史賽克 (SYK) 2005 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Stryker second quarter 2005 operating results conference call. [OPERATOR INSTRUCTIONS.]

Certain statements made in today's conference call may constitute forward-looking statements. They are based upon management current expectations and 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 this conference call -- 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; unanticipated issues arising in connection with clinical studies and eventual United States Food and Drug Administration approval of OP-1, the Flexicore and Cervicore spinal implant products or other new product introductions; changes in reimbursement levels from third-party payers; 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 and other factors are contained in the Company's filings with the Securities and Exchange Commission, including the Company's annual report on Form 10-K and quarterly reports on Form 10-Q. As a reminder, this conference is being recorded Tuesday, July 19th, 2005.

And now I would like to turn the conference over to Stephen MacMillan, President and Chief Executive Officer. Please go ahead, sir.

Thank you, Myra. And good afternoon, everyone. Welcome to Stryker's 2005 second quarter earnings report. With me today is Dean Bergy, our Vice President and Chief Financial Officer.

We're pleased to report another very good quarter. Net sales for the second quarter were 1,219,000,000, an increase of 16.8% over the prior year, and up 15.1% operationally. Net earnings increased 21%, to $184 million. And diluted net earnings per share increased 22%, to $0.45. At this point, we would also remind everyone that this earnings increase is on top of a very difficult top -- last year's very strong 42% earnings growth in Q2. We generated $187 million in cash flow from operations in the quarter, bringing the first half total to $219 million. And as you know, our cash flow is typically much stronger in the second half. The second quarter saw significant strengthening across a number of our franchises and geographies, and our operational growth rate is our best in the last five quarters, though we did benefit from one extra day in the quarter.

Our MedSurg businesses continued their exceptional performances, with sales of 427 million, up 22% in the quarter. Incoming order trends for MedSurg continue to be very good. Orthopaedic Implant sales were $725 million in the quarter, an increase of 15%. On an operational basis, Orthopaedic Implant sales growth was 13%, 2 points faster than first quarter. Our international businesses continue to do very well, with Europe, Japan, Pacific, and Latin America all generating double-digit operational growth. Specifically, on a year-to-date basis, each of the five major European countries and all areas in our Pacific region have generated double-digit operational growth.

Our strength is clearly not built on just one or two countries, but throughout the regions. In fact, Pacific was up 20%, operationally, in the quarter; Europe, a strong 16%; and Japan reached 10%. In total, our international businesses were up a strong 14%, operationally, and 19% as reported in the quarter, a strong compliment to 16% growth domestically.

Now for a quick run-through of our various franchises. Our global hip growth rates of 5%, operational, and 8%, reported growth, were consistent with last quarter, as nice accelerations in international growth offset continued softness in our U.S. hip business. Specifically, Japan, Pacific, Canada, and Latin America all showed nice increases, with the latter three posting double-digit hip growth in the quarter. Our European hip business continues to do very well, posting just short of 10% growth in the quarter and in double digits in the first half. U.S. growth of 2% was our key disappointment for the quarter as launch delays of new products and declines in the hip fracture business offset nice double-digit revision growth in the Restoration Modular System, which continued its roll out in the quarter.

Looking forward, we are much more confident in a third quarter uptick behind the start of a new product cycle. Restoration Modular finished the quarter with strong momentum. The Secur-Fit Max Stem began shipping in late June. And our new X3 Poly (ph) which is actually showing wear characteristics comparable to metal-on-metal is now shipping. We will also be launching additional sizes to our popular Accolade line in August, thus laying the groundwork for renewed growth in our U.S. hip line, all while our hip business outside the U.S. is performing very well.

Driven by positive responses to our new Triathlon Knee, global knee growth accelerated by a couple of points, as every region of the world posted double-digit growth and every key region accelerated versus last quarter. Global operational growth was 14%, and 16%, reported, with the U.S. up 15%, as we began the Triathlon roll out in earnest during the quarter. We feel good about the direction of our knee franchise during a time when the knee market appears to be picking up momentum.

In trauma, we also saw across-the-board strengthening, as every key region grew at least 15%. Japan and Pacific each topped 20%, leading to global operational and reported growth rates of 19% and 21%, respectively. Our U.S., business benefiting from last year's reorganization, continues to pick up steam, growing a healthy 19%, up from 15% last quarter.

