史賽克 (SYK) 2004 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Stryker Corp. second quarter operating results conference call. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded Thursday, July 15, 2004.

Certain statements made in today's presentation may constitute forward-looking statements. They are based upon management's current expectations and are subject 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 on this presentation, such factors include, but are not limited to -- regulatory actions, including cost containment measures that could adversely affect the price of or demand for the Company's products; changes in reimbursements level from third party payors; a significant increase in product liability claims; changes in economic conditions that adversely affect the level of demand for the Company's products; changes in foreign exchange markets; changes in financial markets; and changes in the competitive environment. Additional information concerning these factors is contained in the Company's filing with the Securities and Exchange Commission, including the Company's Annual Report on Form 10-K and Quarterly Reports on Form 10-Q.

I would now like to turn the conference over to Mr. John Brown, Chairman and Chief Executive Officer. Please go ahead, sir.

Thank you, George. I appreciate that introduction.

Welcome, everyone, to Stryker's second quarter earnings report for 2004. With me today are Steve MacMillan, President and Chief Operating Officer, and Dean Bergy, Vice President, Chief Financial Officer, and Secretary.

We're pleased to report that Stryker had a very strong second quarter and first half. For the second quarter net sales were 1,043,000,000, an increase of 17 percent over the prior year. Excluding the impact of foreign currency, sales were 14 percent higher than last year. Net earnings for the quarter increased 42 percent to 153 million, and diluted net earnings per share increased also 42 percent to 37 cents per share.

For the first half net sales were 2,078,000,000, an increase of 20 percent over the prior year. Excluding the impact of foreign currency, first half sales were 16 percent higher than last year. Net earnings for the first half increased 36 percent to 289 million, and diluted net earnings per share increased 35 percent to 70 cents per share.

We generated 178 million in free cash flow in the first half, allowing us to fully repay the final 160 million of debt (technical difficulty) receivable securitization outstanding under our credit facilities. This is a watershed event. After 5.5 years and a high of $1,650,000,000 Stryker is virtually debt free. Howmedica oh has been paid for, and the shareholders have been rewarded accordingly. I must say, it really is a good feeling. We're now poised to take advantage of acquisition opportunities and investment opportunities as they are presented to us going forward.

Domestic sales were 677 million for the second quarter and 1,335,000,000 for the first half, representing increases of 19 percent and 20 percent over the prior year. That US divisions had a great first halves and are in line for excellent years ahead. Orthopedics was up 19 percent in the quarter and 22 percent for the half, with strong growth in reconstructive implants and bone cement. Hip growth slowed somewhat in the quarter, but trauma sales were stronger. Spine sales increased 22 percent in the quarter and 19 percent for the half, led by strong sales of thoraco-lumbar (ph) and cervical products. Leibinger micro-implants sales were up 19 percent in both the quarter and the half, led by sales of craniomaxillofacial implant systems. Instruments sales increased 22 percent in the quarter and 20 percent for the half with strong growth in (indiscernible) instruments, pain management and excellent growth in the Neptune operating room waste management systems, surgical navigation systems and interventional pain. Endoscopy sales increased 24 percent in the quarter and 22 percent for the half with strong growth in video and arthroscopy, and solid growth in the general surgery laparoscopy (ph) line. Medical was up 17 percent in the quarter and 16 percent for the half with excellent growth in hospital beds and solid growth in the stretcher line. Physiotherapy was up 11 percent in the quarter and 13 percent in the half with same-store sales growth in new clinics arising from start-ups and acquisitions contributing about equally to the growth.

International sales were 366 million for the second quarter and 743 million for the first half, representing increases of 13 percent and 19 percent over the prior year. Foreign currency comparisons added 23 million to sales in the second quarter and 70 million for the first half. Excluding the impact of foreign currency, international sales increased 6 percent in the second quarter and 8 percent in the first half. Our international sales growth was negatively impacted by continuing reorganization of some of our less profitable distributor-based businesses. On a local currency basis most of our international direct business had good first halves. Europe grew 6 percent for the quarter and the half, but growth again in the direct business was 12 percent for the quarter and 11 percent in the first half. So the reported number is considerably less than what actually happened to the base business. The strongest performances were in UK, Spain, Benelux (PH) and Germany.

Japan declined 2 percent in the quarter and was up 2 percent for the first half. Price reduction initiatives by the government at the beginning of the second quarter reduced quarterly sales by 5 percent and sales for the first half by 3 percent.

Pacific was up 3 percent for the quarter and 5 percent for the half. Pacific business is also being negatively impacted by some distributor reorganization activities. The strongest performance for the first half were in Southern Asia and Taiwan. China and Hong Kong also picked up this quarter.

Canada and Latin America were up 27 percent for the quarter and 34 percent for the half with the strongest performance in Latin America.

Worldwide Orthopedic Implants sales were 631 million for the second quarter, 1,264,000,000 for the first half, representing increases of 15 percent and 19 percent respectively. That's based on strong shipments of reconstructive products, trauma, spine, micro-implant systems and bone cement. Excluding the impact of foreign currency sales of implants sales increased 12 percent in the quarter and 14 percent for the half.

Worldwide MedSurg sales were 350 million for the second quarter and 691 million for the first half, representing increases of 21 percent in both periods based on higher shipments of power surgical instruments, endoscopic products, patient handling and emergency medical equipment and surgical navigation systems. Excluding the impact of foreign currency, sales of MedSurg equipment increased 20 percent in the quarter and 19 percent for the first half.

Concerning Physiotherapy and our biotech businesses, at Physiotherapy we are making slow but steady progress in responding to the subpoena from the US Attorney's Office in Boston relative to the Department of Justice investigation of Physiotherapy Associates and billing and coding practices. We continue to cooperate with the Department of Justice and hope to resolve this matter in a timely manner.

We're also working through a leadership transition at Physiotherapy Associates. In early June Jason Blackwood, President of Physiotherapy, indicated his desire for a change in his role within the Company for personal and professional reasons. Jason will play an advisor to Steve to ensure a smooth leadership transition to will assist with various Physiotherapy related matters, including the Department of Justice investigation. Jason has led Physiotherapy now for 15 years and played a very large role in its growth from a $3 million business in 1989 to the 200-some-odd million plus business it is today. And on a very personal basis I want to thank Jason for his many contributions during that time.

