our NextGen Knee System.

In other knee systems, Zimmer Uni LCCK and RHK as well as our Prolong Highly Crosslinked Polyethylene grew in double digit. Geographically in the first quarter, our knee sales in constant currency increased 6.1% in the Americas, 5.9% in Europe and a particularly strong 12.3% in Asia-Pacific. We feel very good about our Knee product line, as we look out through the rest of the year at the opportunities we have with recent Knee product launches.

Hip sales increased 3.5% in the quarter reflecting a volume and mix increase of 4% offset by a decrease in average selling prices of 0.5%. These results no longer include bone cement sales, which for reporting purpose have been reclassified as OSP and other product sales. The purpose of this change is to provide you with greater transparency to underlying performance of our hip portfolio. These results reflect steady growth across our primary hip portfolio including porous primary stems and Acetabular cups. Our TM primary and M/L Taper with connective technology experience steady growth offsetting part by lower sales by VerSys Fiber Metal MidCoat, Beaded 6" FullCoat, and other cemented stems.

TM Modular Cups and Durom and Acetabular component sales reported solid growth, as did Metasul large-diameter heads, with the Metasul brand realizing over 26% reported growth in sales in the quarter on a relatively small base.

On a geographic basis, and in constant currency, hip sales increased 3.3% in the Americas, 2.9% in Europe, and 6% in Asia Pacific, inclusive of negative price of 2.3%. Extremity sales for the quarter on constant currency increased 27.3%, on a challenging comp of 29.6% in the first quarter of 2007. Extremity sales increased 30.9% in the Americas, 19.3% in Europe, and 11.5% in Asia Pacific.

Dental sales increased 9.1% for the quarter on a prior year comp of 20.6%. Dental sales increased 5.1% in the Americas, and 26.6% in Europe, including the effect of the distributor acquisition in Italy, which closed in the second quarter of 2007. Dental sales decreased 7.3% in Asia Pacific on a base of less than 10 million, and against a very challenging comp of 46% growth in the prior year first quarter.

Trauma sales in the quarter were up over the prior year period 5.6% in constant currency. This growth is in line with our expectations as we bring greater focus to the sales efforts supporting our trauma product line and continue to face competitive pressures on our Intramedullary Nails and compression hip screws. Trauma sales in the quarter increased 5% in the Americas, 8.4% in Asia Pacific and 4.7% in Europe. A 13.8% of a prior year first quarter spine sales are at pace with market growth led by the sales of Thoracolumbar Outerbody fusion products, Interbody Spacers, and Dynesys.

Spine, in the Americas, was up 11.1%, Europe increased 27.7%, and Asia Pacific was up 20% on a small base. Finally, Orthopaedic Surgical products and other sales grew 0.8% constant currency in the quarter, patients care product sale s declines 15.6% as a results of the OSP actions while Bone cement and accessory sales now reported in this category increased 23.4% over the first quarter of 2007. The OSP and other category was up 3.2% in the Americas, 0.5% in Asia Pacific and decline 9.1% in Europe, compared with prior year period.

Now, I'll focus on the rest of the income statement. Our adjusted gross profit margin of 76% for the quarter reflects a reduction of approximately 50 basis point for inventory related charges associated with OSP. R&D expense decreased 4.5% to $50 million for the quarter, reflecting lower spending on consulting services. Certain US knee and hip development clinical and external research activities have been delayed, as we work our way through operational compliance with the resolution agreements, and our recently announced enhanced compliance and ethics initiatives. We expect activities to resume in the second quarter.

Selling, general and administrative expenses increased to $415.6 million, up 14.9% to prior year and include monitor fees and expenses and higher instrument cost in the quarter. SG&A expenses were favorably impacted by a change in estimate related to share-based compensation expense that resulted in a reduction of approximately 50 basis points in SG&A for the quarter.

Acquisition, Integration, and Other amounted to $7.3 million in the quarter, comprised principally of costs pertaining to 2007 acquisitions. Adjusted operating profit in the quarter increased 2.8% to $339.2 million, and at 32% our adjusted operating profit to sales ratio decreased by 270 basis points from prior year, as a result of a lower gross margin and planned increases in SG&A cost.

Interest income for the quarter amounted to $1 million, adjusted net earnings increased 3.7% to $244.3 million, and adjusted diluted earnings per share rose 6.1%, to $1.04, on 233.9 million average outstanding diluted shares. These adjusted earnings per share are inclusive of approximately $0.05 of share-based compensation and at a $1.02, reported diluted earnings per share increased 4.1% on prior year first quarter reported EPS of $0.98. At 28.1% adjusted for the quarter, our effective tax rate is consistent with our expectations and below prior year due to resolution of certain tax positions.

During the quarter, we repurchased 1,883,000 shares at a total purchase price of $144.3 million or an average price per share of $76.61. As of March 31, 2008, we have remaining capacity to acquire up to 477 million of stock under the repurchase program authorized in December 2006.

As indicated in our release, our Board has authorized an additional 1.25 billion stock repurchase program which expires on December 31, 2009. I will further discuss this in my comments on guidance. For us, in the absence a significant demands on our cash, stock repurchases remain an effective and efficient use of available free cash flow. Operating cash flow for the quarter amounted to $242.7 million, an increase of 26% over prior year first quarter, as a result of strong performance on working capital management and suspended royalty payments of $22 million.

Inventory days on hand finished the quarter at 268 days, a decrease of 19 days from prior year first quarter, reflecting higher cost of goods in the quarter. Our trade accounts receivable day sales outstanding finished the quarter at 59 days, consistent with prior year first quarter.

Depreciation and amortization expense for the quarter increased to $61.8 million. Capital expenditures for the quarter totaled $110.9 million, including $57.5 million for instruments and $53.5 million for property, plant and equipment with $24 million related to infrastructure initiatives. Finally, free cash flow was $131.8 million for the quarter.

Now, I would like to provide an update on guidance for 2008. As reported in our press release on April 3, OSP-related actions are expected to adversely impact 2008, OSP revenues by $70 million to $80 million. These actions are expected to negatively impact 2008 adjusted earnings per share by $0.18 to $0.20, including $0.07 related to inventory charges, idle plant cost and other non-recurring expenses. Approximately, $0.03 for the full year effect is reflected in our first quarter results.

We expect this impact to be offset by reductions in planned operating expenses, share repurchases, and other actions. With regard share repurchases, as already mentioned, our Board has authorized an additional $1.25 billion of repurchases, which can be financed in whole or in part with third party debt. We intend to draw out the 500 million in our credit facility and use the funds to repurchase shares. This together with repurchases and other ongoing program is expected to reduce estimated diluted weighted average shares for 2008 to 230 million from 234 million, and add interest expense of approximately $10 million before tax.

Share repurchases or reductions in planned operating expenses are expected to offset the negative operating margin impact from OSP. Other actions which are likely to incorporate one-time gains are expected to offset the non-recurring OSP charges. Regarding an update then on full year guidance, we expect to deliver top line sales growth in 2008 at the original 10% to 11% range, and adjusted earnings per share in the same range of $4.20 to $4.25, including the items noted.

