史賽克 (SYK) 2002 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Stryker Corporation second quarter operating results conference call.

During the presentation, all participants will be in listen-only mode. Afterwards you will be invited to participate in the question and answer session. At that time, if you have a question, press the 1, followed by 4, on your telephone. This conference is being recorded Tuesday, July 16th, 2002.

Certain statements made in today's presentation may constitute forward-looking statements. They are based upon management's current expectations and are subject to various risks and uncertainties that could cause the company's actual results to differ materially from those expressed or implied in such statements.

In addition to factors that may be discussed in their presentations, such factors include, but are not limited to regulatory actions, including cost containment measures that could adversely affect the price or demand for the company's products. Changes in reimbursement levels for third parties (inaudible) significant claims change necessary economic conditions that adversely affect the level of demand for the company's products. Changes in foreign exchange markets, changes if financial markets and changes in competitive environment. Additional information concerning these factors is contained in the company's filing in the securities and Exchange Commission, including the company's annual report on form 10-K, and quarterly reports on form 10-Q. I would like to turn the conference over to John Brown, chairman, president and CEO. Please go ahead.

Thank you and welcome all of you. We are glad to have you with us this afternoon. I am with David Simpson. We are going to give you second quarter reports for 2002.

We are pleased to report that Stryker had a strong second quarter and first half. The second quarter sales were at $seven34 million, increase of 15% over the prior year. Excluding the impact of foreign currency, net sales were 14% higher than last year. Net earnings were $86 million for increase of 31% over the prior year. Diluted earnings per share was 42 cents for an increase of 31%.

For the first half, sales were $1 billion 437 million, an increase of 13% over the prior year. Excluding the impact of foreign currency, net sales for the first half were 14% higher than last year. Net earnings were $167 million, for increase of 29% over the prior year. Diluted earnings per share was 82 cents for an increase of 28%. Adoption of FASB 142 increased net earnings by approximately 2.7 million, or a penny per share. 5.3 million or 3 cents per share for the half.

Cash flow and asset management were solid. Reduced debt by 88 million in the quarter and 105 million for the first half. Domestic sales were $478 million for the quarter and 943 million for the half; representing increases of 14% and 15% over the prior year. Divisions had a solid first half and are well positioned for a great year. (inaudible) was up 16% in the quarter and 15% for the half, with strong growth in spine, trauma, hips, knees and shoulder implants. Instrument sales increased 11% in the quarter and 8% for the half, with solid growth in stereo shield, irrigation, pain management, new offerings in the neptune place management system and delivery systems.

Powered insulin picked up nicely 10% growth in the second quarter. In endoscopy increased (inaudible)% in the quarter and 25% for the half, with strong growth in arthroscopy and video sales. (inaudible) was flat for the half. Medical was up 21% in the quarter and 20% for the half, with strong growth in hospital beds, stretchers and cots.

Physiotherapy was up in the quarter and same store sales growth and several small acquisitions.

International sales were $256 million for the quarter and $494 million for the half, representing increases of 16% for the quarter and 9% for the half. Currency comparison added 4 million to the top line in the second quarter and reduced the top line by 11 million for the first half. Excluding impact of foreign currency, international sales increased 14% for the quarter and 12% for the half. On local currency basis, most of the international divisions had a very solid first half and the comments I will give you about the international divisions will be based on local currency.

Pacific was a growth leader at 31% for the quarter and 23% for the half, with strongest performance in Australia. Europe was up 17% in the quarter and 12% for the half, with strong performances in the U.K., Spain, Scandanavia and Italy, which was helped by last year's acquisition of a distributor. Japan grew 7% in the second quarter and the first half, with strongest performance in orthopaedic implants. Canada and Latin America was up 3% for the quarter and 9% for the half, with strongest performance in Latin America. Orthopaedic implant sales were 415 million for the quarter and 810 million for the half, representing increases of 70% and 13%, respectively. That was based on strong shipments of reconstructive products, trauma and spinal implants.

Excluding impact of foreign currency, sales of Orthopaedic Implants increased 16% in the quarter and 15% for the half. MedSurg Equipment sales were (inaudible) and 526 million for the half, for increases of 12% in both periods, which is based on higher shipments of endoscopic systems, hospital beds, stretchers, power and surgical instruments and craniomaxillofacial implants, along with the image guided surgical systems. Excluding the impact of foreign currency, sales of MedSurg Equipment increased 12% in the quarter and 13% for the half.