While we consider alternative to permanently succeed in the Jason in the business, we've appointed Judd Hopp (ph) to serve as acting General Manager at Physiotherapy Associates. Judd has most recently been Vice President of Regulatory Affairs Quality Assurance for Stryker. Judd is working closely with Jason and the rest of Physiotherapy's senior leadership team to ensure the continued success of the business.

Biotech had a solid quarter with OP-1 shipments registering a new record and hitting the gold standard of growth compared to prior year. In the last days of the quarter we also began shipping our OP-1 putty product for use in revision spine surgery under the recently granted humanitarian device exemption approval. Biotech will be going against easier comparables for the remainder of the year due to product release testing issues we faced in last year's second half, but we still expect that capacity constraints (indiscernible) US approval will hold OP-1 sales to modest levels throughout the rest of this year and early 2006.

Now I'd like to turn the microphone over the Steve MacMillan first Steve's observations on the second quarter.

Thanks you, John, and good afternoon, everyone.

The breadth and depth of our businesses again helped generate overall solid results in the quarter. We experienced exceptional performances across all of our MedSurg businesses and strong but not exceptional performances in our own (ph) products business. In the US strong 23 percent growth in knees was offset by more moderate 14 percent hip growth as we begin to go against the anniversary of the Trident ceramic-on-ceramic launch. After several quarters of very strong growth in US hips we returned to more mainstream 17 percent growth rates in our core hip products. Our reported 14 percent rate reflects a delayed phase-in our new Modular Revision Hip System where we accelerated European launch but pushed back the US. Ceramic penetration inched up slightly into the low 30 percent range, and we continue to roll out our MIS instrumentations at a measured pace. With tougher comps ahead of us, we're now launching the new modular revision system into the US in the third quarter and re-initiating Jack Nicholas patient education campaign which ran at very limited levels in the first half.

While Dean will provide the specifics by franchise and geography, we also wanted to provide more insight into other actions which impacted our reported results. As John mentioned, we're currently reorganizing our less profitable distributor-based business. This action significantly clipped our topline performance for both Europe and Pacific in the quarter, and will continue to do so for the rest of the year while having little bottom-line impact. This action also negatively impacts the global and regional growth rates for our orthopedic implants lines. As an example, our direct countries in Europe posted double-digit operational growth as John mentioned, yet we're reporting mid-single-digit growth. Likewise, our European hip franchise rebounded to post strong mid-teens growth in our direct countries as the impact of the reorganization brings this to more modest single-digit growth. And our reported European spine and trauma numbers are actually below last year, yet each experienced high-single-digit growth in our direct operations. These actions are clearly strengthening us for future, but they muddy the waters and depress our sales results in the short term.

Now for a further review of our results by franchise, starting with hips.

We covered our US hip business earlier. Japan also experienced slower growth, (indiscernible) to two key issues -- the continued shift of the bipolar business, which has a positive offsetting effect in our trauma business; and the biannual price reduction, which was implemented on April 1st. In the quarter we initiated several sales changes to better address the shifting bipolar market, including leveraging our strong trauma business. Meanwhile, the Centaur (ph) system launched in the first quarter is growing nicely. In Europe, we were very encouraged by a strong rebound fueled in part by the launch of our new Modular Revision System.

The rest of our orthopedics implants business was strong in the quarter, highlighted by operational knee growth at 23 percent in the US and 18 percent on a global basis. We are very pleased with the continued strengthening of our knee franchise which has historically lagged our strong hip business. The US business is particularly benefiting from marketplace momentum, Scorpio and Duracon product enhancements and our newly established a leadership position in MIS knees, which received significant news coverage in the quarter.

In trauma our US growth accelerated 14 percent in the quarter behind the successful launch of Gamma 3. Also in the quarter we initiated US sales force changes to bring even greater focus to this important business, and we expect these changes to be felt in the upcoming quarters.

We're also beginning to see the positive effect of several changes initiated last year at our Leibinger, Navigation and spine businesses. After its splitting out Leibinger and Navigation, with Navigation now being equally handled by our instruments division, Leibinger reported it second straight quarter of 19 percent US growth, not bad for a business which was in a consistent decline prior to last year's second quarter. We're now beginning to think of Leibinger as a business which has achieved a successful turnaround and should be counted on for sustained growth.

Another real positive in the quarter is the emerging strength of our spine business. As you know, spine is obviously a large and high growth segment of orthopedics, and we're striving to further develop this franchise. We initiated several key actions last year which began to show results in the quarter -- the established a newly dedicated sales force; a leadership change; and a boost in R&D. Behind the very successful launch of the Oasis Cervical System, US spine growth accelerated to 20 percent in the quarter. The Oasis launch is also going very well outside the US, including helping to drive our Japan spine franchise in double-digit growth in the quarter. While there is more work to be done here, we expect our spine business to become a key driver of future growth.

In our MedSurg businesses, a second straight 20 percent plus growth quarter suggests we are clearly taking a share in almost all of the categories in which we compete. We had strong performances throughout these businesses, highlighted by particularly strong growth in power tools, endoscopic equipment and hospital beds. Given the slower underlying growth rates in many of these categories, however, we do expect more moderate growth levels in the quarters ahead.

Now, on to Dean for more details.

Thanks Steve. I'll start out with the impact of foreign currency on the quarter.

As John said, it was again favorable in the second quarter, increasing international sales by $23 million or about 7 percent. This is the ninth straight quarter of positive currency impacts we've had, and if currency rates hold at current levels we expect we will see a positive impact on sales of about $20 million in the third quarter of this year. However, the positive currency gains are clearly dwindling and are projected to be almost 0 in the fourth quarter of the year.

Looking at price volume analysis, for the quarter price contributed about 2 percent to our 17 percent sales growth. Foreign currency exchange contributed about 3 percent. And that volume mix with the remaining 12 percent of that 17 percent growth. I will bring in the year to date numbers of 3 percent in price, 4 percent on foreign currency, 13 percent on volume mix, and of course 20 percent total growth.