As always our guidance and assumptions exclude the affect of potential future acquisitions or other unforeseen material business event. Taking a closure look at sales expectations and the effect of a weaker US dollar, we now anticipate four points of growth to come from foreign currency. Therefore, with the OSP impact, our sales guidance now assumes a constant currency growth rate of 6% to 7% for the year.

We anticipate a tax rate of around 28.5% four-tenths above our first quarter rate for 2008, which includes the favorable resolution of certain tax positions. To arrive at our GAAP earnings per share, you should assume subtracting acquisition integration and other cost of approximately $27 million or an estimated $0.8 per share.

Turing to cash flow, we anticipate capital expenditures in the range of $400 million to $500 million, reflecting the capital components of many of our 2008 infrastructure and operating initiatives.

David, I'll turn the call back over to you.

David Dvorak

Thank you, Jim. We're excited about the opportunities that are ahead for Zimmer. We believe that our products are the best on the market and we respect and appreciate the responsibilities that come with being a market leader. The strategic initiatives we've discussed today will make Zimmer even stronger in the long run and better able to meet the demands of the future. In the immediate term, we will continue to execute against our three major priorities. First, meet or exceed our stated goals for financial performance. Second, implement the infrastructure and operational initiatives that will prepare Zimmer to participate in the future growth of the market in a significant way. And third, develop the market exceptional products under compliance standards for collaboration that consistently earn the trust of our stakeholders.

And now, I'd like to open the call to your questions.

Question-and-Answer Session

Operator

Thank you very much. (Operator Instructions). Our first question today comes for Bob Hopkins with Lehman Brothers.

Bob Hopkins - Lehman Brothers

Hi, thank you and good morning.

David Dvorak

Good morning, Bob.

Jim Crines

Good morning, Bob.

Bob Hopkins - Lehman Brothers

Couple of questions. First, of the two point decrease in constant currency growth guidance that you're giving, is that entirely OSP-related? Or is there also reduction in your outlook for hip and knee constant currency growth for the course of the year?

David Dvorak

That is the direct effect of the OSP impact.

Bob Hopkins - Lehman Brothers

So there is no change in your constant currency growth assumptions for the full year for hips and knees versus the guidance that you gave on your Q4 call?

David Dvorak

No, that's correct. We are seeing the same market that we saw when we put our plan together for 2008, where we believe again the procedure rate is mid-single digits and then there is still an opportunity for one to three points on mix.

Bob Hopkins - Lehman Brothers

But, if you look at your first quarter constant currency hip and knee results, especially in hips, it's still off about 3 to 4 points sequentially from the Q4 kinds of levels. Could you talk to why we saw that sort of decrease in the first quarter and what sort of headwinds you faced in the first quarter?

David Dvorak

Well, I think that the procedure growth that we reported out on the fourth quarter of last year was stronger than what was averaged in 2007 and our 2008 full year guidance assumes again a mid-single digit procedure rate with that mix opportunity. So, that was a fall off from procedure growth, but some of that could be reflected by virtue of the fact that we had an impact on billing days as well as the timing of Easter and some of the other companies reported on that.

Bob Hopkins - Lehman Brothers

What kind of impact do you think, like was the selling days one day and what kind of impact do you think you saw from Easter?

David Dvorak

If we put all of that together, Bob, the Easter holiday, the timing of the academy as well as the billing day, it's probably a point in our estimate.

Bob Hopkins - Lehman Brothers

Okay. Couple of other things, quickly. Do you expect the OSP products to be back on the market by year-end 2008?

David Dvorak

Our plan would contemplate that those products would come back on market.

Bob Hopkins - Lehman Brothers

Okay. And then, one other question I have. I am just curious about the timing of things. Obviously on the fourth quarter call, you guys gave very bullish report and very bullish tone. And yet, when we look back at the timing of the FDA recall announcement as it relates to OSP, that was sort of in full swing, as you are giving that guidance. But it wasn't disclosed. And now we are hearing that it's a $0.18 to $0.20 headwind for the full year. I am just wondering why didn't you disclose it on the first, on that call, on the fourth quarter, especially now knowing that it's going to be such a major headwind for the full year?

David Dvorak

Yes. We had identified a particular recall problem and acted upon that promptly and obviously, the problem was much deeper than what we knew at the time of the call. So, work was underway, but the scope of that issue had not been defined as of the first quarter call. So, we reported out on the magnitude of that issue as soon as that was defined, Bob.

Bob Hopkins - Lehman Brothers

Okay. And then finally for me, do you think any of the deceleration in growth in constant currency in the first quarter that you saw was related to any fallout from the changes you are making inside Zimmer as a result of the settlement with the DOJ. In other words, do you think you lost any share or lost any physicians or sales people or any turnover and distributors that might have impacted results in the first quarter?

David Dvorak

Nothing of any significance I will tell you. I think that there is going to be impact over time and there may have been some in the first quarter, because different people are going to come out with these changes with different speed. But we really believe that we're making the right decision for the long-term and our guidance would reflect any impact that we would foresee in that regard.

Bob Hopkins - Lehman Brothers

Thank you. I will get back in queue.

David Dvorak

Thank you.

Operator

We will take our next question from Joanne Wuensch with BMO Capital Markets.

Joanne Wuensch - BMO Capital Markets

Thank you very much. When I take a look at absorbing 18% to 20%, that's a huge number, I understand the components of it. But when you think about that amount of money, is it $0.05 a share repurchase, $0.05 from cost cutting. Is there anyway to sort of figure out the magnitude of what you need to do to absorb that?

Jim Crines

Well, hi Joanne, this is Jim. As we pointed out the combination of plant reductions and operating costs as well as what we've went through specifically on the call with the share repurchase program going to $500 million on the credit facility and using those funds to repurchase shares. It's a combination of those two things that sort of covers off the loss margin on that $70 million to $80 million of OSP sales impact, and other actions that we have contemplated that would offset the normally current charges with the normally current charges related to your inventory life losses and idle plant expenses and extraordinary outside service fees that we're incurring as we operate, manage our way through that issue.

Joanne Wuensch - BMO Capital Market

Is there any thing that you are cutting out that you wouldn't have otherwise? I mean if this hadn’t come along would we be looking at a 27 B in 2008?

Jim Crines

Well some of what you are seeing, and you see it in our first quarter results as we get further down the road on our enhance compliance and ethics initiatives there is clearly some lower spending. You saw that in the quarter in R&D. So, some how what we have reflected in the reductions and plant operating expenses are consistent with what you're seeing in the first quarter and otherwise in some respects it’s timing. We came into the year planning to increase our spend in total at around $100 million and it does take time to have ramp up that kind of increase in operating expenses. We don't, at this point see it having any effect on the ability to execute on those strategic infrastructure and operating initiatives, but there is a bit of timing issue in terms of the ramp up of those expenses.