In the new product area, the (inaudible) was lost in the first quarter and is off to a nice strong start in the second quarter. Scorpio Mobil bearing is doing well in Europe and Australia. We are launching this product in Japan and we have an id underway in the U.S. The reflex anterior cervical plate is doing well in the U.S. this is the first offering in the growing cervical spine market. In the trauma area, the launch of t-2 nail system is well underway in the U.S., Europe and Japan, our three major markets. T-2 provides wide range of fracture repair options for tibia and femur, using a common set of instruments.

T-2 system was completed in 2002, with the addition of nails. (inaudible) knee navigation system was launched in the U.S. market last quarter. This is a unique, non-invasive system to assist surgeons with alignment for total knee replacement surgery. The via stainless steel line was launched in the U.S. late last year. Stainless steel version of our spinal implant line.

Instruments launched that are cordless driver 2 late last year, which is a powerful battery powered piece for joint surgery. Endoscopy launched a camera mid-last year and it is having a big impact on sales to date. This is the market's first chip camera.

The ceramic implant is selling well in Australia and Europe. We recently obtained approval from Canada. It is still on hold in the U.S., as a supplier completes FDA inspection. OP-1, we are pleased with initial sales activity in Australia and the U.S. by small specialized sales organizations. Europe is off to a slower start, but are developing dedicated OP-1 product managers or specialists in key country markets. We are recruiting patients to the uninstrumented spinal fusion trial for the U.S. and making plans for a clinical trial with (inaudible), which we recently obtained. In Japan, we submitted request for clinical trial for instrumented post lateral spine fusion trial and hope to kick it off later this year.

Regarding Rutherford, the plant we made an announcement on earlier. Discussions with the union over the closing of the Rutherford, New Jersey manufacturing facility have begun. Our objective remains to achieve a fair settlement with our Rutherford employees and an orderly phase out in production over the next year. We hope to reach an agreement with the union in the third quarter, but there is no guarantee we will. The employment-related costs are expected to be $10 to $15 million and will be recorded in the quarter in which the agreement with the union is reached and signed.

For surgical dynamics, the acquisition of the spinal implant business was completed on July 1, with cash payment to Tyco of $135 million. The integration process is proceeding as planned and we are pleased with the results so far. Surgical dynamic sales of spine products were $17 million in the second quarter and $33 million in the first half of 2002; representing increases of 25% over the prior year. We will begin to reflect the sdi numbers in financial statements on July 1. And the first report you will get on that will be at the end of the third quarter.

Stryker's fine ribs are being trained on products and will begin cross-selling in the third quarter. And I am going to turn the phone over to Dave, who will cover the financial results. I will come back for a short wrap-up and then we will open up for Q. and A. Dave.

Thanks, John. The foreign currency comparisons turn favorable in the second quarter for the first time in the last 11 quarters. As noted in the press release, foreign currency added 3.9 million to our sales this quarter and they had previously nipped $15 million from the first quarter. So, that left us down about 11 million on foreign currency for the half.

If current rates hold, we will continue to see positive impact on sales and that could be in the neighborhood of $13 million for the third quarter. Moving over to price volume, U.S. implant prices were up about 6% in Q2 and the first half. In Japan, prices were flat in Q2 and declined about 1% for the half, while prices elsewhere generally improved slightly. The overall price volume analysis as a percent of sales is - for the quarter price added 3%, foreign currency added 1%; acquisitions added 1%, leaving volume and mix up 10%, which is right in line with Q1.

And moving on to surgical dynamics, as John indicated, we will begin reflecting their sales for the current quarter, third quarter. We expect to see some fall-out in the integration process, as not all of the sdi distributors will want to join forces with us and vice versa. Sales of sdi products will flatten out or decline for the next couple of quarters until the Stryker sales force comes up to speed and cross-selling starts to take hold. If we - there were no sales lost in the integration, the proforma numbers for the second quarter would be almost $48 million. That is adding surgical dynamic sales of 16.6 to our spine sales. Compared to almost 34 million in the second quarter of last year for overall increase of 43%.