US implants prices were up about 3 percent in the quarter and 5 percent for the first half. Prices in Japan were down about 5 percent in the quarter, 3 percent in the half. John has already alluded to that as a result of the MHLW price reductions which took place on April 1st. Prices in Europe were up slightly. And for the first half the volume mix was up about 17 percent in the United States and 7 percent overseas.

Now turning to the business segments for the Company, orthopedic implants, as you know, represent 61 percent of our sales. Sales of implants were up 15 percent in the quarter and 19 percent for the first half on an as reported basis and 12 percent and 14 percent respectively on a constant currency basis.

Turning to the product lines, I will give you the breakdowns for domestic, international and total, and then turn to the constant currency after that. So on an as reported basis hips were up 14 percent domestically, 10 percent internationally and 12 percent in total in the quarter. Knees were up 23 percent domestically, 19 percent internationally and 21 percent in total for quarter 2. Trauma in the quarter was up 14 percent domestically, 8 percent internationally and 10 percent in total. Spine was up 20 percent domestically, down 3 percent internationally and up 11 percent for the quarter. Leibinger up 19 percent domestically, 9 percent internationally and 14 percent in total. And for the total business, up 18 percent domestically, 11 percent total orthopedic implants was up 19 percent domestically, 11 percent international and 15 percent in total.

Turning to the constant currency results, obviously the domestic numbers are the same. The international saw it go across on the international in total lines -- hips grew 2 percent in constant pricing internationally and 9 percent in total; knees, 12 percent internationally and 18 percent in total; trauma, 1 percent internationally and 5 percent in total; spine, down 8 percent internationally and 9 percent up in total; Leibinger, up 2 percent internationally and up 11 percent in total; and for total implants, up 4 percent internationally and up 12 percent in total. Again, those are the quarter numbers.

Now turning to a little bit more flavor on the individual product categories within orthopedic implants, hips, as we said, was up 12 percent in the quarter and 18 percent year-to-date reported. We had a good quarter in hips. Our Trident ceramic-on-ceramic hip system continues to be a strong performer in the United States. On a unit basis ceramic inserts sales represented approximately 32 percent of our total insert sales in the quarter. The mix shift (indiscernible) also continued in the quarter with a strong growth experienced in our Accolade, SecureFit and Citation products. Our overall hip business was negatively impacted, particularly in the United States, by a transition to our new Restoration Modular Revisions Hips System. The Restoration product should be fully deployed to the field in the second half of this year. In Europe hip revenue growth was led by Trident and Exeter, and we experienced solid mid-teens local currency growth in direct markets. In Japan hip sales declined modestly in the wake of the MHLW price cuts and the continued mix shift away from bipolar hips to treat hip fractures.

Now some comments on knees, which were up 21 percent in the quarter and 23 percent year-to-date on a reported basis. We had another excellent quarter in knees. Our primary and revision businesses both generated greater than gold standard growth in United States. Scorpio and Duracon products did extremely well in both the primary and revision categories. The GMRS product launched last year also saw accelerated US growth in the quarter. In Europe our Scorpio knee had an extremely strong quarter, and local currency growth in direct markets was near 20 percent. Knees were soft in Japan with the pricing impacts and the beginning of a transition to our new Scorpio NRG product which was launched in May. And finally for knees, the Scorpio Flex Knee had a very good quarter in the Pacific region.

Our trauma products were up 10 percent in the second quarter and up 14 percent year-to-date. That represents an acceleration -- or the US trauma business accelerated 14 percent growth in the quarter and grew by 20 percent if we exclude military sales in the quarter. The T2 intramedullary nail system had another great quarter and continues to lead our trauma sales growth. Again, hip fracture product also did well in the US and was helped by the launch of the new Gamma 3 product. International trauma growth comparisons reflect the impact of a large European export sale in the prior year. The base European business generated mid-single-digit growth. Japan saw double-digit trauma sales growth in the quarter, despite the price reduction impact.

The spine was up 11 percent in the second quarter and is up 16 percent year-to-date. Spine sales growth in the US was led by sales of our Xia 2 (ph), our 90 vertical lumbar products and by the Reflux Anteris Cervical Plate (ph) and recently launched Oasis Cervical Plate. Sales of inter-body cages (ph) were down in the US. International spine numbers were negatively impacted by the large prior year European export sale, and a Pacific distributor reorganization. European direct market business was solid and Japan was also boosted by the Oasis launch.

Leibinger was up 14 percent in the quarter and 18 percent year-to-date, as reported. Leibinger micro-implant business had another very nice quarter led by sales of craniomaxillofacial products. This business continues to build on an improving sales force and strong new products.

Now turning to our MedSurg businesses, I will remind you that the MedSurg group is comprised of three operating divisions that represents 33 percent of our total sales, and the makeup of sales within the group is represented 44 percent by our instruments business, 34 percent by our endoscopy business and 22 percent by our medical business. MedSurg group sales were up 21 percent as reported for both the quarter and the half, and 20 percent for the quarter and 19 percent for the half on a constant currency basis.

Turning to the product lines, we mentioned there the instruments line increased 19 percent in the second quarter and the half as reported, and 16 percent for the quarter and 15 percent for the half on a constant currency basis.

I'll give you the breakdown by products within instruments, our powered instruments business was up very strong in the second quarter -- 21 percent in domestic, international and in total. Other OR equipment was up 23 percent domestically, down 3 percent internationally and up 16 percent in total. So the total instruments business was up 22 percent in the United States, 10 percent internationally and 19 percent in total. (indiscernible) had a great quarter based on excellent growth in power instrument systems and solid shipments of other OR equipment. Domestic sales were extremely strong in the quarter. International growth dropped 10 percent as last year's second quarter included more significant sales Steri-Shield products resulting from the SARS epidemic in certain markets. Both our heavy-duty and micro-powered tool systems had tremendous quarters. The Neptune operating room waste management system, pain manager and interventional pain products also sold well in the quarter. In addition, our Navigation products, which as you know were added to (indiscernible) at the beginning of the year, had another excellent quarter domestically.

Turning to our endoscopy business, that business was up 23 percent in the second quarter and 22 percent for the half on an as reported basis, and 22 percent for the quarter and 21 percent for the half on a constant currency basis.