Likewise, our spine business continues to strengthen, posting its fifth straight quarter of 20% or better growth in the U.S. International sales rebounded sharply from a first quarter decline to also exceed 20%, leading to global operational growth of 20%, or 22% as reported. Consistent with its overall exceptional performance, Europe led the way with growth over 20%, while Japan exceeded 15%. We continue to feel very good about the direction of our spine and trauma businesses, both of which posted their fastest growth rates in the last eight quarters, and are encouraged by growth in all regions around the world. Both of these businesses have now reached a scale to be meaningful contributors to our total business, and we are particularly pleased that the growth rates are accelerating.

Leibinger also posted another double-digit quarter globally, up 12%, operationally, and 15%, as reported. Europe, Pacific, Latin America, and Canada all reached 20%, while Japan was flat, and the U.S. was up 7%. OP-1 continues to be well received by the surgeon community, though sales remain limited due to the restrictions imposed by selling under the Humanitarian Device Exemptions in the U.S.

Moving to our MedSurg businesses, our instruments business continues to grow nicely, up 18%, operationally, and 19% in the quarter as reported. U.S. sales were up a solid 17%. And international markets grew 18%, operationally. With the exception of Japan, which posted single-digit growth, all regions posted at least 15% growth, driven both by continued growth in power tools as well as operating room equipment. Endoscopy continues to outperform, with global sales for the quarter up 26%, operationally. The U.S. posted yet another 20%-plus quarter, up 24%. Encouragingly, we are seeing this franchise, which has been significantly underdeveloped globally begin to show real traction outside the U.S., as Europe, Pacific, and Canada all posted growth in excess of 40%.

Medical also continues its exceptional run, up 21% globally in the quarter, and at 30% in the U.S. for a second straight quarter. This business continues to significantly outperform expectations.

Finally, our service business, Physiotherapy, grew 6% in the quarter, with same-store sales growth remaining flat. As you've likely picked up from these results, we are pleased with the breadth and depth of our results in the quarter. Overall, we are outgrowing the market in most franchises and in most geographies. And where we are not, we have plans in place to accelerate our growth.

To summarize, we feel great about our trauma, spine, knee, instruments, medical, endoscopy, and biotech franchises on a global basis. We feel great about hips outside the U.S. and are improving hips in the U.S. Our international divisions are performing probably as well as or better than they ever have. These results are deep and broad, and this strength is reflected in our overall P&L.

While Dean will provide more specifics in just a moment, I would like to summarize the P&L. Both our gross and operating margins are up versus last year, and the asset management is strong. Importantly, we are using the strength of our businesses today to also increase our investment in the future, with first half R&D up over 26% versus last year, as each of the divisions have boosted their new product activities.

I will now turn it over to Dean Bergy for more details.

Thank you, Steve. I'd like to start with talking about foreign currency impact in the quarter. As you can see, foreign currency comparisons were again favorable in the second quarter, increasing sales by $18 million. If currency rates hold at current levels, we expect the impact of currency on third quarter 2005 sales to be about neutral. The impact on fourth quarter of 2005 sales would be negative by around 15 to $20 million.

Now turning to the price volume analysis as a percentage of sales. In the quarter, price added about 2 points of growth, foreign currency added about 2 points of growth, acquisitions added 1 point of growth, and volume and mix was up 12%, for 17% total growth. Summarizing price, U.S. implant prices were up approximately 2% in both the second quarter and the first half. Prices in Japan were down slightly in the quarter, while prices in Europe were up slightly. For the first half volume and mix was up about 13% in the U.S. and 11% overseas.

Now turning to our product line categories, Orthopaedic Implants, I'll remind you, represents about sixteen -- 60% of our sales. Sales of Orthopaedic Implants increased 15% in the second quarter and 14% in the first -- for the first half, as reported, and 13% and 12%, respectively, on a constant currency basis. If you look at the sales growth rates for Orthopaedic Implants by product line, I'll give you the breakdowns here for the second quarter. Hips, domestically, were up 2%; internationally, up 14%, for total growth of 8%. Knees were up 15%, domestically; 19% in the international markets; and 16% in total. Trauma, up 19, domestic; 22, international; and 21 in total. Spine, up 21, domestic; up 24 international; up 22 in total. Leibinger, up 7, domestic; 23, international; 15 in total. And in total, Orthopaedic Implants, up 12, domestic; 18, international; and 15 in total.