Joanne Wuensch - BMO Capital Market

Okay. How much did the moving of the bone cement out of hips impact the hip growth number this quarter?

Jim Crines

It's by about a points and which is consistent as well with what we would have reported last year.

Joanne Wuensch - BMO Capital Market

Did you see any pickup in hips because of the striker product recall?

Jim Crines

Not in our numbers, no.

Joanne Wuensch - BMO Capital Market

Okay, thank you very much.

Jim Crines

Welcome.

Operator

We'll take our next question from Mark Mullikin with Piper Jaffray.

John Crawler – Piper Jaffray

Hi, actually this is John Crawler [ph] covering for Mark. Just a couple of quick questions here, I’m sorry if this is already been covered, but did you see any competitive impact of the DOJ settlement in this last quarter, either gaining share or affecting your over all growth in the quarter?

David Dvorak

I don't think that there is anything that's discernable in that regard. I think that the structure of that resolution is to ensure that there is a level plain field, and I think they are generally speaking effective in achieving that objective.

John Crawler – Piper Jaffray

Okay, great and then just a quick question on, are you guys seeing any increases in the cost to your components that maybe affecting your bottom-line at this point?

David Dvorak

No, John, we have some visibility coming into the year to the increase you maybe referring to in cobalt chrome prices. Yeah, we use cobalt chrome in many of our devices, but again we have good visibility to that coming into the year and that was reflected in the guidance that we provided on the margin.

John Crawler – Piper Jaffray

Great, alright and then one just last quick question on the cash you currently have on the balance sheet, is any of that in like auction rate securities, something that maybe you wouldn't have access to at this point in time?

David Dvorak

No, John, going back to sort of, the middle of last year. We didn't have anything in auction rate securities per say, but we took action to even move money out of money market funds that might have had some exposure to those securities, and our $475 million is invested in short-term treasury back securities. So, we have no exposure to what's happening, or what has happened with those auction rate securities markets.

John Crawler – Piper Jaffray

Great. All right. Well, thank you very much.

David Dvorak

Thank you.

Operator

Okay. Your next question from Tao Levy with Deutsche Bank.

Tao Levy - Deutsche Bank

Hi Good morning. I was wondering if you could actually give us a dollar amount for the bone cement in the hip business.

Jim Crines

We have not, Tao, provided that kind of detail and as I said, it declined about a point of growth in the quarter. That’s consistent with what it was contributing as you go back to last year and as we make this change. Obviously we will go forward with the filing of our quarterly filing that will be reflected in the prior year numbers as well. You will able to the math then when you see the quarterly filings.

Tao Levy - Deutsche Bank Securities

Okay. And also just a follow up on Bob’s question, he asked whether OSP would come out, come back online in 2008 and I think you just said, it would come back online and I don’t know if meant in ’08 or ’09?

Jim Crines

Yeah. Our plan is obviously, as soon as we can be comfortable that we are operating with our quality standards in mind to bring those products back online. Some of the products are still online at this point in time and we are very comfortable with those obviously. If all goes well, we would expect before the year is out to bring the other products back online, but we couldn’t give you any absolute assurance of that.

Tao Levy - Deutsche Bank Securities

Okay. And then just lastly, I just wanted to get a sense, obviously we have seen other companies report and you mentioned that the Easter affects your billing days. What’s your sense as you exhibit the quarter as you feel a little bit of April, you look back at to that as a business returned more to a click that you would have, that you are seeing, sort of at the beginning of, sort of in the January, February timeframe. I was trying to make sure that maybe are we going to see bit of a bolus activity here in the second quarter because of those issues?

David Dvorak

We obviously reported on the first quarter, and we don’t have visibility as to what we overall markets and the other companies are going to be reporting for the month of April at this stage.

Tao Levy - Deutsche Bank Securities

But I was just trying to figure out, how do we get comfortable that we are talking about Easter billing day, if your billing days is in fact what's going on and it's not a major market slowdown that’s not reflected in billing days, etceteras.

David Dvorak

Well, as we said with perspective of the first quarter, we still believe that it’s a mid single-digit procedure growth rate with an opportunity for 1% to 3% mix, and that's the premise to our 2008 plan and continues to be our insight as to what the market's doing through the first quarter.

Tao Levy - Deutsche Bank Securities

Okay. And then just lastly, the activity that’s going on in Ireland and new manufacturing facilities, what’s going to come out of there and when we do we start to see that, I assume it effect your I assume gross margins. When do we start to see that impact the business?

Jim Crines

Sure, what we're going to focus on initially in that facility is femoral component need, femoral components. Those are high margin devices; this is in a low tax jurisdiction so make sense for us to have those kinds of components. We also have a process; we have in place to pickup this modular cell manufacturing process, and get them setup fairly quickly in Ireland. We have an aggressive time table that has us producing products in the beginning of next year, and selling that product into the European market initially in I would say the second half of 2009 before it really begins to have to have impact on either gross margin or net margins.

Tao Levy - Deutsche Bank Securities

Okay, thank you very much.

Operator

We'll take our next question from Mike Weinstein with JPMorgan.

Mike Weinstein - JPMorgan

Thank you. Good morning and thanks for the questions. Let me just follow-up with a couple of the questions we've had so far just to clarify Dave what your views are on the business. Last year you grew your recon business about 9% constant currency, it was I think closer to 10% in the fourth quarter, and then here you reported 6% growth in recon, which obviously excludes the impact of what's going on in Dover. And you said maybe a point of that was attributable to that being from a comp standpoint fewer selling days and Easter being in March this year instead of April. What do you think the other 3% is versus fourth quarter or maybe 2% than versus '07?

David Dvorak

Primarily I think that versus fourth quarter the difference is the procedure rate, and we saw an uptick I think that all other companies reported favorable results in the fourth quarter. To reconcile this back to last year, you're getting into some timing issues with respect to new product launches. For instance, Mike, we are anniversary out of a mix benefit on the gender line for Next-Gen, but we're also picking up opportunities.

In the second half of the year, we're going to be able to fully exploit the opportunity that we have with the mobile bearing knee. We also are very optimistic about what we might be able to generate in the way of opportunities with respect to the Natural-Knee with the Gender Flex attributes included, and then the M/L Taper with connective technology is a product that we're optimistic about.

So, I think that it's product cycle oriented, but we feel like we're in good shape to produce good results on knees, and we also feel like as the year progresses and we are in the next year, we ought to be able to improve on our hip performance.

Mike Weinstein - JPMorgan

You're guiding now to 6% to 7% total company constant currency growth but the OSP impact is about 200 basis points. So I assume you're thinking that recon is going to be more like 8% to 9% this year versus for the year versus the 6% we saw in the first quarter.

Jim Crines

It's certainly fair to assume Mike. This is Jim. That it's going to be higher than to 6% to 7% that we guided to for the overall results.

Mike Weinstein - JPMorgan

If you're of the assumption that that growth accelerates over the balance of the year, you think its steps up in the second quarter. Is there something that drives in actual acceleration?