Looking at the product lines within that business, our arthroscopy business was up 11 percent domestically, 38 percent internationally and 18 percent in total in the quarter. General surgery business was up 18 percent domestically, 22 percent internationally and 18 percent in total. Video was up 32 percent domestically, declined 6 percent internationally and grew 25 percent in total. And the total endoscopy business was up 24 percent in the United States, 19 percent internationally and 23 percent in total.

Endoscopy had another excellent quarter across the board. US growth was paced (ph) by video sales for our communications business needs, but we're also very pleased by the initial reception of our new 1088 high-definition camera. Internationally where we have a smaller but faster (indiscernible) business -- our Fasbury (ph) business -- arthroscopy and general surgery were stronger.

Turning to our medical business, the medical line was up 24 percent in the quarter and 25 percent for the half, as reported, and 23 percent for both the quarter and the half on a constant currency basis. In the quarter domestic business was up 17 percent, international business was up 52 percent to get to that 24 percent total growth number.

The medical division had an excellent quarter with great growth in the US, and a second consecutive quarter of extremely strong sales growth in Canada. Our bed business led the way in the quarter with EMS products also putting out gold standard growth and stretches finishing with mid-teens growth. We would, however, expect to see sales growth in Canada to return to more normal levels in the second half of the year as they have had 2 great quarters there.

And then the physiotherapy business, as you know, is up 11 percent in the quarter, bringing the first half revenue growth to 13 percent. Same store sales are up 7 percent year-to-date and that contributed to about half of physiotherapy's growth this year and the start-ups and acquisitions are coming from the remainder. Our physiotherapy business now has 407 clinics in the United States, up from 395 last quarter.

Now turning to the operating results, the P&L, down from the sales line, gross profit margins, as you can see, in the quarter were up sequentially and as compared to last year at 65 percent versus 63.3 percent last year and 64.4 percent in the first quarter. Excess and obsolete inventory costs are down this quarter when compared to the first quarter, and absorption is high as we continue to run our plants at a very fast pace. In addition, last year included some duplicative costs for plant production moves including the Rutherford move I think you are all familiar with.

Research and development spending is up 14 percent year-to-date, and the ratio as a percentage of sales continues to run at a range from 4.8 to 5.1 percent. We continue to further increase focus on our development efforts, but that we're maintaining discipline and adequate size and the quality of ideas as opposed to spending a set percentage of sales dollars.

Selling, general and administrative costs ran at 38 percent of sales in the quarter versus 39.1 percent last year and 39.7 percent in the first quarter. The costs are up 18 percent year-to-date. A little under half of the decline in the SG&A as a percent of sales for the quarter when compared to last year results from a legal settlement gain in this quarter. We've also added to our sales force on a slower than expected pace during the first half of 2004. Over the year in total we had higher sales meeting costs and higher insurance costs compared to prior year, contributing that 18 percent growth in the total cost.

Intangibles amortization increased 11 percent in the quarter, primarily as a result of higher costs from the acceleration of the Howmedica trade name amortization that we talked to you about at the end of last year.

Interest expense is dwindling away. The interest expense plus the accounts receivable securitization discount was $2.2 million in the quarter, up slightly on a sequential basis, but down about 70 percent compared to the prior year.

And finally, I will give you the breakdown on other income for the quarter. It is a total expense of 100,000 in the quarter. That's comprised of interest income of 300,000, foreign currency transaction loss of $300,000 and minority interest of $100,000.

Then, as you know, the income tax rate for the quarter and the first half declined to 30 percent from 31 percent, primarily as a result of the increased manufacturing in low tax jurisdictions such as Ireland and Puerto Rico. And the annual income tax rate at the last year was at 30.5 percent.

Turning briefly to the balance sheet, I will point out a couple of things here. One is you see a significant increase in accounts receivable that's really due to the reduction in debt under our credit facility. As John alluded to, as you know, we have an accounts receivable securitization program that has been fully extinguished at the end of the second quarter. There was (ph) $182 million that was outstanding under program, in the prior year $150 million that was outstanding at December 31, 2003. We have a maximum of $200 million that we can still draw into that program, but obviously we are not drawing anything at the current time.

(indiscernible) impact our receivables are up 8 percent year-on-year -- I'm sorry, compared to the end of last year. Receivable days finished the quarter at 60 days. That's down 3 days compared to the prior year and 2 days in the quarter. Inventory days finished the quarter at 129 days. That compares to 121 in the first quarter and 128 last year. Those inventory days are up somewhat as we're building inventory to accommodate product launches that are taking place.

John mentioned the total debt plus the accounts receivable securitization declined $155 million in the quarter. We have now paid off all amounts under our credit facility, but we have about $16 million remaining (indiscernible) debt which we anticipate paying off as it matures.

Just a couple of brief comments on the cash-flow statement. We obviously had extremely good cash-flow (indiscernible) second quarter and the first half. If you exclude the impact of the proceeds of payments related to the accounts receivables securitization for both years -- because we view that securitization as more of a financing type activity although it appears in the operating activities section of the statement -- the operating cash flow in the first have would have increased from 179 million in 2003 to $253 million in the current year. So we obviously are very pleased with that result.

With that, I will turn it back over to John.

Thank you Dean.

I thought we might just go ahead and comment on the outlook before we go to Q&A. As you know, we had an excellent first half and we, frankly, continue to be optimistic about our prospects for the rest of 2004 and the future. I know that all of the analysts are working with various models, but you should know that our goal here is still to do -- on the topline to do about 4.3 billion. And everything that I can see, my prediction is we will hit that or awfully close to it.

For the second half in earnings, we had obviously very strong earnings here in the second quarter. And the turn though (ph) through second half R&D spending will probably inch up a little bit. SG&A could very well climb back up a little bit. And the currency impact is probably with us third quarter, but certainly it's going to disappear in the fourth quarter. And clearly historically for us, and everybody else for that matter, (indiscernible) exchange rates do nice things with the topline. They do nice things to the bottom line too, for that matter.