Now turning to constant currency or operational growth, I'll give you the international and total numbers for each of the franchises within implants. Hips, up 9%, international on a constant currency basis; 5 in total. Knees, up 14, international; and 14 in total. Trauma, 19, international; 19 in total. Spine, 19, international; 20 in total. Leibinger, 18, international; and 12 total. Then, for the total Orthopaedic Implants, a business grouping up 13, international; and 13 in total.

Now turning to the individual categories. Hips were up 8% in the second quarter and year-to-date. Hip sales growth for the quarter matched the first quarter, as stronger international results offset the softer performance in the U.S. Growth in sales of our Trident Ceramic-on-Ceramic Hip Systems slowed in the United States. And ceramic insert sales penetration levels stayed relatively steady. Our Accolade cementless product continued to lead U.S. hip sales growth. And we, again, saw a nice boost in Revision hips as we continued to roll out of our new Restoration Modular System. However, a decline in U.S. sales of hip fracture products offset a portion of these gains.

In Europe, hips achieved high-single-digit constant currency growth, led by strong gains in Trident products, and very solid growth from Exeter. In Japan, local currency hip revenues grew at mid-single digits as we anniversaried the MHLW price reductions. Growth was led by our centpillar stem, which is designed specifically for the Japanese market. The Pacific division posted double-digit operational hip growth, led by our Trident and Exeter product line.

Now turning to knees, they were up 16% in the quarter, and they're 15% year to date. Knee growth was solid in the quarter, in the United States our primary and revision businesses both achieved mid-teens growth. Our recently-introduced Triathlon Knee is gaining excellent early acceptance, and contributed substantially all of the growth in primary knees. We are continuing to roll out posterior-stabilized sets to meet the demands for Triathlon.

European knee sales grew at low double digits in constant currency, led by Scorpio. In Japan, sales of our Japanese-market-dedicated Scorpio NRG product helped the division to generate double-digit operational growth. Pacific knee growth was over 20% in local currency, also paced by our high-flexion Scorpio Knee.

Trauma products were up 21% in the second quarter and year-to-date as well. Our U.S. trauma business grew 19% in the quarter, 20% if military sales are excluded. U.S. growth was led by excellent results in hip fracture devices, intramedullary nails, and internal fixation. Our Gamma3 and T2 product lines continue their excellent performance. International trauma sales were also very strong in the quarter, with substantially all geographies and all product categories contributing to the results.

Spine was up 22% in the quarter, and is up 17% year to date. Spine posted another 20% growth quarter in the United States. This growth was led by cervical products, including the OASYS Posterior Cervical System and the Reflex Hybrid Anterior Cervical Plate, both of which were recently launched. Interbody devices were also extremely strong in the U.S. as our AVS PL Spacer continues to be well accepted. Sales of thoracolumbar products were solid in the quarter.

International spine sales rebounded nicely from a very soft first quarter, with every product category producing good growth. Performance was excellent across most geographies, with the strongest growth in Europe and Japan.

Now turning to Leibinger. They were up 15% in the quarter. They were up 14% year-to-date. They had another good quarter, posting double-digit sales growth for a seventh consecutive quarter. International sales were stronger this quarter and product line sales were led by our hand and neuro categories.

Now turning to our MedSurg group. I'll remind you it's comprised of three significant product categories. Our instruments group makes up 43% of those sales, and MedSurg -- MedSurg is 35% of our total sales. Endoscopy is 35% of those sales. And medical is the other 22% of the MedSurg group sales. MedSurg group sales were up 22% for the quarter and 23% for the half on a reported basis, and 21 and 22%, respectively, on a constant currency basis. Sales of our instruments product line increased 19% for both the quarter and the half, as reported, and 18% for both periods on a constant currency basis. In the quarter, domestic sales were up 17%, international sales were up 24%, for that 19% recorded gain.

The instruments business had a great quarter with very good growth in powered instrument systems and excellent growth in other OR equipment. Instruments generated another quarter of strong sales growth in the U.S., and constant currency sales internationally, et cetera, accelerated to post 18% growth. Our System 5 Heavy Duty Power Systems had excellent sales growth for the quarter. And Micro Power tool sales were solid. Growth in other OR equipment was led by navigation products, interventional pain, the Neptune Operating Group's room waste management system, and Sterishield.