Moving over to orthopaedic implants. I will remind everybody that Orthopaedic Implants account for about 56% of our overall sales. The hip line in the second quarter was up 11% in the U.S., 17% internationally and 14% worldwide. We had a very strong quarter in hip sales, especially in the international market.

The knee line was also - did really well. Domestic sales were up 16%, international up 26, for overall increase of 20%. Trauma was up 20% in the U.S., 5% internationally and 10% worldwide. Spine had a great quarter, up 62% in the U.S., 47% overseas and that gave us 55% growth rate for the quarter.

So, overall, domestic sales of orthopaedic implants were up. Now, let me give you the numbers on constant currency basis. I won't repeat the domestic numbers, but, the hip, the international numbers for hips are up 15. That puts the worldwide at 13. For knees, international up 24, puts overall at 19. For trauma, international up 4 and the overall stays at 10. Spine, the international is up 44, and overall, at 53. And 16% overall for international and 16% worldwide.

On the hip side, cemented stems continue to lead the growth driven by H-a stems accolade (inaudible) citation tzmf. Revision stems continue to do very well, led by restoration t-3. Cement sales were flat, as the market continues to convert to cementless stems. Cup growth is very strong, driven by the trident tabular system for polyethylene in the U.S. and ceramics overseas and continued penetration by Crossfire. We also introduced hemispherical trident cups in the first half to address Howmedica cup users we previously introduced the peripheral cups for the osteogenic users. They are selling at a nice premium to the cups they are replacing.

In Europe, Trident, Exitor and abj-2 are doing very well. The hip star system was introduced last quarter. In Japan, Super secure fit, cup ion and ABC ceramic hip system are doing very well. Our supplier of alumina ceramic components is working toward U.S. approval of their manufacturing processes. We are helping them with that. We are hopeful of U.S. approval early in 2003. In the meantime, the ceramic on ceramic systems are doing very well in the international markets and the results of our ceramic on ceramic clinical study continue to be excellent. In knees, another great quarter, with both Scorpio and Duracon showing solid increases in the U.S.. The systems are doing very well and the new modular rotating knee hinge has been well accepted. Dias, our new uni-knee is off to a strong start in the U.S.. In Europe the Scorpio knee was introduced in the first quarter and we recently got approval in Japan and have a U.S. IDE underway. The new Scorpio super plex knee for patients requiring extended range of motion was launched in the U.S. in Q2, with encouraging results so far.

Our MRS, which stands for modular sequential system, or complex revision and oncology procedures, continues strong performance. In the trauma area, trauma continues on steady growth trend in the U.S. and overseas. The gamma hip fracture devices continue to show strong growth and as John mentioned, the new T-2 nail system is doing extremely well.

Spine, the Zia lumbar systems are very strong in the U.S. and overseas. The reflex anterior cervical knee was launched in the U.S. in late June and in Europe in the third quarter, with the new Zia - that was late June in third quarter of last year. With the new Zia stainless steel for scoliosis introduced in the U.S. late last year. We now offer spinal implants for lumbar, cervical and deformity surgery. The Q3 addition of surgical dynamics cages will complete the Stryker spine line-up.

The Orthopaedic Implants sales force in the U.S. is at about 660 reps and managers and will build to approximately 700 this year, including about 20 dedicated spine reps from the surgical dynamics distributor network. Now, let me move on to the MedSurg group. I will remind everybody that is 37% of sales, comprised of four operating divisions: instruments, which makes up 39% of the group, endoscopy at 31% and Leibinger, under 10. And, we had really nicely balanced growth in the second quarter. U.S. - this is for the overall MedSurg group. They were up 11% internationally for 12% growth overall for the second quarter.

The instrument line increased 13% in Q2 and 9% year to date. The powered instrument business picked up nicely with 10% U.S. growth, 24% international growth, giving us 13% powered instrument growth overall. And the other OR equipment was up 11 in the U.S. and 22 internationally and 13 overall, for total domestic growth of 11%, international growth of 23% and overall, 13. As you know, we had a little challenging quarter in Q1, but are pleased with the results in Q2, as the comparables leveled out a little bit here.

Moving on to endoscopy, they were up 24% year to date. The 3 main lines there are Arthroscopy, up 16% and 18% worldwide. General surgery was up 14% in the U.S., 34% overseas and 17% worldwide. In the (inaudible) business was up 8% in the U.S. and 36% OUS and 12% worldwide. That gave us 14 percent domestic growth and 16% overall.