And I would add that as we told you all along in the last year that we have every intention of reloading our gun, meaning that when we get the debt paid off that we will be more aggressive about looking to new opportunities, and we're doing that now. Certainly at this point we have several ideas that are coming in that we're taking a look at. So there will be some acquisitions ideas going forward in the second half.

We're increasing our guidance to you. And you call it guidance; I would tell you that it is our budget and it is our goal. And we're increasing that from $1.40 for the year to $1.42 on a diluted per share basis. That will be a 28 percent increase over 2003.

And with that, George, we will open it up to Q&A.

(OPERATOR INSTRUCTIONS) Mike Weinstein, J.P. Morgan.

It is actually Taylor Harris here for Mike. I have a couple of questions. First of all, on international growth, just wondering about the distributor transition and when we should expect that to be concluded, and then how you think about following that international versus domestic growth comparison. And then secondly, just a question on gross margin; if maybe you could just walk through the difference between last year at this time and this year. It sounds like some of the difference was the plant transition, bringing down margins last year. But maybe help us understand what the rest of the difference is and then what the outlook for on the gross margin line is for the rest of the quarter. The rest of the year, sorry.

Thanks for both those questions. The first one I am going to give it to Steve with this preface. Steve came in and I think did very good job at looking at our businesses, and he made a comment that particularly in Europe and in a couple areas in Pacific we were basically in the distributor business it really wasn't making any money for us. And he did a very good analysis, and then led us to taking another hard look at that and making reorganizations. Steve?

(indiscernible) bring a little bit of pain in terms of our topline numbers right now, and that will continue really through the third and fourth quarter of this year, and partially into the first quarter next year. We really started the reorg right at the start of the second quarter this year. So this is the first quarter we really got hit by. We had top line impact, yes, and it cascades through all businesses, particularly the Orthopedic Implants launch, but not really affecting the bottom-line at all.

So are those distributors primarily Orthopedic Implants focused? Or what's the different dynamic between the different business lines there?

Yes, primarily Orthopedic Implants, and probably disproportionately large and spine and trauma which are seeing the impact of this quarter.

And we will let Dean handled the gross margin question.

Relative to last year, we had a couple of things going on relative to the plant production. One is we had as we were ramping up production in one of our new MedSurg facilities we were actually running pretty spotty and taking it on (indiscernible) with some real high costs. In addition, we also had some duplicative costs as we were moving out of the plant. So that really did depress last year's second quarter margin a little bit.

And then this year, as I mentioned, I think on a comparative basis we're running the plants a little bit faster pace, partially for product introductions, and you are seeing it also as the inventory days ramp up. And that's contributing to faster or higher absorption as well.

If I think about the outlook for the rest of the year, I do still feel good about the moves we have made and how the plants are running. So I'm certainly comfortable with it being at that kind of level probably for the remainder of the year with the one proviso -- that in the quarter the mix of our business shifts a little bit. And as those that have followed us know, we tend to have a little bit higher proportion of MedSurg sales in that quarter because in the implant businesses we tend to get a summer slowdown in surgeries, and that mix shift does sometimes swing the margin down sequential a little bit in the third quarter.

John, it's Mike. Just a follow-up real quick. You've done a good job, I think, of prepping the Street for the potential on the company considering the acquisitions over the back half of the year. What I think would be helpful is to get a sense of as we think about it what range of potential sizes in terms of transactions might the Company consider. And then second, in your attempt to prep the Street, just to put it that way, what -- in doing so, what are you trying to necessarily prep the Street for? Is it so the Street is ready for the Company to take on more debt; so the Street will be comfortable if a transaction dilutes earnings a little bit? What is it the Street needs to be prepped for, if I could ask that?

And then if you could tell us names, that would be fantastic.

That's a fair question. We could do another acquisition of substantial size. I'm not talking about a Howmedica, but nor am I talking about taking down a huge amount of debt. But the cash flow is strong and our first order would be to try to pay for it right out of cash flow as we go forward. But in turn, we have a $1 billion debt facility here that we could draw against, and with the right opportunity we wouldn't hesitate to go after that. I must say we don't have anything right now that's going to test that limit by any means. But we do have some ideas that could be 100 to $200 million.

Which is relatively small potatoes for a company your size.

I guess it is today. It didn't used today that way, but I guess it is.

But right now, based on what you're thinking about, those are the sized or the types of transactions that we might be looking at over the balance of the year; nothing that might test the size of that credit facility?

(indiscernible) more in the lower end than in the high end.

Just one last question. What's the current rate on that facility?

I don't know. It's LIBOR plus a very small (multiple speakers)

That's what I was assuming. Perfect. Thank you guys.

Katherine Martinelli, Merrill Lynch.

Good evening everybody. I guess just one question, first of all, just for total clarity. It doesn't sound like any of the shortfall you saw relative to your hip business and on the trauma side and spine side outside the US, would it be fair to say that was all "Stryker specific" due to some of transitions you're doing versus seeing any change in the underlying growth in either the recon market or trauma and spine?

Outside the US, Katherine, yes. With the exception of Japan obviously it is probably more of a market dynamic (multiple speakers) the rest of it is more self-imposed.

And the US, you would say the same?

More self-imposed, yes.

Secondly, and I don't mean to be unfair, but beating by 3 cents in the quarter, raising for the year by 2 pennies, anything we should read into that? Is it going to be some acceleration in some of the sales force additions since I think you made the comment you didn't add as many bodies as you had planned? I'm just trying to figure out if that's a timing type of issue on the expense side.

We are clearly stepping up spending in areas that we think are going to help grow the business down the road. And secondly, this currency thing is going to disappear, and that has been a significant (indiscernible) the upside in the earnings.

Any way to quantify that in the quarter in terms of the 3 cents?

I honestly (multiple speakers)

Katherine, I think that's very, very difficult to do. It's been helping us for awhile now, but we do have some natural hedges in place (multiple speakers) given the growing size and importance of our European business, it's definitely been helping us more than it has if you look back over Stryker's past history too.

That's great. That's very helpful. Thanks.

Wade King, Wells Fargo Securities.