Turning to our endoscopy business. They had a great quarter, up 27% in the quarter and 29% for the half, as reported, and 26% for the quarter and 28% for the half on an operational constant currency basis. Domestic growth was 24% in the quarter, international growth was 41%, for that total 27% growth. Endoscopy posted another quarter of 20% or more sales growth, with reported growth exceeding the 20% benchmark in every product category. Endoscopy's quarterly growth was led by video sales, which were boosted by the first quarter eTrauma acquisition and continued strong sales of the 1088 High Definition Camera. General surgery product sales were strong across the board, and arthroscopy products sold better internationally, but were very solid in the U.S., where they reached the mid-teens mark.

Last in the MedSurg group, our medical business was up 21% in the second quarter, and 22% for the half, as reported, and twenty-four -- 20% for both periods on a constant currency basis. Domestic was up 30, international was down 3 for the 22% growth in the quarter. The medical division had another 20% or better growth quarter. U.S. sales surpassed 20% growth for a fourth consecutive quarter. As expected, international sales growth was again depressed by difficult comparables in Canada. Bed shipments were extremely strong in the quarter. EMS sales were very solid. And stretcher sales were very good domestically, but lagged a bit in total, as a result of the international slowdown.

And in physiotherapy, which represents 5% of our total sales, recorded 6% growth in the quarter, bringing first half revenue growth in at 7%. And as Steve indicated, start-ups and acquisitions generated all of physiotherapy's growth this year. Physiotherapy ended the quarter with 472 centers.

Now turning to the rest of the P&L, gross profit margins in the quarter were up sequentially, to 65.4%, and as compared to last year. Sequentially, 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 manufacturing plants at a fast pace. Compared to 2004, we benefited slightly from improved pricing, offset somewhat by the mix shift in MedSurg.

R&D spending, as you saw, ran at 5.4% of sales in the quarter. R&D spending is up 26% for the half, as we continue to put increased focus on our development efforts, including added year-over-year spending for the development of our acquired SpineCore products. SG&A costs were up 15% in the quarter and 12% for the half, with sales commissions driving a significant portion of the increase. Instrument amortization costs associated with new product roll outs were also higher in the quarter. These increases were partially offset by lower meeting costs (ph). In addition, compensation costs and insurance premiums are growing slower than sales, contributing to the client and SG&A costs as a percentage of sales, which you saw finished at 37.5% of sales in the quarter. Total operating income increased 19% in the quarter and 23% for the first half, and our operating margins are up nicely from last year.

And finally, turning to the breakdown of our other expense for the quarter, I'll give you the breakdown. Interest expense in the quarter was $1.9 million. Interest income was $2.1 million. We had an FX, or foreign currency, transaction loss of $300,000 in the quarter, and minority interest was $100,000, contributing to that total of $200,000 of other expense. Reported effective income tax rate for the second quarter and the first half was 29.5%, compares to a 2004 annual underlying tax rate, if the SpineCore purchased in-process research and development is excluded, in consideration of 30.0%.

The Company continues to analyze whether we should repatriate foreign earnings to the United States under the provisions of the American Jobs Creation Act of 2004. Based on our current analysis, we could repatriate up to $775 million, for an estimated income tax cost of about $38 million. This cost would result in a charge to net earnings if we were to decide to bring back these earnings, of which no previous income tax expense has been recorded. As a reminder, we have until the end of 2005 to make this determination.

Now turning briefly to the balance sheet, you can see, I think, that's in very good shape. Accounts receivable days reached a new record low of 55 days, five days below the prior year, and two days below the prior quarter. Inventory days snuck up a little bit in the quarter. They finished on 124 days, but that was also a five-day decline from the prior year. At June 30, we have no amounts outstanding under our credit facility. We have about $9 million in remaining legacy debt, which we expect to pay off as it matures..

As you know, we meet with the rating agencies annually, and Moody's upgraded our rating to 83 with a stable outlook just today. This follows a first quarter upgrade by Standard & Poor's to A with a positive outlook.

And then last, but certainly not least, cash flow. We had very good operating cash flow in the quarter and the first half. Operating cash flow for the half finished at $219 million. This year, we're making large investments in loaner instruments. Some of these in ERP systems. We've also seen higher cash usage for accounts payable and heavier tax payments so far this year.

And with those comments, I'd turn it back over to Steve.

Thanks, Dean. Now we'll update our 2005 outlook. We had a very good first half. We continue to believe we're in a good industry and that our overall geographic and products depth within orthopaedics positions us for continued strong growth, even in a changing environment.