The endodivision had another excellent quarter based on strong growth in arthoscopy and solid lines with solid growth in video. You may recall we had a weak first quarter a year ago. The Q1 comparison this year was spectacular. What you are looking at now is more normal growth, which we will expect for the rest of the year.

Leibinger was up 1% in Q2 and 2% year to date. In the U.S., they were down 6, international up 12. So, we are - they are under pressure here. The lines that did the best were the image guided surgical systems and the Colorado electric needle. We are also winding down OEM business that came to us with the ITT acquisition. If you exclude the OEM business, Leibinger was really up 4%. Still not up to Stryker standards, so, we still have work to do here.

Medical was up 10% in Q2 and 10% year to date. The domestic business continues to be strong, up 21%. International was down 16. For the first half, we have had really tough comps, especially in Canada, where we shipped a really big order last year. In the overall, numbers are up 10% in the quarter. That business is in very good shape with new products and a better sales organization leading the way.

Physical Therapy Services accounts for overall sales. They had another solid quarter at 13%, which is the same as Q1. Same store sales were up 4% for the quarter and the half, with start-ups and acquisitions making up for the rest of the growth. I think they are getting a little bit of price there, too.

We grew the PT centers by about 10 to 311 in the second quarter. Moving over to the PNL, overall margins improved nicely against last year, 63.6% versus 62.9 a year ago. The consolidation of our implant manufacturing facilities will be playing a bigger role in our long-term goal of increasing gross margins and reducing inventory levels over time. The R and D ratio declined as a fair amount of biotech costs are treated as cost of sales and SG and A. Those ratios are 4.7% versus 5.5 a year ago, pretty in which line with Q1. The SG and A ratio increased as new sales resources have been added that are not yet fully productive and costs are now treated as SG and A. Those ratios are 39.2% versus 37.9 a year ago. Operating income increased 16.3% in Q2 and the operating margin was up slightly compared to a year ago. The operating margin is 19.7%, versus a year ago in the second quarter.

Interest expense, including the AR securitization discount, which is now only $700,000 in Q2. It is declining very nicely. When you add the surety discount we are looking at 10 7 versus 18 4 a year ago. As John noted, most of the decline in the intangible amoritization relates to the adoption of FASB 142, where we are looking for total effect of about a nickel this year.

Other income and it has got a couple of things in it that you might want to know about. Interest income was up to 1.5 million in the quarter, as we got a tax refund that had interest attached to it. FX losses were up significantly and that was driven by big swings in Latin America currency. Minority interest was steady at 300,000 negative. Overall, half a million negative. The income tax rate held steady at 33%. We expect to see this tax rate improve or continue to improve as production expands in Ireland and other favorable tax jurisdictions.

The balance sheet is looking very solid. Receivables were up about 14 and a half%. A little faster than sales growth, but I would remind you that the strengthening international currencies have popped our entire balance sheet up year at the end of June. Inventories were up 8.8%, nicely underneath the sales growth rate. And our shareholders' equity is improved significantly because of the strong profits and also because of the impact of reconverting currencies at a more favorable rate. The AR program remains at $130 million. I would remind everybody that has been deducted from receivables and you will have to add that back to see what our real receivables are.

When you do that, I hope you find DSO came out at 62 days in the second quarter, up a couple of days from Q1. Again, the FX impact probably accounts for half of that. Very nice comparisons from 66 days. Inventories. Inventory days are 149 versus 147 in Q1, for the same reason as receivables, but compares nicely to last year. We were at 162 days. So, total debt, plus AR securitization declined 105 million in the first half and 88 million in the second quarter,right on internal plans for debt reduction. Debt numbers continue to get better. Debt to EBITDA are at 1.08 and interest coverage is up to 12.4. So, these ratios are looking good.

On the cash flow statement, operating cash flow of 173 million is up about 14% for the half and up about 42% in the second quarter. We borrowed $135 million on July 1, for the SGI acquisition, which is not reflected in the cash flow statement, but we hope to pay it off before the year is out. With that, I will hand the phone back to John.