Good afternoon folks. Congratulations on the quarter. Could I follow up, Steve, on your comment as it relates to the instruments and endoscopy businesses? Obviously those have been great performers for the Company for quite some time. Could you tell us a little bit more as relates to new product introduction plans at those areas? I know you indicated you don't expect them to grow 25, 20 percent necessarily looking ahead, but could you talk to us a bit about what you do have on the new product side that would help to support hopefully double-digit growth of the high-teens or 20 percent level going forward?

We're rolled out at the AOS meeting a whole bunch of new products that really were launched in the first half of this year, particularly in the core -- a lot of the micro instruments that are being used in a lot of minimally invasive surgery. The new 1088 camera which has got to be the best camera on the market with the high-definition. And uptake on those things has been significantly faster than probably what we predicted certainly within the first four months of selling those. Going forward we will obviously be looking at future generations, but we don't have any real products planned to launch in the second half. Those will really primarily first half launches that will carry us through. But I think the uptake has been faster than we expected. Normally we probably would have expected a smoother transition between second, third and fourth quarter.

So that certainly contributed to the domestic video business being 32 percent so strong, and possibly also the strength of domestic instrument lines?

Yes. The power tools, yes. I neglected to mention the power tools in instruments, which growing in the low 20 percent in a marketplace that's got to be probably at best mid-single-digit.

Where do think the sustainable growth rate is for you folks in those two areas, given your comment about the underlying market growth and your plans on the new product side?

Higher than the market and as high as possible, but hard to ever predict really much more than mid-teens. We've got to think about it as mid-teens growth business, which pushes us well ahead of the marketplace and when we can juice it more we certainly try to.

Very good. Thanks very much.

Bill Plovanic, First Albany.

Just to circle back to the uses of funds, you had mentioned thoughts on acquisitions. Would you entertain a dilutive acquisition? And if so, would it be 12 or 24 months? And then talking on the SG&A, it looks -- if I do the math right, Dean -- just correct me -- it looks like that settlement got you somewhere between 5.5 to $6 million benefit in the quarter, so that actually gave you a penny. Just if you could see if I am correct on that.

To answer the second question, it's a little bit less than that. But getting around close to that.

And back to would we do a dilutive acquisition, I think it depends on whether there is a compelling argument for the acquisition. It would all depend on what we thought the future would be. So we don't have a rule that says we won't do a dilutive acquisition. On the other hand, we look at (indiscernible) until we had proof or pretty compelling arguments that it was going to accretive down the road.

And then lastly, I think I'd seen something cross the tape -- not across the tape, but we had seem something where Smith & Nephew is bringing a lawsuit against in the trauma area. I was wondering if you could just expand on that a bit.

No we can't. I mean I can't. I know we've got a lawsuit, and it's over in the US --

(multiple speakers) We don't have all the details. We've got to get back to you on that.

I don't have a good answer there, but I don't think it's significant.

Smith & Nephew: Thank you.

Mark Landy, Susquehanna International Group.

Probably a question for Steve. Steve, could you maybe just kind of explain to us the P&L impact that this reorg that you are undertaking could have with respect mainly to gross margin and SG&A?

Minimal really on those fronts.

We said these are less profitable businesses. As you can see from results in the quarter, we saw a topline impact, but I think you would agree that the bottom-line is awful strong. And that's just an indication that the reorganizations we're doing here are of businesses that are not adding a lot of the bottom line right now, and hopefully as we reorganize we will change that dynamic a little bit.

Let me just make a general comment. If you were take all these businesses in the group that Steve and his guys came up with and put them on a sheet of paper, and you looked at the receivables and what we have tied up in funding those businesses and in the amount of money we're making on them, you would realize we're not making good use of our assets. Let's look at what drove us to reevaluating them are asking ourselves are these good businesses to be chasing, and the conclusion was no.

Just a couple of quick questions thereafter guys. Could you maybe just kind of give us your best guess as to where ceramic-on-ceramic will top out as a percentage of hips? And then if you could update us on the OP-1 trials really with respect to timing and where we are in those trials at the moment?

Ceramic-on-ceramic, we still think the right answer is somewhere between 32 percent and 100 percent (multiple speakers) John and I are thinking closer to 100; the guys closer to the business are a little south of there. As we get into Medicare patients and other things like that, you start to see a natural limit. We have clearly seen the (indiscernible) coming on that, so we're figuring mid-30s to high-30s in the shorter terms still hopefully. And I think it's still too early to fully figure it out. We ultimately believe this is the best product, and between us and other people coming to market long-term there should still be significant upside to that. (multiple speakers)

On the OP-1 trials, we had an un-instrumented trial on OP-1 going in United States for which we wrapped up enrollment in the late third quarter, early fourth quarter last year. That study has a two-year follow-up before we can submit a PMA application. So we're in the follow-up days right now and really don't have anything more to say about that.

We had a Phase II study going, an instrumented study, in Japan. That study enrollment wrapped up -- it was a pilot study, a very small enrollment -- that enrollment wrapped up around the same time, a little bit later -- late last year. And that study has a one year follow-up before we would go to a Phase III trial. Right now we're just kind of waiting and evaluating results in those trials.

Thanks very much guys. Good quarter.

Milton Hsu, Bear Stearns.

I have a couple of questions. First, John, Steve, you both mentioned -- talked a little bit about acquisition strategies. But is that limited to orthopedics only, or are you guys looking a little bit outside of it? Because last time -- I guess in the past we've spoken to you about it and both John and Steve you mentioned that over the longer-term you might want to expand outside of Ortho.

It would certainly still include endoscopy and minimally invasive surgery outside the orthopedic field. So it is not actually just orthopedic.

Okay, but cardiology and maybe diabetes out of the question?

I think we would have to think about that.

And the second question, also back on ceramic-on-ceramic. Dean, could you maybe give us a little bit more detail on the end-user? From the end-user perspective, are most of your surgeons using ceramic? Is it spread evenly across the board or are there a handful of surgeons using ceramic at this point?

It's somewhere between to be candid. We've have got some really high-volume users that are virtually anybody under 65, they know that's absolutely what they ought to get. And then we've got a number that are putting in a couple a months. So there's still significant upside, we think, in terms of greater penetration among our existing users. It's not like everybody's throwing them in all over.