Even with the strengthening dollar, the underlying strength of our businesses has us still planning for mid-double-digit top-line growth for all of 2005, which translates to sales of approximately $4.9 billion, or reported growth in the range of 14 to 15%. Second quarter net earnings of $0.45 per diluted share were exactly in line with our internal projections. As a result, we are maintaining our 2005 net earnings guidance at $1.75 per diluted share, with per-share earnings before charges expected to be up at least 20% in each of the last two quarters. Our annual earnings guidance represents a 22% increase on 2004 adjusted net earnings. On a reported basis, this EPS objective will be up a projected 54% from 2004. Now we'll open it up for questions and answers.

Thank you. [OPERATOR INSTRUCTIONS.] Our first question comes from the line of Milton Hsu from Bear, Stearns. Please proceed with your question.

Hi. Good afternoon, guys.

Afternoon, Milton.

First, Steve, just two questions. First, can you just give us an update on any changes in the sales force made since Mike assumed his position in Ortho? Have any of the benefits been realized? And should we expect to see a continuing improvement in the selling effort as we head through this year and into next?

Sure. You should absolutely expect some improvements in that organization. Mike is dug in and making some sales management changes as well as ultimately down to the rep level. And I would tell you to categorize it, I think some of us, we got a little complacent by being the leading hip company in the U.S. And Mike is shaking up that complacency. That's going to take a little bit of time, Milton. As you know, you don't turn that battleship overnight. But we feel very, very good. I can tell you I was down at a sales meeting that that division had this weekend. And I feel as good about that division and where they're headed now as any time since I've been with the Company. Taking a little bit of energy, but it's going to be in the right way.

Okay. And the second question is a macro question. It seems like everyone's been focused on pricing recently, but could the ability to drive a favorable mix shift be a larger issue over the next few years? I know, I understand the industry continues to launch new, premium-priced, innovative devices. But at what point do we reach the point of diminishing marginal returns on these newer technologies? And do you really anticipate that to be part of the drive going forward? Thanks.

Sure. It's a great question. Because I think there has been so much focus on price. And as you appropriately point out, mix probably is going to be as big of an issue. We think there's still significant opportunities for improvement. But, obviously, need to be mindful of our customer's pricing pressures as we come out with new products. But I'd give you an example, where what we're trying to do is increasingly come out with newer technologies that can bring a benefit to the patients and a benefit to the system, but not necessarily cost more money. If you look at something like our X3 Poly, which clearly is going to be a price premium relative to our current generation of Poly, when we look at the wear rates, we, frankly, think there's a pretty good story that even a metal-on-poly or a ceramic-on-poly hip can be cheaper for the hospital to put in and probably have equal, if not better, wear rates than more premium-priced products like metal-on-metal. So that's the direction we're trying to go so we can work with the hospitals to come out with better products, but try to offset other costs in the system.

Okay, great. Thanks a lot.

Sure. Thank you, Milton.

Thank you. Our next question comes from the line of Mike Weinstein from JP Morgan. Please proceed with your question.

Hi there, it's Taylor Harris here. I've got one question, and I think Mike's going to follow up. So just on the hip business, can you give us a sense -- well, first of all, of the hip fracture portion of the business, you've had some tough comps there. When do we start getting through that? Is that in the back half of the year? And how much has that been dragging down the overall hip business?

It -- I think in the fourth quarter, that starts to go down a little. We're pretty solid on it for a little while. Dean, can you -- ?

Yes. I think so. I mean, Taylor, frankly, this -- I would say we think this is part of, kind of, the analysis of the sales force. This is a little bit tougher sell because in many respects, hip fracture are really like a trauma sale. And so it's not a scheduled procedure. So part of what we look at as we reinvigorate the sales force's methodologies, whereby we attack that part of the business a little bit differently, maybe. And we think that will -- that will have an impact because, frankly, we think we've got good products there. So I think it's part of how we look at it, evaluate, and work through and drive a little bit better sales force performance.

Taylor, we're also seeing -- the offset to that, and we don't lump them together, we would tell you that our Gamma hip nail business, within our trauma business is doing exceptionally well. And if we lumped that into our hip franchise numbers, we could make them look significantly better because that business is going really well. But we keep that segmented out as trauma. A little bit like we even had in Japan going on about a year ago, where some of the hip business was being hurt, and yet we were seeing a shift to trauma business. We see some real positives on the trauma side of the hip business going on, even in the U.S. right now.