Thanks, Dave. Just summing things up, we are still very bullish on orthopaedic market and are optimistic about all the markets Stryker is participating in. They are all strong. We like the implant market because the unit demand continues to grow nicely. We don't see anything that will really slow it down. With a little help from the dollar and the SDI acquisition in the second half, we think that we have got a real good chance of hitting 3 billion dollars. As you know, I wouldn't say that if I didn't expect us to make a run for it. That is no guarantee we will do it, but I can name 13 guys or 14 guys that will be working awfully hard to hit that number.

Just a word of caution on the earnings. Obviously the 42 cents is a little bit higher than what the analysts had for us for the second quarter. I think you had 40 cents. We are 2 pennies above that. And what we would ask you to do is keep in mind that we are still shooting for $1.66 for the year and what we would ask you to do is think about maybe trimming your third quarter and fourth quarter by a penny each quarter, just to bring your model back to the $1.66. Our goal here is to report $1.66 after covering the one-time cost closing the Rutherford facility. It is $1.66, for the year, after covering the cost of the Rutherford closing.

We are looking forward to a good third quarter and good fourth quarter and our next phone call would be 5 o'clock on October 16th, 90 days from today. Before we go to the third quarter, it is probably appropriate we take your questions for the second quarter and the first half. So, Irene, we are ready to accept questions.

Thank you. Ladies and gentlemen, if you wish to register a question for today's question and answer session, you will need to press the 1, followed by 4 on your telephone. You will hear a prompt to acknowledge your request. If your question has been answered and you wish to withdraw your request, do so by pressing 1, followed by 3. If you are on speakerphone, pick up your handset before asking your question. One moment. Our first question is from Bruce Jacobs.

Thanks so much. Congratulations. Two questions. First on the bottom line, it was unusual, but welcomed surprise for the upside. I wonder if there is anything in particular that surprised you this quarter to bring the bottom line couple of pennies better than you had expected? That is question one. Second question is given the growth you have shown here, that which the others have shown, is it possible that (inaudible) market is growing in the mid to upper double digits or are there other people losing share we haven't had heard from yet?

Thanks, Bruce. Good to hear from you. You must be on a cell phone. We will try to answer both questions. As far as gaining market share, I don't know who is losing market share. I think the conclusion has to be again, this is a very, very robust market. So far shows no signs of topping out. Our feeling is that it will continue to grow. The other point and I will let Dave pitch in because he can do it more eloquantly I can. The way we put our plans together is that we have our operating divisions have a budget and each one of them are expected to hit their top line and bottom line number. But, we know it is impossible for 11 divisions to always hit those numbers.

So, we always put in condense for each quarter and each year in the budget. I would just say in general, I think the operating divisions in the second quarter of 2002 overall, had good performance and so, there was no particular way we could keep the number down.

Uh-huh. And I know you asked for us to kind of keep the year as it was. If the quarter continues throughout the balance of the year, is it fair to say you might revisit the drop in the back half of the year?

Probably about January 4th or 5th of 2003. Right now, I would say no.

Okay. Great. Thanks guys. Great quarter.

Bruce, remember we have to absorb 10 to 15 million dollar one-time cost here for Rutherford.

Fair enough.

That could be over $20 million pre-tax. Okay.

Thanks, guys. Appreciate it.

Next question is Scott Davidson with U.S. Bancorp Piper Jaffray.

Hi. I want to clarify the last point. It is important. I think I got it right, but want to double check. The $1.66, that is after you are already running these costs due to the Rutherford closing through the pnl, right? You are not taking those out one time, is that correct?

I am not exactly sure how we will report that, but it is after the charge.

Okay. Thanks. Also, Dave, can you touch briefly on the earnings impact of the favorable FX move? Is there any? Is that something that gets hedged away? Clarify there.

It is really the same answer I have been giving for the last 11 quarters on the FX impact of the declining or strengthening dollar. It is not a big deal. It is very manageable and just like we were able to make our numbers when the dollar was strengthening. It didn't have that big an impact on the other way. Ot flip side when it was weakening.

Super. Just given what is going on in terms of the accounting debates, Dave, have you guys thought about following the lead that was set a few days ago in terms of expensing stock options and if you did, have you begun to spec out the earnings impact?

(inaudible) whenever the rules changed, we have been reporting that for a long time. I think it is note 7, Scott. It is laid out for you. My recollection is that it amounts to just a few cents a share. The proforma earnings are right in our annual 10-k and annual report.