Metric-wise, just to chime in with another question, the international distributor changes, can you just expand on that a little more, maybe talking about the impact on the customer? I assume you guys are going to be adding sales folks and maybe the implications for SG&A, if any, and why it is just a couple of quarter impact and why it's not longer process. If you could just flesh that out? Thanks a lot.

A lot of these are orders that are kind of sporadic from time to time, and we have not had a sustained presence with the customers in a lot of these countries. Plus, over there, frankly, in some countries we're not making money. We're reevaluating and looking at whether it continues to make sense, but there's also big knock-on effects through our operational efficiencies. As our unit volume has picked up in the number of plants over the last 16, 18 months, our ability to provide great service in our core countries to our core customers is affected by trying to fill some of the orders for some of these small things. Going forward again, very limited impact on the SG&A line, on the profit line. And we've got to just flush through for the four quarters where we will have no sales areas that we used to have some sales. But then going forward we will anniversary that and be through it.

Thanks very much.

Rob Faulkner, Prudential Securities.

I wonder if you could (technical difficulty) that age-old issue of pricing here. I think I heard you right that it was 3 percent in the US. Is that in reconstructive surgery or maybe you can flesh that out?

That is our US implant pricing.

And that's meaningfully lower than it was last quarter, I think. Why is that, and why at this time of year? Does it have something to do with anniversarying the major uptake of ceramic?

I think if you think about it, it is down a little bit sequentially. It's still in the range of kind of the guidance we have given you to what we expected our price increases would be for the year. We're seeing a little tightening of prices in some areas, and I think, frankly, it probably is some of our newer products where we're kind of adjusting to the marketplace. We brought out the Tobra (ph) Simplex last year, and that's moderated some of the market a little bit, and maybe a little bit on ceramic. But we will have to watch it as we go. But certainly I think if we've told you on a consistent basis that we do expect the US price increases to moderate over time as we go forward over the next several years.

Sure. And again, was there anything other that was unique about this quarter? And is there -- maybe you could talk about the dynamics and cost pressures in the hospitals and what that looks like from your angle.

I don't know that there's anything that stuck out in the quarter, per se.

Okay.

Other than what I just talked about.

But we're not seeing a major effort by hospitals to change the way they negotiate a price or anything like that?

I think hospitals are always concerned about costs, and that's true across all our businesses. So we have those discussion every day.

Sure.

We are seeing a continued tightening; nothing dramatic in this quarter. But clearly as hospitals continue to get tighter and tighter on their budgeting, we're just feeling it.

Okay, and do you think that's an industry-wide phenomenon, or do you think some of the adjustments you talk about were unique to you?

We think it's a little more industry-wide.

Good. Thank you.

(OPERATOR INSTRUCTIONS) Mark Mullikin, Piper Jaffray.

On the direct to consumer front, I actually recently saw a television commercial featuring Jack Nicholas, and I was just wondering what the latest plans are, how broadly you anticipate a campaign like that and if we can expect more in the future?

Glad you saw the campaign. To be quite honest, we came out pretty heavily with that campaign in the fourth quarter of last year. We also figured there was probably a two four-month lag affect in the results of that campaign because as you know it's not like direct to patient where somebody just walks out either buys a product or gets a prescription for a product and goes to his drugstore. In this case you are setting up an appointment to see a physician to get a surgery scheduled.

We then wanted to see how that really played out, and we sat largely tight through the first quarter and really until about mid-June without running the TV campaign. As we evaluated and analyzed it, we think there was a little more pop there and have just gone back onto television with it. And are planning on boosting our spending in the third quarter on that and see. We're still learning in this area, but we clearly think it has an impact and want to see where it goes.

Is that a national campaign or are these being done in pilot markets? Or what's the current status?

It's very -- there's some heavy ups in certain geographies, and then there's a national overlay -- a targeted national overlay in terms of news programs and some of that stuff.

Do you anticipate the financial impact being noticeable or is it still relatively limited?

Still relatively limited. We would say it has a very, very modest impact on the SG&A line.

Okay, thank you.

Michael Lachman, ThinkEquity Partners.

Just one more thing on pricing, turning to Japan. Can you talk about both the magnitude and the timing of the price changes? When did this latest round of price changes come into play, and what's the outlook in terms of whether or not there's more to come on that front?

Japan traditionally -- and they were right on schedule -- does a price modification every two years. Some of this is the biannual price reduction that we got. It took back effect on April 1st of this year as expected, and it was about 5 percent. And we would expect that to carry on through. And they take another look in a couple of years. This was across a good part of our products. There's a couple other products that they could review on a different cycle, but this is the majority of our products that they looked it in this cycle.

One more question on the reorganizations that are taking place outside the US. Are these markets that you're planning to exit permanently or are their plans either direct or through new distributors to readdress some or all of these markets?

And it's a bit of both. You should not expect to see a lot of direct activity put into these.

But we will certainly modify the terms with which we accept orders -- payments and discounting, that sort of thing.

Thanks a lot.

Steven Lichtman, Banc of America.

Could you give us a sense of the impact of the transition to the modular hip on the US hip business, either quantitatively or qualitatively?

It probably cost us a couple of percentage points of growth. We look at our revision (ph) business was down reasonably significantly in the quarter, and this is one where out US business kind of took one for the team. We historically have been launching things first in the US, and then starting our Europeans. You may recall our European hip business was in pretty rough shape for the last few quarters. So we wanted to kind of get them back on track, and think we successful achieved that. But the US took one for the team. So they're getting that out now.

So you anticipate that reversing somewhat in the back half as that rolls out?

We certainly hope so.

Secondly, on R&D spend you talked about perhaps seeing an increase in the back half of the year. Maybe for Steve, given that's an area I know you have been focused on, can you give us some broad areas in terms of where you think the focus will be in terms of an investment from an R&D perspective?

I will tell you it's pretty consistent across most of the divisions. What we've really been doing is seeking out within the divisions and try to challenge them to look for more ideas. And some of this may feed into some of the acquisition stuff as well. There may be some technologies, some product ideas, some emerging technologies that we may be looking to acquire as well with some of the various businesses. So you'll see it across the board.

Thanks guys.