Jim Crines

Well, that's really as David pointed out that's products cycle related, and as we get deeper into the launch of these new products, the mobile bearing, the natural flex, the connective, the Gender hip offering with connective technology.

Mike Weinstein - JPMorgan

I mean you clarified a couple of other items Jim. You made a comment where you said that you change the accounting for stock-based comp expense and that reduced the SG&A by 50 basis points for the quarter. Did I hear that right? Maybe you could just explain it?

Jim Crines

Sure, we didn't change the accounting; we recorded a change in estimate. We've recorded a change in estimates, recognized the difference in actual versus assumed forfeiture rates that were being used to accrue for a share compensation expense and that adjustment was made in the quarter, and it had that impact on SG&A expense.

Mike Weinstein - JPMorgan

So for the year, will it produce by 50 basis points or is it one-time?

Jim Crines

No, its more of a one-time, they don't reduce it modestly going forward but the effect you saw in the quarter was more of a one-time adjustment to just get caught up for those differences.

Mike Weinstein - JPMorgan

And then, as you talked about the $0.18 to $0.20 impact from OSP and the $0.07 that you are calling non-recurring, you're saying you're going to offset that through some other actions, some other one-time gains. Can you give us any visibility on what those one-time gains might be that would offset that?

Jim Crines

Well, I won't give you any specifics, but I will tell you coming into the year that we were looking at some opportunities that we are really focused on improving returns on invested capital, the more balance sheet focused initiatives. That included financing share repurchases with that. We've obviously taken action on that. And some of the other things that are included, for example, are monetizing non-strategic assets and that's what results in one-time gain. And again, I don't want to get into any specifics, but I will say that there is a high probability of those transactions occurring between now and the end of the year.

Mike Weinstein - JPMorgan

Okay. But basically, the way you wanted to do it, you wanted to take out that $0.07 and based on what you are saying is true, cost cutting, share repurchase, you are going to offset $0.11 to $0.13 which you would call recurring or operating, incremental operating or loss operating income because of OSP?

Jim Crines

That's a right way to think about it.

Mike Weinstein - JPMorgan

Okay. And then the last question is to clarify. Dave, the answer to Bob's question about the timing of the April 3 announcement on OSP, because the recalls, we have this from the FDA database occurred in December and then I think on January 30. So what was it that took place that made you say, hey, we have got to come out and make this announcement now on April 3. Was it that you closed the quarter and you said there was a real impact there and we've got to make sure the Street knows about it?

David Dvorak

Let me walk through with a little more detail, Mike, of the events that occurred. And as you said, we had a recall in December, there were other recalls subsequent to that event and as we were re-scoping those issues we got deeper and deeper and became more and more concerned with some of the fundamental quality systems there ultimately leading the decision that we announced earlier this month. Included in that time period was, as you know, any time you make a recall, there is likely to be an FDA inspection. There was an inspection. There were some observations. We had a third-party come in and essentially do a wall-to-wall review and as a consequence of that very in-depth review we identified some specific actions that we want to take. So, that’s a lot of work over the course of many weeks, subsequent to that first quarter call leading up to that announcement.

The actions that we were taking both at the end of March and into the beginning of April, included notifying customers, explaining to employees what we're doing to ensure that the quality systems were at the level that was consistent with our standards. And so, we didn't want to have any type of disclosure issue there as we were taken the right steps to protect the patients' interest at all times. We didn't want to have some miss construction of that information in the financial markets and we thought that the best way to solve that problem was to put the release out that we put out earlier in the month.

Mike Weinstein - JPMorgan

Thanks for the explanation.

David Dvorak

Sure.

Operator

We will take our next question Michael Matson with Wachovia Capital.

Michael Matson - Wachovia Capital

Hi, thanks for taking my question. I guess with regards to the slowdown that we seen in procedures, I was just wondering, are you guys hearing anything at all about the possibility that the economy is affecting procedure volumes. Obviously, consumers are under some extreme stress here and I have the sense that copays may have increased over the past five to ten years. Is there any increased economic sensitivity out there?

David Dvorak

I don't detect that there is. I think that there was some speculations at the end of last year that supported the bolus that we saw on procedure growth in the fourth quarter that some people may have been concerned about potentially an economic downturn that accelerated there, locking into date for these elective procedures. But in the core recon market, I don't think that we're seeing any fundamental impact I suppose if there was a long-term and a sustained economic downturn that could have an impact, but we're not seeing any of those signs in the core business. The segment although we still like the market a great deal that we have probably seen some consequences to an economic downturn that is the dental market because that's much more private pay oriented.

Michael Matson - Wachovia Capital

Okay. And then with regards to the compliance changes that you announced and I guess there is the possibility that you buy out some of the royalties. And I was just wondering what the timing of that would be and whether or not that would have any kind of impact on your P&L?

Jim Crines

Yes, Mike, this is Jim. We anticipate those buyouts to occur on a rolling basis over a period of several quarters. We do expect at this point at least that we will fund those buyouts out of the free cash flow on a quarterly basis. We are at this point a bit uncertain as to the exact outcome and timing, and we can't provide any more specific items than that. We will of course provide updated disclosure on any material developments and our periodic filings as appropriate. But that says, we're going to work, we're interested in moving forward expeditiously, and again that as much as I can provide in terms of detail at this point.

Michael Matson - Wachovia Capital

Okay. And then, can we interpret this large repurchase authorization and the fact that you're planning to take on by about $500 million in debt to finance some of that. As a sign the acquisitions or particularly sizable acquisitions may be less likely over the next 12 months or so?

Jim Crines

I don't think you should construe the share repurchase move as an indication of any of our intent or opportunity with respect to merger and acquisition activity. Rather you really always just look at that as our capability on the balance sheet.

Michael Matson - Wachovia Capital

Okay, and then on gross margin, can you quantify how much of an impact the hedging had for foreign currency?

Jim Crines

Well, what I will say Mike, is I would really go back to the guidance that we provided on the fourth quarter call coming into the year that this, we'd indicated there that the guidance of 76% to 77% gross margin for 2008 that the difference between '08 and '07 was principally due to this hedge losses that we're going to be running through our results for 2008. And, that gives you some sense, and I guess the other thing that we pointed out if look at the contribution that we're getting on our top-line from currency, we said that typically gets neutralized thorough our hedging program on the operating profit line. So you can apply our operating profit ratio as a benchmark to that pickup that we're getting on the top line. You get a sense of what's running through cost-to-goods on hedge losses.

Michael Matson - Wachovia Capital

Alright, that's all I've got. Thanks a lot.

Jim Crines

Thank you.

Operator

We'll go next to Matt Miksic with Morgan Stanley.

Matt Miksic - Morgan Stanley

Hey, good morning, thanks for taking the questions. I think a lot of the stuff here has been toured pretty well, but I got a couple of follow-ups on the trends in the quarter. I guess it sounds like it’s sort of summing it up, you had some year-over-year comparison that impacted your numbers and is 1% Easter selling days and did I hear that right that it was also about 1% OSP, or is that that all together?