Great. Any thoughts about whether you might proactively decide to go ahead and expense that?

I will we will pick the Gillette route. When the industry decides to adopt that accounting philosophy, we will do it and we will, too.

Super. Can we quickly get your perspectives on this knee arthroscopy article that came out and caused controversy a few days ago?

I will comment on it and Dave can, too. I read (inaudible) article on it. This study was run at a VA hospital and our people just say the patient population described in the study is not what they see when they go into the OR and see an arthroscopy procedure run. Our conclusion is that you would be making a mistake to take the data from that study and apply it to the full arthroscopic patient set-up, which is about two million people. It is a different kind of patient and different set of patients.

I think most of the patients we see are sports medicine related. That study inapplicable.

Great. Thanks a lot and congratulations.

Our next question comes from Rick Weiss. Please proceed with your question.

Good afternoon. Hi, John. Couple of PNL questions to follow-up on Dave's comments from earlier. Dave, you talked about the planned consolidation being key to further gross margin improvement and I think you said, as well, lower inventories or lower working capital use. Can you expand that a little bit and flush out what we could expect and when and just the implications for gross margins?

LI don't want to make detailed PNL predictions, but we are clearly seeing gross margins as a continuing opportunity. The Rutherford closure will represent the completion of the Howmedica integration. It will take us all of next year and we would expect to see moving margins as that starts to really kick in with probably the full impact in '04.

And just in - quantify it in terms of dollars or cost savings or give us perspective on that, Dave? Any color there?

Well, the payback on this is going to be fairly quick. I - my recollection is it is in the neighborhood of about a year. About what we will have to pay, we will get that back pretty quickly.

Okay. Another point you made, you expect tax rate to continue to improve. Can you update us on what you expect that - we were assuming you continued 33% tax rate for the next few years. Maybe I misunderstood in the past. Do you now think that rate might come down sooner?

Well, you watched 00:59:18 that rate come down from 36 or 35% over the last few 00:59:23 years. In the meantime, we have done that largely 00:59:27 by moving production to tax favorable jurisdictions 00:59:30 and certainly the action in Rutherford will be a continuation 00:59:37 of that. 00:59:38 00:59:39 >> ANALYST: The last six quarters have 00:59:40 been around 33% pretty much for the last six. Do 00:59:43 we expect to see that come down in the next couple 00:59:46 of quarters? Or is this more like beyond '03 kind 00:59:53 of? 00:59:54 >> DAVID SIMPSON: I expect it to come down. I cannot predict 00:59:57 when. 00:59:58 00:59:59 >> ANALYST: Last. I asked this last quarter. You are talking about Leibinger, what is needed to bring Leibinger up to Stryker standards? Just your ongoing thought process, John?

We need a stronger sales force. We - our turnover rate there is way too high and the quality of the sales force is not up to standard. Until they get that straightened out, it doesn't matter what we give them, they have to get the sales force fixed first.

Any sense of timing there or when we might expect some change?

We have already made management change with marketing and a management change with the field sales. I think it will be later in the second half before we see results. Toward the end of the fourth quarter, I expect Leibinger to pick up.

Thank you very much.

Our next question is Catherine Martinely with Merrill Lynch.

(inaudible) it looks like the worldwide market increased 15%, which is probably the highest rate we have seen in the past few years. The big difference really seem to be outside the U.S., looking like double-digit growth this quarter. Is there something specific you are seeing in any of the countries where maybe they are catching up in terms of revision procedures or starting to shift to higher margin products? It would seem if that was the case, the trends are sustainable.

I can't point to anything specific, other than to tell you in the major markets in Europe and in Japan, the unit demand has continued to grow.

There hasn't been shifts in terms of funding for any procedures or waiting lists starting to be addressed in a meaningful way in many countries?

Not that I know of.

Just a real knit question. What extremity growth might have been in the quarter?

I think it was not as high as hips and knees. I think it was in the - was less than 10%.

Worldwide?

Let me see if I can find that. I would just while I am fumbling around here, just add on the international business, we continue to introduce our good selling new products in the international markets in every degree we can. We try to get premium - move the pricing up, too. There is continual rollout of new products is helping us a lot in the international markets.

Okay.

Yeah, it is up solid single digits.

Any color on what you think in the quarter, the mix of percent of cementless was versus cemented?

