Have you looked at your lower unit oil? Sounds like you have either dropped the lower unit gears or the drive shaft down from the motor.

Sounds like a new prop is needed. Had this happen on the old Yamaha a while back. Fairly simple fix. 

 Except that you said you took off the prop, put the motor in gear, and could still turn the propshaft by hand. At least, that's how I understood it. So that rules out the prop hub, doesn't it? Mercs don't run a rubber hub like Yam's do, suzi q, different set up althogether. Replaceable flo-torque hub insert, not the old rubber.

 Sounds like you hit something and damaged the lower unit  . Better contact your insurance company!

As an aside, the Verado changed to a larger 'offshore' lower unit with a larger bearing housing in the lower unit in 2006 so make sure it is replaced with the larger one if it is currently fitted with the smaller one. Not sure if this was limited to the L6 verados only or included the L4 as well.

Don't think I have hit anything as it was in the channel heading out from Tantas. There was no bang. I can only ask the question after I get merc dealer to have a look

It cant be the prop hub as I can turn the shaft with the motor running and in gear.

Also forgot to mention that when it happened there was a smell of oil and a small slick behind the boat. Could not work out where it was coming from. Even after I got home could not find any oil coming from anywhere. Checked engine oil and its fine, motor runs fine.

Spoke to a dealer over east due to the public holiday here and looks like the gearbox is toast.

Lost faith in the mercs now so might be a new Yamaha or Suzuki going on the back.

 It ummmmmm really really sounds like u hit something.    Possibly submerged?  My insurance payed out after I got caught on a long cray pot rope and did in the gearbox.  They wouldnt have payed out if I didnt hit something.

 Definately  hit something mate. 

 Same as if you ever overheat it's always a plastic bag that you picked up which cover the intake screens .  ALWAYS

The rubber seal where the shift rod goes into the gearbox can sometimes be the culprit on the verado’s. But I’m your case, you’ve almost definitely hit a turtle by accident!

 you may have picked up some fishing line that wrapped around the shaft and did the seal in . lost all the oil in the gear box and it blew. insurance paid out thankfully as it was a costly fix

All of the comments above are valid and the issue might well be a legitimate insurance claim, you do not have to hit a rock, line, turtle, anything "other than water" might trigger your policy. The key is get a detailed report from the outboard mechanic and MAKE SURE all parts are kept for inspection by the insurance assessor.  If you need any help lodging a claim do not hesitate to drop me a pm  

Thanks for the comments guys. Will head In today see mechanic and have a chat. Did check again last night and found the gearbox is full of water and no oil. No metal on the screw so hoping its just a seal that went on the day and not prior to me buying the boat.

Seal failed at that point, picked up some braid or line is certainly a possibility  

Seal failed at that point, picked up some braid or line is certainly a possibility  

 Dont the Verados have a plate behind the prop to keep fishing line out of the seal?
My Suzis certainly do and Ive picked up lines a few times without issue

I could be after some controls n gauges for a 150 verado soon if you decide to wreck

Thanks guys. Had Waddy up here take the gearbox off and have found the internals destroyed and a write off. Going to try insurance first see how we go.

Cheers