Jim Crines

Well, the OSP number that we quoted was about was $6.5 million net for the quarter.

Matt Miksic - Morgan Stanley

Okay.

Jim Crines

A little less than 1%.

Matt Miksic - Morgan Stanley

Okay. And, I wanted to get a sense as we go into Q2. Are there any similar year-over-year comps, either positive or negative that we should be aware of as we think about modeling the second quarter?

Jim Crines

No. I would tell you there isn’t anything of the nature that we saw in the first quarter.

Matt Miksic - Morgan Stanley

So, no getting back on selling day? No getting back Easter?

Jim Crines

That there is, as we look, I guess about at the balance of the year, we do expect to pick up that billing day that we lost in the first quarter, and as I don’t have it here in front of me and I don’t know that that’s in the second quarter, but we do pick that up in the balance of the year.

Matt Miksic - Morgan Stanley

Okay. Question on the quality system remediation that you are working on for OSP, if you could give us some sense of maybe what that is running or what that runs in terms of operating expenses, and whether that’s included in the $0.18 to $0.20 impact that you talked about in the press release?

Jim Crines

It is reflected in the $0.18 to $0.20 impact.

Matt Miksic - Morgan Stanley

Okay. But, you don’t want to give us any sense of what that is, just because that will be something, I guess the question also is, does that roll off towards the end of the year?

Jim Crines

Sure. What we did, we pointed out, I guess in the $0.18 to $0.20 we have included $0.07 for what we thought for inventory charges, idle plant cost, and other non-recurring cost that the other non-recurring is include significant outside service fees that we're incurring. Thus we work our way through the issues at OSP and we would expect those service fees to take or off as we get towards the end of the year.

Matt Miksic - Morgan Stanley

Okay. I want to, couple of questions on sort of the monitoring and compliance, the DOJ related issues. Can you give us some sense? You've talked about what the quarterly expense rate was in helping us put together our '08 numbers related to the federal monitoring expenses. Any sense of how you are tracking against that range, which I guess was in $8 million to $10 million range?

Jim Crines

Yes, as we weigh it, guided to $0.02 to $0.03 per quarter and indicated that we in our guidance, were anticipating being at the high end of that range. The monitor fees for the first quarter were within that range. We expect they will continue to be within that range. We have and continue to reflect in our estimates for the year, an expectation that between monitor fees and other outside service fees on compliance, we would be at the high end of that range.

Matt Miksic - Morgan Stanley

Okay. And, then you also talked a little bit about these contracts holding up some the R&D spending, external consulting spend, and you are expecting that to resume in Q2. If I understand that correctly, I am assuming that means that you will have your contract sort of restructured and approved to begin those that work in Q2, is that right?

Jim Crines

Yes, generally that’s right. Matt, I think that, one thing that you ought to know is that our annual needs assessment is approved, so that we have the ability to conduct meetings, those meetings are getting scheduled, surgeon contracts or being sent out now to engage those surgeons for services that are contemplated by that annual needs assessment. So those activities both on the training and education side as well as we hope on the development side will begin again here in this quarter. I would expect that you are going to see a gradual ramp up in the second quarter, and then by the time we get into the third quarter we should be at a full cliff.

Matt Miksic - Morgan Stanley

Okay. And any sense you can give us as to how that might show up in your P&L, if there is any charges or changes on accruals throughout the rest of the year that we should think about. I think you are not guiding to it now, but just to give us idea.

Jim Crines

Well I guess what I will say is this Jim. As we've pointed out in the past, we continue to accrue, for example, under our legacy royalty arrangements, our royalty expenses under the terms of those legacy arrangements. And that's what we have at this point, that's what we have reflected in our guidance and our assumptions going forward for the balance of 2008. As we pointed out before, as we go through this process of settling out those agreements and there are any material changes to those expectations, we'll have to provide that information at that time. And most of the rest of what you see in the way of the surgeon payments falls in the R&D line within the P&L.

Matt Miksic - Morgan Stanley

Okay, that's helpful. Just wanted to talk a little bit about, if you could just give us a quick status as to how things are progressing on some of the major product launches you have in recon like knee, Natural-Knee, gender hip and the mobile bearing knee. And maybe just at a high level, where are you sort of in instruments and training, any of them moving faster or slower, any kind of updates you have as to when during the year, you'd expect to start to pickup some momentum.

Jim Crines

Yeah, I would say, we're sort of where we anticipated we would be, we're still obviously early into the launch as we pointed out. We did not have the opportunity with NBK for example to build out a lot of inventory in advance of getting approval .So there is, that ones maybe relative to where we are for example with the natural knee flex, that ones facing a little bit behind, in terms of getting the inventory and instruments out into the field. And on the hip side, that the M/L Taper with connective technology were in good shape, in terms of where we are relative to where we expected to be getting again the instruments in the inventory deployed out in the field.

As far as training goes, obviously there, with not having conducted any surgical skills training in the first quarter, that may have had some modest effect on certainly our ability to bring on any new customers, who are unfamiliar with those systems. That's probably more of an issue with the connective than it is with the knee systems. I think a lot of the customers that we were talking about those new knee systems are either very familiar with using a mobile bearing knee or very familiar with using the posterior referencing system that goes along with the natural knee gender flex product.

Matt Miksic - Morgan Stanley

Okay, and then there's one final question, if I could on spine. It looks like this is another sort of mid-teens constant currency growth quarter taking some share, a modest amount of share in that market. Could you highlight what’s going on in spine, what the drivers are, and if there's anything we can expect in the next three or six months to maybe affect the growth of that business?

David Dvorak

Yeah this is David, Matt. I think that what you are seeing principally is outer body sales, you know we have fully integrated the Endius acquisition. We have a good pedicle screw system for both thoracolumbar and the cervical region now, and so we are seeing an up tick in sales there. Obviously that affects the interbody sales as well. So it's basic offerings with respect to fusion procedures, and I think that our differentiating product continues to be Dynesys and we continue to work towards the expanded regulatory clearance for the non-fusion application. But in the meantime, we market the product as an adjunct to fusion and that is a product that we continuously hear good things from clinicians.

Matt Miksic - Morgan Stanley

Any timing or milestones we can look forward on Dynesys data or anything like that?

David Dvorak

I don’t have anything specific for you at this point in time.

Matt Miksic - Morgan Stanley

Okay. Well thanks very much for taking the questions.

David Dvorak

Okay. Thanks Matt.

Operator

Our next question comes from Jason Wittes with Leerink Swann.

Jason Wittes - Leerink Swann

Hi. Thanks a lot. I just wanted some clarification on how you are going to make up the $0.18. Specifically it looks like you are holding back on some expenditure notably in R&D and SG&A I assume. Does that mean that in ’09, some of the investments that you plan on making this year fall into next year? How should we be thinking about that?

Jim Crines

Yeah. Not necessarily, Jason. Reductions in planned operating expenses are really probably, I guess focused in a couple of different areas. One, you see the lower spend on consulting services in the first quarter, some of those initiatives is, that’s more of a timing issue.