I don't have the numbers handy, but I think it's really shifted over more than 50% now to - at least in terms of dollars. The units are still way behind that. In terms of dollars, it is now shifted over to more than 50%.

Great. Thank you.

Our next question comes from Steve Hammil with RBC Capital Markets. Please proceed with your question.

Good actual and congratulations on a wonderful quarter. My first question has to do with the debt situation, Dave. You mentioned you borrowed was it 41 million for the surgical dynamics?

No, 135.

You look to pay that off by year end. Do you expect to pay down on other lines of credit at this point, as well?

We will have our hands full paying that off. Thank you.

My second question has to do with the overall capital equipment market at hospitals. Obviously, we have gone through a buying or replacement cycle, due to demand last year for beds and stretchers. Are you seeing a change in terms of what hospitals are buying at this point? Does it appear to be favorable toward your other lines of capital equipment?

I would say beds, stretchers and endoscopy continue to do well.

I don't see a change. Our capital products are continuing to motor along very nicely.

Okay. One last question for you, Dave. Can you give us crossfire penetration for the quarter?

I think it is in the high 70s now. I think it is not quite 80, but getting close.

Great. Thank you.

Our next question comes from Larry Koush with Goldman Sachs. Please proceed with your question.

Hi. Good afternoon. Dave, just quick question on R and D. Now we have had obviously two quarters that were below the absolute levels from a year ago and I understand shifting the expenses into SG and A. Is it fair to assume that R and D for the year actually on absolute basis will be below last year?

It is possible. I haven't spent a lot of time thinking about that, but it is possible because that shift of biotech costs - Well, I think it started in the fourth quarter of last year, but I could be wrong there. I think it will generally - the trends you see today will continue.

Okay. Then, on the Rutherford closing, I don't have a lot of experience with laboring unions and such, but what needs to happen to just sort of get the thing buttoned up? What are we waiting on at this point?

You know, what has to be done, you have to get into pretty intense negotiations. And each side has to understand what the other side needs and then you try to reach a compromise to accommodate the basic needs of both sides. It's not a science, it is an art. And we are dealing with, we think a good union, a fair union and are confident we have good negotiators on our side. We feel like we will wind up with a good agreement and a fair agreement for the employees and for the company. It would be inappropriate to say a whole lot more than that.

Okay. When you take this expenses associate wide the closing, dave, is that likely to all be in one quarter or could we see it stretched into a couple of quarters?

It will by and large, happen at once. Once we reach agreement, we will know what the cost is. We will take as much of it as we can right at that point.

Right. Two last questions for you. You know, with the assuming you hadn't done the two cent performance this year and still had the Rutherford cost in front of you, would you still be guiding to that same $1.66 number for the year? Perhaps you can give us an update on where we stand with the sales force adds?

On the first question, I view the extra performance in the second quarter as helping us with this one-time charge for the year. That is why John and I will be trying to encourage you guys to lower your numbers a penny on each of the next two quarters. I say in the next two quarters because we don't know which quarter it will hit. But, clearly, the couple cents to the better here in Q2 is couple cents that we have sort of got under our belt here toward the ultimate cost.

Sorry to interrupt. I don't want to beat a dead horse on this one. If you knocked on this much debt or in this quarter and we did have costs come along, there could have been the flip side, where you could have been reducing year-end guidance?

I doubt it. We wouldn't give up that quickly.

That is what I want to hear. Perfect. Just on the sales force adds?

We have six months to scramble. Sales force adds, I don't have a lot of numbers other than the ones I gave you for Howmedica Osteonics. What I have given in the past are goals for the year and those are in tact. I can't tell you division by division where the sales head counts are.

Perfect. Thanks very much, guys.

Larry, we are adding to the sales forces without exception.

In most cases, we are at year-end goals.

Great. Thanks.

Next question is from Greg Simpson with A.G. Edwards. Please proceed with your question.

Good afternoon and congratulations on the quarter. Since I enjoy the guidance you give so much, I am going to have to go that route, as well. Both my questions have been answered, but Dave, let me put you on the spot on 2003, then. You know, we figure by our numbers allowing for erosion in sdi sales we could see a trickle or so from that. Given the plant closing and improvement in gross margins and everything else, especially with impressive Recon market, is that $2 still valid? I know you said sdi is part of the mosaic that gets you to the $2. Can you address the 2003 numbers, then?