Great. Okay. And then just a couple other questions on the hip business. Can you give us the ceramic portion of the U.S. franchise? And with DePuy on the market now, how are you feeling about overall the competitive landscape in ceramic? And then, just any more comments around the launch of X3 would be great. Thanks.

Sure. The penetration of ceramics has really plateaued in the mid-30s. And we are certainly seeing a little bit of competition out there. I think it's more we're seeing some modest growth in our ceramic business. We would still categorize that one. That one took off a lot faster than we imagined, and it's probably slowed a little bit faster than we would have expected because of that. We continue to feel good about it.

And regarding X3, I would tell you, I think we're very excited about X3. When you look at, we've consistently been out in front on a lot of the alternative bearings, between coming out with a Highly Crosslinked poly, and now taking it to another generation. Our X3 poly essentially reduces wear by 97% off of first-generation polys, and is still about, probably, 70% less wear than Highly Crosslinked polys. So we think we've got a real, real strong story here. And the initial surgeon acceptance looks very good. We've just started shipping that. We see that as being something that, frankly, our sales force is very excited to have in their bag going into the second half.

Hi, Steve, it's Mike.

Mike.

Hi, there. Good quarter, by the way. Let me just ask you a couple broader questions. I look at this quarter, and your growing top line mid-teens or better across, really, almost all your businesses. You are generating great cash flow. Your -- actually, your balance sheet ratios are improving. And you're growing R&D 30% year-over-year. I guess question one is, could you give us a little more insight into where you're spending the incremental R&D? Because, clearly, you're trying to build out some of these platforms and these R&D opportunities for the longer run, otherwise you'd be showing even more in earnings right now. Two, with seemingly the businesses all running so well right now, where are you spending your time, if not tactically, where are you spending it strategically? Thanks.

Great questions, Mike. I would say on the R&D front, we are continuing to invest in a lot of what I call the blocking and tackling -- the line extensions, particularly in our MedSurg businesses, just keeping the ongoing product flow of new power tools, new video cameras, all of that stuff, and the same, frankly, in our other implant side. Then what I would say is we're investing increasingly in expanding new platforms. If you look at spine, we were largely a thoracolumbar business just two years ago. Now we've got a much better cervical offering, a much better interbody offering, and we have the artificial disc on the horizon, also some work in dynamic stabilization. So we're investing in more and more bets that are also slightly longer term. OP-1 continues to eat up some of our moneys, but even franchises like trauma, I can tell you, we're looking at some technologies that are more significant improvements than what we've done historically. And, therefore, requiring a little more investment now, and won't hit in necessarily the usual, say, 12-month time frame, but might hit more in the '07-'08 time period. So I think that's why we're very excited about continuing the future.

Is that -- ?

The second part -- oh, go ahead.

Is that a little more, I guess, invention rather than just, kind of, iteration innovation? Is that more -- you're spending more than the Company was previously on longer-term bets, longer-term opportunities. Is that accurate?

Yes, is it is. I think what we're -- what's also happened is we gained a lot more strength in spine and trauma. And even, frankly, with our growing knee business, we're getting more and more ideas probably coming our way that, maybe, some external ideas either from surgeons or from other smaller folks out working on things that we're probably placing a few more bets. And they might not all come to fruition, but we're feeling better and better about what they could do for us in the future. That answer that part of it?

Absolutely. Go ahead.

Okay. Great. And then I think your second question about what are our concerns and where spending time right now?

Sure.

That was the question? Okay. I would say, when you look at our business, we're probably firing about 9.5 out of 10 cylinders, or 9 out of 10. The U.S. hips still troubles us a little bit. But I would say on this call, at this point in time, as Mike's -- Mike Mogul, our new head of the U.S. business -- he's getting the operational side under control, so we're getting the products launched now that should have been out in late first, early second quarter. He's getting the sales force engaged at a higher level, and that's still the area we're spending some time on, but feel very good about where that is headed.

Now that's still going to be a sequential uptick. It's not going to just quadruple overnight. But as we look at each quarter going forward, there's no doubt in my mind that those numbers will get better. Strategically, it's continuing to build out, the broader platforms that we have. The very broad spine, obviously, with OP-1, we should be gearing up for the PMA submission early next year. And that could be a huge event for us in '07, and then the discs in '08. So it's figuring out where these next platforms are and continuing to grow out the line, so that we can deal with any potential price pressures in any one segment of our business in any one key geography, call it the U.S. or whatever. Thank you. Anything else, Mike? Okay.