Scott Summer (ph), Edward Jones.

I just have two quick questions. I noticed, first, that you didn't mention anything on the call about the launch of Triathlon, the new product. I guess given that Scorpio has done so well I don't know if you guys are trying to get a little bit more out of the product line first or if there is a plan for sort of a targeted rollout in the third or fourth quarter. Just an update on that. As well as I think -- even if Bank of America already asked this question, but just on hips, I was wondering if you sort of see this quarter in the US as sort of a low mark and sort of seeing that trending towards the back half of the year.

Good question. Triathlon, we're trying some things with Triathlon in terms of development of this product that we haven't really done before. We want a make sure we've got it totally right before we roll it out. We're probably still another quarter or so away. We probably thought we were a little closer at the start of the year. I would also tell you that this is one that some of the capacity in our plants that has pushed back some of the qualifications for. So we're a little slower, but that is (indiscernible) Scorpio and Duracon right now. We will continue to focus on those in the short-term while we optimize Triathlon and build inventory to have a good, high-profile launch.

If I could just make one comment there. I think the better way to think about it is we shouldn't expect to see much impact from Triathlon until certainly the fourth quarter, and probably the first part of next year.

It will really be more in '05.

On the hip business, to get to your second question, we would hope to be able to start a re-boost the hit business growth number coming out this quarter. We are good to go out (ph) and get some tougher comps, but our job is to strengthen that.

Thank you.

Larry Keusch, Goldman Sachs.

First, Dean, I just want to make sure that I understand your hedging. And I know you talked about the natural hedges, but can you remind us again if you are doing any hedging of translation or transaction, and then how much you may be hedged at this point? And the other question, perhaps for John or Steve, you mentioned in the call that sales of the inter-body cages were down in the quarter, so I was curious what might be behind that. And lastly, just any insight you may have on your thoughts on artificial disk technology.

On hedging, the only hedging that we are presently engaged in -- and this is generally too; we have not done a lot of other hedging -- is when we have a nonfunctional currency that goes on the balance sheet -- in other words, if a plant of ours or a distributor of ours -- and intercompany distributor would be the best way to say it -- buys product from a he US plant and is required to pay US dollars, when that US dollar currency goes on that balance sheet, which is denominated in a different currency we hedge that payable at that point in time. And that is really -- receivables and payables of a nonfunctional currency nature are the only things that we are hedging right now. So that is designed really to control that line on our P&L -- or the transaction gains and losses. Obviously we can't do that 100 percent. That's only thing we're hedging really. The natural hedges that I referred to is just really based on the fact that we are manufacturing. We have European manufacturing plants to supply Europe. And that is providing a natural hedge, if you will.

So really, most things outside of Europe you're getting an impact to the bottom-line then it sounds like. Is that fair?

Fair enough, yes.

Okay. And the other questions?

On the inter-body cages we're clearly seeing a shift from cages to a lot of the spacers that is clearly happening in the marketplace. I'd say we -- our SDI acquisition -- we got the cages; they are under-performing relative to what we would have hoped. The rest of the product line is actually significantly over-performing what we would have imagined. So if we go back to look at our model, the total SDI acquisition is paying off -- it's coming in different ways than what we initially anticipate.

on artificial disks, I saw you just issued a 63 or 64 page write-up on that. And there's clearly a lot of movement -- haven't read it in detail yet, but clearly a lot of movement. The big three guys are there. We're continuing to talk to clinicians, look at that space and assess it. But it does look increasingly like there's going to be a real future on artificial disks obviously.

In other words you guys might have an interest there?

We're certainly paying close attention.

Thanks very much.

Jason Wittes, Leerink Swann.

I know we've covered this question from many angles, but I just wanted one last attempt at clarification. On ceramic hips, that's probably the one area where we've heard physicians complain that the hospital administrators are balking at the price. Are you saying that the price reduction you saw in the US was pretty much across the board or can we still assume that maybe a little more of it was related to ceramics?

I'd say it's more on ceramics.

Yes, that is a fair assumption.

That is a fair assumption. The other question I had -- and this one is to you, John. I know you have sort of given yourself different sort of milestones in terms of what your relationship to the Company is going to be at the end of each year. And I guess the question would be how should we thinking about your position as a company next year?

I should tell you that I was fortunate to get reappointed at the annual meeting back and April, so that was good.

Congratulations.

And there is a lot of doubt about that, let me tell you.

My plans are to go be a non-executive Chairman in next year, and so I would expect to give up the CEO title at the end of the year.

And this year? Okay. Thank you.

That would be my plan. (multiple speakers)

Lynn Pieper, Thomas Weisel Partners.

I just have one quick follow-up. I think if I heard correctly you started reorganizing some of the under-performing distributors early in the June quarter. As you move forward through this process should we expect a greater negative impact before we start to see improvement, or should we be thinking about it more as a gradual improvement over the next several quarters? Or what should we be thinking about going forward?

It shouldn't get worse over the next few quarters. We have started to see the biggest impact in this quarter and then a gradual -- still a gradual phasing over the next three.

Perfect. Just so I understood correctly, this clearly had a disproportionate effect in trauma and spine. Did this affect the large joint franchises at all?

Yes it did as well.

Perfect. Thank you.

(OPERATOR INSTRUCTIONS) Joanne Wuensch, Harris Nesbitt Gerrard.

I don't want to start playing the game of animal, vegetable or mineral, but in regards to an acquisition, would you think about a drug or some type of a pharmaceutical play?

Probably not.

Okay. One other question. Given your gold standard times two type of EPS performance this quarter, it makes for tough comps into 2005. Does that put you in a position to fall below the 20 percent growth rate?

Over my dead body.

Thank you very much.

Mr. Brown, there are no further questions at this time. I will turn the call back to you. Please continue the presentation or closing remarks.

Thank you, George. You did a good job for us. We appreciate it. And thank you everybody. We got more Q&A this time than we normally do, but we appreciate that. And we would tell you that Stryker's future looks good. We appreciate your interest. Our next quarterly call -- conference call will be the third quarter on Thursday, October 14th. Thursday, October 14th for the third quarter. And again, thank you for your interest. I hope everybody has a nice evening. Thank you.

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