I don't think we are prepared at this point to make further comments about 2003. Clearly, the $2 is a very comfortable number in our planning at this point.

Okay. Fair enough. Sneak another one in. John, you said you don't see anything changing on the market growth, things like that, at this point. Can you then, just elaborate on pricing, which remains strong and give a little bit of comment as to what you see going forward?

Well, we are working on our fall plans, which for budgets and that would include plans for price increases. I am really not at liberty to comment on that now because it has not been firmed up.

Thank you, guys.

Next question comes from (inaudible) with Chase Morgan.

Good actual. Two questions. First, on the anticipated Rutherford charge in the second half of this year. Yet, do you have a sense on where you will take that charge in the pnl yet?

I think the appropriate reporting format is one line item. Somewhere in the body of the pnl.

Okay.

Something that says - you will be able to see it. We will do whatever the rules say to do. I think that is what we are supposed to do is a one-line, single-line item in the pnl. It will be contained within operating income.

Okay. And then, just looking at sdi in the quarter, looks like it grew 25%. Is there a way to flush it out more and think about what the cage business did as opposed to the rest of the instrument business? Then, maybe comment on what you are expecting for the second half of this year in terms of the cage revenues in the face of Medtronics approval?

We are not going to go into those details of those numbers. We are just not prepared to get into those discussions at this point.

Okay. But, if anything, if you look at the second half of this year, would you expect - are you starting to see any pressure on the business itself from the approval? I know it has only been a few weeks?

Not a bit.

Okay.

Ladies and gentlemen, to register for a question, press the 1, 4. Our next question comes from Bruce Jacobs with Georgia Bank. Please proceed.

Sorry. Just time for one quick follow-up. In terms of the acquisition, has that maybe occupied throughout the year with that? In other words, does that take you out of additional acquisitions or signal that more might be to come? I had a quick question on OP-1. Will you comment on the sales for that product at all?

OP-1 will only be quantitated by the end of the year, we might comment on it. As far as other acquisitions, it all depends. If something came along that was exciting, we would take a look at it.

John, on OP-1, how many vials are being used per case or doses, is it one or averaging more than that?

The average is between 1 and 1 and a half per case.

I am not sure. It is not unusual to have 2.

Okay. On OP-1, in terms of the trial for spine fusion, any idea on the timing of completion of enrollment?

That will take us longer than we thought. We were hoping complete enrollment this year. It doesn't look like that will happen now. I think we will be enrolling patients into next year.

Okay. Thanks for indulging here. Appreciate it.

Our next question comes from Kirk Cruger with bank of America. Please proceed with your question.

Hi, guys. Could I ask about your plans for Alograph Phones to supplements your working in spine and cages? If you have plans there? As well as, bring us up-to-date with the mobile bearing knee. You have a clinical trial underway. Would you likely be the second player in the United States with that?

Alograph Bone, we have relationships with several bone banks that are starting up. I don't see that as being a big part of our implant business, but we are working in this area. And as to the mobile bearing knee, ide, we are excited about it, but, there's a long way to go yet before we will have the patients all recruited and presented anything to the FDA.

Would that be 2004 or 2005 product?

I learned a long time ago not to project out that long.

I should have, too.

Thanks.

Next question comes from Steve Hamill with RBC Capital Markets. Please proceed with the follow-up.

Thank you. Dave, you talked about SG and A and why it was at the levels it was here. Should we be thinking of this now as line item that will probably continue to come in above 39%, that is above historical ranges?

I don't know. I always look at that SG and A line as an opportunity. I would hope that you don't see it go up any higher. I think the opportunity is to - for all of us to find a way to make it a lower percent of sales.

Okay. One last one. Is there a chance of mobile bearing knee that we actually see down classification before you complete the trial?

Always possible.

Great. Thank you.

I am showing no further questions at this time. Please continue with your presentation or closing remarks.

Thank you. With that, I think we will close down. Just a reminder, the next quarter third quarter will be reporting on October 16th at 5 p.m. We appreciate you joining us today. We hope you agree with us it was a good, solid second quarter. We are looking forward to having a great year. Thank you and good evening.

Ladies and gentlemen, that does conclude your conference call for today. We thank you for your participation and ask that you disconnect your line.

Thank you.