Jason Wittes - Leerink Swann

Well timing in terms of, it’s still all going to occur this year or some of it will now occur next year?

Jim Crines

Some of it will spill over into next year.

Jason Wittes - Leerink Swann

Okay. And, so in terms of R&D spend, it was down this quarter. I guess part of that was due to the monitor. Could you give us an indication on what the right level is for R&D spent for your company?

Jim Crines

Well, we came into the year guiding to between 5% and 6% of sales. We would still expect the full year spend to be between within that range. Maybe a bit the lower than I think we had indicated.

Jason Wittes - Leerink Swann

I mean, more towards 5%.

Jim Crines

Likely to be in the middle of that range.

Jason Wittes - Leerink Swann

Okay.

Jim Crines

Probably a little lower on relative to that guidance.

Jason Wittes - Leerink Swann

And, I guess from a longer-term perspective that’s also about the right range, you think about for R&D spent.

Jim Crines

That’s right.

Jason Wittes - Leerink Swann

Okay. Great, thanks.

Operator

Our next question comes from Kristen Stewart with Credit Suisse.

Kristen Stewart - Credit Suisse

Hi, thanks for taking my call. I just wanted to clarify on that R&D? Did you say it’s going to be low end of the 5% to 6% range or a little bit than the 5%?

Jim Crines

No, towards the low end to that range, Kristen.

Kristen Stewart - Credit Suisse

Okay. What's really change in terms of your expectations in reinvestment here, because in January, I guess you talked a lot about needing to reinvest in the business as in that R&D was something that you needed to increase and that’s one of the reasons why had expected to increase over the level that you saw in 2007. I guess, what's really going on there and any comment on whether or not you are still comfortable with gross margins at 76, 77, and then your SG&A levels at 39 to 40 for the full year?

Jim Crines

Sure. Nothing has really changed with respect to our plans to invest in the infrastructure and operating initiatives that we had outlined on the fourth quarter call. I think, if you go back, you would see a lot of that investment was, as we pointed out then, more focused on either manufacturing, selling and distribution infrastructure, IT infrastructure and in places that would show up in SG&A, not necessarily in R&D. And as we just pointed out that given just where we are with the compliance, with resolution agreements, and some of the delays that we experienced in the first quarter, we are now sort of guiding to lower end of that 5% to 6% range on R&D as opposed to being in the middle of that range, which is what we had indicated on the fourth quarter call.

As per gross margin, we would have the impact as we pointed out that reflected in the first quarter results of inventory charges related to OSP. That had the impact of reducing gross margin in the quarter by about 50 basis points. We do still expect to be for the year within that range that we have guidance to 76% to 77%.

Kristen Stewart - Credit Suisse

And SG&A, after the full year?

Jim Crines

And SG&A, we have guided to a range of 39% to 40%, still within that range. We had indicated, I guess on the fourth quarter call likely to be in the middle of that range. That maybe more towards the higher side of that range, given some of the fees, the non-recurring fees, we're incurring associated with that OSP issue.

Kristen Stewart - Credit Suisse

It sounds like OSP would something that, maybe take you a little bit by surprise. Have you gone through and reviewed the quality systems at your other facilities? Are you comfortable there? Do you have any FDA warning letter that you have received or any 483 observations? I guess what level of comfort do you have that your quality systems elsewhere are what you might expect?

Jim Crines

The manufacturing in our other facilities isn't affected by the OSP announcement and the quality of our products from those facilities is in question, never mind. We have a very proactive effort to continuously improve our quality systems, and those over the course of the last year or so have included in depth audits conducted by our third party and it's the firm that we brought in the OSP and are getting their help in scoping out any redesigns that are necessary as part of those remediation efforts. So, our implant facilities, our major facilities have been reviewed by that same firm and we're comfortable with our quality systems at those facilities.

Kristen Stewart - Credit Suisse

Any 483 or warning letter?

Jim Crines

We have no pending warning letters and we wouldn't. The 483’s are going to be part of any inspection that takes place. We wouldn’t be reporting with that level of specificity. But, we would always have (inaudible) entered on our system, where we are correcting and preventing any root cause issues that are identified. So, that's part of an ongoing operation of a quality system.

Kristen Stewart - Credit Suisse

And, I think in your kind of earlier comments, you had said that you did expect, although you didn't see it in this quarter, a longer term effect of the change in the consulting agreements, could you just kind of elaborate on this comments just in terms of what you do expect to see?

Jim Crines

In what respects, specifically Kristen.

Kristen Stewart - Credit Suisse

I think, the question was are you are seeing in terms of the consulting in the DOJ monitoring that had have expected to see a longer term impact over the time? I was just wondering if you could elaborate on your comment?

Jim Crines

I’m just not clear as to what contexts that comment was made?

Kristen Stewart - Credit Suisse

You made it earlier I guess, when you were talking about the change in consulting arrangement promoted by the DOJ settlement, and then you went on to say there is going to be an impact overtime of the change of this consulting agreements, and so I was unclear as to what.

Jim Crines

Okay

Kristen Stewart - Credit Suisse

You are trying to say

Jim Crines

Well, I do think it’s going to be a dynamic environment. It certainly has been over the course of the last seven months or so, but I think that you’re going to see medical device businesses in general revisiting these issues, and it’s one of the reasons that we’re coming out with a strong move in this area to clarify how we are going to collaborate with Surgeons. We think that collaboration is extraordinarily important both to the development of the right products and then training surgeons on the safe and effective of use of those products.

So, we want to continue to collaborate but we want to structure those relationships in a way that inspires confidence and trust among all the stake holders that are going to be scrutinizing those collaborations on a go forward basis and so that can come in a number of different forms. It could be how we fund those initiatives, for instance we want a take any of our charitable giving and general medical education support and put those funds in the hands of a third party, so that can be disseminated in a manner that doesn’t even give the appearance of a impropriety. And, it’s also going to come about in the form revisiting both structure and compensation arrangements within those collaborative arrangements, whether it’s training and education or under design surgeon side

Kristen Stewart - Credit Suisse

To what degree do you think there is going to be a longer term impact on R&D, if you are unable to going to work with doctor’s in the same manner that you have in the past. Do you expect to have difficulties kind of on the innovation side on R&D productivity? And, do you expect over the longer-term mix implications from any of the changes in the consulting agreement?

Jim Crines

Our first priority is to continue to put out best in class products and address unmet clinical needs. What it may involve overtime is a repositioning of those, of that dollar spends. So, that if there are certain surgeon services that are important to those collaborative efforts into development of the right products that the people are scrutinizing heavily, you may bring those resources inside even in an extreme. But, I don’t see that this is going to have any negative impact on our ability to put great products out and to train people properly on those products.

Kristen Stewart - Credit Suisse

Last question, can you update on the Hip Resurfacing? I apologize if I missed that.