Thank you. Our next question comes from the line of Bill Plovanic from First Albany. Please proceed with your question.

Great, thank you. Good evening.

Hi, Bill.

Hi, Bill.

Just a couple questions. First on the Crosslinked poly, you mentioned that it is a higher ASP. I was wondering if you could just give us an idea on the amount of that increase in pricing for the X3? And then, secondly, any plans on bringing out that Crosslinked poly in the knee? Have you developed anything that's applicable to that? And then a couple more follow-ups.

Okay, sure. I'll let Dean --

Yes, on the pricing, I think, Bill, it's still very early. Suffice it to say, it will be a premium, but we want to evaluate the marketplace as we go a little bit here. So I'd prefer not to give you a concrete on that -- answer on that right now. And on knee, we're looking at that.

Okay. But nothing imminent?

We're developing it. And we do think it'll be a great product in knees, and may be able to really do something there. So you can expect that we're certainly working on it.

You know what? I think you'll hear something sooner rather than later is probably a fair way to characterize it.

Okay. And then on the R&D, just to jump on Mike's question. You're spending a little more on some longer-term projects. Should we expect that the R&D spending may be a little higher than that 5% number you've kind of given in the past?

Well, we're at 5.4% right now. And I -- I think it will, at least, probably, for the rest of the year, tend to be in that range or a little higher. I think that's fair.

Okay. Great. Thank you, very much.

Thank you. Our next question comes from the line of Ben Andrew from William Blair. Please proceed with your question.

Good afternoon. Just wanted to talk a little bit about some of the potential contract arrangements that customers have been looking for, and if you can give us any comments if you've seen any changes in compliance in some of those larger contracts yet?

Great question, Ben. There's, obviously, been a lot of pressure out there. I would tell you as we've entered into a few of these, we're probably not blown away by the level of compliance. And I think it's still proving more difficult for some of the hospitals to really effect some of the changes. So there's been the talk, we're waiting and seeing in terms of whether the compliance really comes through.

And to the extent that that compliance does not come through, does that have meaningful implications for your overall price with, again, those types of arrangements?

No, probably not dramatically. I mean, I think the way we're positioned is, we can go either way. If the contracts stick, our pricing's probably a little lower, but we make it up in volume. And if they can't deliver, our pricing bumps back up a bit. And if -- but, again, it's just U.S., primarily, so it's not going to have a huge effect globally.

All right. And Dean, I think you talked about 2% global price in Q2 and for the first half. Are you comfortable with that sort of level as we finish out the year?

I think, generally, as Steve said, we're looking to really, probably, have price increases in the inflationary level. Now, we always have an inflection point, usually between the third and the fourth quarter where, generally, pricing flows pretty steadily through the first three quarters, and as we start to negotiate contracts, we see -- get our first indication as we go to the fourth quarter of what the coming year will look like. So we'll know more then. But I think, generally, we feel comfortable in the -- what had kind of said was a 1 to 3% range at the outset of the year, and that seems to be holding.

Okay. And just switching over to knees real briefly. I mean, you talked about the, kind of, evolving launch of the Triathlon. Would you say you're, kind of, at full speed now? Are you fully rolled out yet, or should we see, potentially, further acceleration on the knee side as you get the Triathlon out in different versions?

I would say we are at full speed in the roll out, but the roll out is not complete. The original roll out was probably geared more to be over a 12-month period. Mike Mogul and his team have clearly accelerated that, and up to the number of sets that we were getting out in both April, May, June, above what the original plan had been. But that original plan continued to call for roll outs through the end of December. What he's trying to do is pull a little more of that forward and continue to roll that very aggressively over the next three to four months, in terms of getting the full number of sets out there by September-October. So we, clearly, see it affecting third quarter, but also continuing into fourth as well as beyond.

Okay, great.

We think there's a lot of mileage left there.

Great. Glad to hear it. Thanks.

Thank you, Ben.

Thank you. Our next question comes from the line of Glenn Reicin from Morgan Stanley. Please proceed with your question.

Good afternoon, folks. Couple of questions here. First on OP-1, did you get -- did you see any sequential growth, or are you really maxed out in terms of capacity right now?