Jim Crines

Yeah, we had as we pointed on in the past Kristen, working down two pass, one is to submit PMA with foreign data and the other is to complete a US Id. We have recently experienced some delays on both fronts. We would now sort of project the earliest that we would be on the market with the hip resurfacing device in the US is 2011. Given that positioned our sales and marketing, our product development efforts are going remained focused on addressing the other 90% of the hip market here in near term.

Kristen Stewart - Credit Suisse

Does that change your expectations for your underlying hip growth? In the last year you were talking about how that was going to be an impact? Do you, how confident are you that you can sustain higher underlying growth rates in hip as we move out this year above kind of where you are in this recent quarter?

Jim Crines

No, it does not change our view, as we pointed out in our last call, we are tracking very carefully on an account basis very closely by the, our performance on the unit basis and we continue to view our opportunity with respect to our primary hip portfolio in a way that sort of how this is keeping face with market growth.

Kristen Stewart - Credit Suisse

You're contrary to what you thought last year, your expectations for Hip resurfacing or maybe a loss of an impact, now of it to what you thought back in October?

Jim Crines

I think that's fair and again that's consistent with we had pointed out on the last call as well.

Kristen Stewart - Credit Suisse

Okay. Thanks very much.

Jim Crines

You’re welcome.

Operator

We'll take our next question from Michael Jungling with Merrill Lynch.

Michael Jungling - Merrill Lynch

Great thank you taking my questions. I have three. The first one is in relation to hedging losses. Can I just confirm from the last discussion in the Q4 call, whether you still believe that the impact from hedging losses will go away in the second half of 2008, and also into 2009 or have you had to re-hedge and therefore that pain could be extended for a longer period of time? Secondly on SG&A, can I just confirm that the monitoring cost in the quarter were around $8 million, and as you can also comment on perhaps some of the precise details why SG&A to sales has gone from 37.4 in the fourth quarter to 39.7 adjusted for your changes in compensation expenditures inline with the fact that we've seen a reduction in selling or entertainment expenses both at the annual meeting in Boston, and at the WS meeting in San Francisco. And, the third question I have is in dental, can you comment or where that the US market for dental implants has seen a sharp or more difficulties from the fourth quarter of last year to the first quarter of this year? It'll be great, thank you.

Yeah, and Michael this is Jim. I'll cover the first couple of questions that you had. First of all in the hedging losses, I think as I pointed out in the past, we layer these hedges in overtime, and so on a month-by-month basis we are looking at anywhere from 18 to 24 months and layering in new hedge contract to cover off projected cash flow exposures that we have. So, we would not anticipate the hedge losses that are tapering off particularly not to the extent that dollar has continued to weaken in the second half of '08. At some point the dollar stabilizes and you anniversary out of those hedge losses, but it would not be in the second half of '08.

With respect to your question on SG&A, the monitor fees as we pointed out are within the range that we guided to you, they are not going to give us specific number, but again I would just point out that they are within the range that we guided to. And if you look at over the balance of the year, between monitor fees and other outside service fees that we are incurring on the enhanced compliance and ethics initiatives, we would expect to be at the high-end of that $0.02 to $0.03 range that we guided to.

And then regarding the SG&A ratio for the quarter, that really is a function of all the things that we discussed on the fourth quarter call coming in to the year. In terms of the infrastructure and the operating initiatives that we had outlined, that includes the monitor fees and expenses, that includes the increased cost associated with getting more instruments out in to the field in the US, that includes sort of an enhanced commission opportunity to bring more focus to our trauma product line within our core market here in the US and also investments in sales force infrastructure and our global businesses in dental, in trauma outside the US.

So those are some of the things again that we had outlined on our fourth quarter call coming in to the year that are contributing to that increase in the SG&A ratio.

David Dvorak

And I would say that, with respect to your question on the dental market, we have seen a continued slowing of the US market that is progression that has continued through last year and in to this year.

Michael Jungling - Merrill Lynch

And just a quick follow-up on the SG&A side. Can I just confirm that the increase in the first quarter in the ratio was the investment in capital equipment, so the amortization and depreciation of sales samples, was that a key driver or was it more the other things that you mentioned such as investment and sales goal, monitoring cost and fees etcetera. Thank you.

Jim Crines

It's a pretty significant contributor, the increased depreciation on the instruments that are being put out in the field. But again monitor fees and expenses are also contributing to that increase.

Michael Jungling - Merrill Lynch

Right. Thank you.

Jim Crines

Thank you. Okay.

Operator

We'll take our next question from Brue Nudell with UBS

David Dvorak

Hello Bruce.

Operator

Sir we are not hearing your question. Please check you mute button.

Bruce Nudell - UBS

Good morning, I am sorry. The most interesting thing about the quarter reported so far was that the US hip market last year was double-digits. This year with everybody reporting it seems to be around 4% selling day aside may be 5%. Unit have averaged about 3%, 4% over the last six seven years barring '07 perhaps. Could you get a feel for why the market was so robust last year as oppose to assuming a more traditional type of revenue growth this year.

Jim Crines

Bruce, this is Jim. I think that when you're looking at the market, there have been over the last couple of year, I think, there have been a number of companies that have been able to increase their penetration with their alternate bearing offerings, much specifically metal-on-metal, that price represents frankly an opportunity going forward that’s contributed to pretty significant mix benefit. And as obviously, those companies achieve higher levels of penetration with those devices at some point, they anniversary out of that mix opportunity and you see results falling sort of back in line with unit, something closer to unit growth.

Bruce Nudell - UBS

Thanks so much on that. And looking at the categories and after kind of adjusting for your taking cement out of hips, were there any categories in US or all US hips where you felt you maybe lagging the market this quarter?

Jim Crines

I would say we have seen a bit of competitive pressure in our revision hip line. There is some instrument issues there, that we're fully aware and are addressing with development efforts. And I would tell you those sales were somewhat weak in the quarter.

Bruce Nudell - UBS

But basically, you think for all the categories you're within a point of the market, US or US hips and knees?

David Dvorak

Putting hip resurfacing aside on a unit basis, yes.

Bruce Nudell - UBS

Okay. And with the $70 million to $80 million hip to top-line this year, we had called you, when we were trying to figure out the EPS impact and, we were kind of told that it was at the lower end of the margins scale of your product line. But just doing a quick calculation, it looks like the incremental operating margins to explain 11% to 13% have to be quite high, well north of 40%. Was there disconnect, or we just missed here.

Jim Crines

It’s all relative. These are lower margin products relative to hips and knees, but still healthy margins.

Bruce Nudell - UBS

Okay, and then Dave a more strategic question. I think that you guys have taken the lead on the compliance front. I think you’ve probably set the standard for doctor company relationships going forward. But, assuming everybody comes to the level that you are hoping to establish and we look out, it could make for a more fluid market share environment. And, so when you sit back and think about the strategic plan for the company and given the dominant market share position you have in hips and knees, how much, just to kind of speak to the level of risk, how much share do you think is at risk due to potentially a more fluid environment when you say, how much should I invest in hips and knees versus spine and dental and trauma?

David Dvorak

Yeah, I think, that our core business is one that we are very optimistic. We can continue to expand our leadership with respect to and that's part of the reason that we're making those adjustments and establishing an appropriate standard for this collaborative relationship on a go-forward basis. These product decisions need to be made in accordance with what's in the patient’s interest and the vast, vast majority, hopefully all of the surgeons that we do business with our making decisions because they firmly believe that these products that we produce provide them with the best opportunity to do right by their patients.

And that's the basis upon which we want to compete. It’s the basis upon which we compete everyday and we do that successfully. On a go forward basis, we're going to continue to be very effective with developing great solutions to address unmet clinical needs and training the surgeons on the proper use of those products. So I don't see any risk component to that. It’s just going to come back to how effective we are developing the right solutions and marketing and selling those products.

Bruce Nudell - UBS

I guess just the final thought on that issue, does the OUS experience with regards to surgeon loyalty or I don't believe there are nearly as many consultancies etcetera tell you anything about the degree to which share loyalty is driven by instrumentation, and great service, and products.

David Dvorak

It’s instructive, but the US isn't instructive as well Bruce. I mean, there are thousands and thousands of surgeons that select our products and resulting in millions of our implants being used every year, and we don't have any relationship with those surgeons beyond a pure customer relationship. So that’s the basis upon which most of the surgeons have always made their decisions and we're the leader in that market, so we're really comfortable with our ability to compete in that world going forward.

Bruce Nudell - UBS

Thanks so much.

David Dvorak

You're welcome.

Operator

Our next question comes from Bill Plovanic, with Canaccord Adams.

Bill Plovanic - Canaccord Adams

Great, thank you. On the OSP business, how much of that do you expect to come back online? If you are loosing $70 million over the course of the year, what do we end up getting back at the end of the day, considering you are discontinuing some of these products?

Jim Crines

We, it comes back in faces over the balance of the year Bill, and we haven't obviously put an operating plan together for 2009. So, there will be some challenges, obviously the competitors that are getting into those accounts, where we have lost that business. We are going to work hard to get it back, but I honestly couldn’t tell you at this point, when it’s all set and done, how much of that business we are going to get back.

David Dvorak

But just to clarify, Bill, that we aren’t discontinuing products. Those remediation efforts are intended to bring the products back online. So, there is no discontinuation plan.

Bill Plovanic - Canaccord Adams

Okay. And then, if I just did a little back of the napkin math here, in some of your comments that US Hip business, 4% up in the first quarter excluding the less days was in line with the last year. If I kind of run some of the numbers with demands up 24% year-over-year, I am just trying to, it looks like the hip number, what I am trying to get at here is actually reported number is about inline with expectations when you back out, just a math, as you push it to OSP. Question is, OSP, this is the first quarter you are reporting it in and this is the first quarter you are reporting cement in the OSP line, correct?

David Dvorak

That’s correct.

Bill Plovanic - Canaccord Adams

So, and in the US Hip business, instead of growing 9% last year, it grew about 4% to 5%, if you back the cement out, is that pretty fair when we see those numbers?

Jim Crines

Yeah. Our first quarter in hips, excluding bone cement in 2007 would have been 4.3%.

Bill Plovanic - Canaccord Adams

Okay. The bone cement with in the US, somewhere around $65ish million last year. Am I backing into numbers pretty…?

Jim Crines

For the full year? You are in the neighborhood.

Bill Plovanic - Canaccord Adams

Okay. And then just secondly, what’s the cost of the credit facility? If you are taking on $500 million in you are buying back stock, just so that we can do the numbers, how much do you think that’s going to cost you and what are you getting on your cash balances these days?

Jim Crines

Yeah, while I've, we had indicated on the call that we on the $500 million, we are projecting about $10 million of interest cost pre-tax for the balance of the year.

Bill Plovanic - Canaccord Adams

Okay. Then what are your cash balances earning you right now?

Jim Crines

It’s somewhere in the order of 2% to 2.5%.

Bill Plovanic - Canaccord Adams

Right, great. That’s all I had, thanks a lot.

Jim Crines

Thank you.

Operator

Our next question comes from Philip Lezlie [ph] with Thomas Weisel Partners.

Philip Lezlie - Thomas Weisel Partners

Hi, there. Quick question on the Mobile Bearing Knees, you mentioned Mobile Bearing and Flex knee together were about 10%, what was Mobile Bearing just on a standalone basis as a percentage of sales?

David Dvorak

Yes, that’s a detail that we're not going to disclose.

Philip Lezlie - Thomas Weisel Partners

Okay. How about, how much have you disclosed, how much of a premium you get on the Mobile Bearing Knee?

David Dvorak

No, we wouldn’t provide that type of breakdown. I mean the Mobile Bearing opportunity is significant. What we have right now cleared is a product that probably can compete effectively and about half the US opportunity. If you assume that that is about the 15% of the overall knee market, it’s a bit over $300 million. So, take half of that number and that’s the opportunity I would tell you that at this point in time is obviously an insignificant percentage, but the product was just launched and as we stated previously, we expect our ability to seize that opportunity to ramp up over the course of the second half of the year.

Philip Lezlie - Thomas Weisel Partners

Okay, that’s helpful. And, then I wanted to maybe follow-up a bit on Bruce's question earlier. In terms of how you are, you are taking a leadership position on the physician consultant issue. How different do you think your position will end up being from how your competitors choose that?

David Dvorak

I wouldn't suspect that at the end of day it will be significantly differenct, but I can't project out for you Phil with any certain as to what kind of a time lag there maybe is applied to either this sector or the broader medical device industry.

Philip Lezlie - Thomas Weisel Partners

But do have a sense that I mean, you must be talking to physician already, do have a sense that your actions are sort of more draconian for lack of a better word or is everybody kind of on the same page here?

David Dvorak

Well I think that directionally there is a lot of consistency here and this a unique circumstance in the sense of the leaders in this sector are all under similar terms because of the deferred non-prosecution agreements that they entered into and there is a stated objective by the department of justice and the monitors that are working with them to ensure that there is a level plain field. So, I think within this sector, people are directionally on the same page. We're making these decisions in a very principled way. We don't want to incrementalize this initiative. We want to make sure that any adjustments that we make, we're making these adjustments once, and we believe that that's going serve for the long-term interest of the company and the surgeons that we work with and the patients that they serve. So, we're very confident that we're doing the right thing, and as for the other companies, we'll have to see what pace they come along.

Philip Lezlie - Thomas Weisel Partners

Thanks very much.

David Dvorak

You're welcome.

Operator

At this time there are no further questions. I'd like to turn the conference back over to Mr. Dvorak, for any additional or closing comments.

David Dvorak

Okay, thanks Laurie. And thank you everyone for joining us today and for your continued interest in Zimmer. We look forward to speaking you on our second quarter conference call, which will be held on Thursday, July 24th, at 8:00 a.m. Have a great day.

Operator

Thank you very much ladies and gentlemen. This does conclude your conference. You may now disconnect.

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Source: Zimmer Holdings Inc. Q1 2008 Earnings Call Transcript
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