We saw some sequential growth, but we are pretty closely maxed out in the U.S. We are seeing some nice growth, particularly in Australia and outside the U.S. But, clearly, bumping up against it. We want to be very careful in the U.S. not to exceed the numbers.

And what about on the back half of the year on a worldwide basis? Could we see sales begin to open up at all?

For OP-1?

Yes.

Probably a little bit. I think it'll be continued probably slow, sequential growth on a global basis, given that the U.S. is the bigger market. We do see more opportunities in Europe, but there, we still have the trauma indication. I think, ultimately, once we get the spinal indication, both in the U.S. and ultimately beyond the U.S., that's when we really expect it to turbo charge.

Okay. You've had previous comments before integrating -- indicating that knee growth this year would be in the upper teens, maybe even break 20%. Where are you now in terms of your outlook this year?

We're --

For the second half of the year?

Yes, I think in the second half, we see, certainly, next quarter being in the high teens in the U.S. and probably move into 20 in the fourth quarter.

Okay. And then can you talk a little bit about in trauma, the opportunity in depression locking plates, where are you right now in terms of introduction?

We have a system developed. It's basically in early customer preference trials right now. I know there's been a few last tweaks to some of the -- some of the instrumentation with them, but the initial reaction has been very, very good. That really should be, probably, a late third quarter or so, more of a fourth-quarter-ish event and, therefore, more of an '06 in terms of --

Both U.S., international? Or just international?

That would be global. That would be global.

Global. Okay. Just a couple other quick questions. Triathlon instrument sets per month. How many are you placing right now?

It's now well over a hundred a month. And we have been way, way below that early on.

Okay. And then in terms of DTC, where are you there?

DTC, we're continuing to assess and evaluate, and looking at some regional stuff here and there. And we're trying to be sensitive to that, frankly, given the hospital paying pressures right now. Having watched where the pharmaceutical industry is gone, we want to be careful not to go too far that way, and yet, we also want to make sure we are educating people and letting them know it's out there. So, I would say it's in a -- in iterative mode right now, that you'll probably see more of it, but in a controlled way from us.

You think it works?

Yes. The key is still making sure that you've got the orthopaedic surgeon fully on board, and I think that's what we want to make sure, because we want to be careful that we're not sending people in demanding products versus asking the surgeon what are the best products. And being aware of the alternatives that are at least available to them.

Okay. And then final question, are you seeing any pushback these days on mix and, specifically, on cemented versus cementless mix on hips?

I think we are seeing --

I don't know that -- I don't know that we're seeing a lot of pushback, Glenn, per se, but I think it is fair to say that, probably, the mix shift is slowing down a little bit. And that might have been expected. I mean, that mix shift has been going apace for a pretty long period of time. And it may just be a natural slowing down in it, but it's -- I don't know that -- I mean, you can see our results. It's not -- we're still seeing -- we're still seeing growth in the cementless side.

So what's mix now?

It's -- I think it's north of 60% now.

And that's off sequentially or pretty flat?

I think sequentially it still is up.

Yes.

Okay. Very helpful. I'll get back in line. Thank you.

Great.

Thank you. [OPERATOR INSTRUCTIONS.] Our next question comes from the line of Steven Lichtman from Banc of America Securities. Please proceed with your question.

Thank you. Hi, guys. Just a few questions. First, for Steve. You talked about knee market momentum. Obviously, we're seeing it in the results the past several quarters. What would you say is, in your view, driving that momentum in knees?

What we're -- we don't have a direct answer, but what we're hearing from the surgeon community, and we've seen a number of surgeons who maybe used to do 50, 50 hips, knees that say they may be doing 60, 40 now, knees to hips. That they're ascribing it more to, frankly, obesity, and feeling that the growing obesity epidemic in the U.S. is putting greater pressure on knees than on hips. That's probably the most scientific answer we have at the moment. We've been wondering whether it's product-cycle driven, or some other things, but it looks to be that more than anything right now.

Okay. And then on endoscopy, couple quick things. What was the growth without eTrauma? And also, Steve, you mentioned that international endoscopy was particularly strong. Could you give us some more color on what's driving that overseas?

Sure. Do we have the number, Dean, without -- ?

Yes. No, I don't have that number off the top. eTrauma's contributing a little bit, but it's not -- it's not a huge driver of that growth. Their numbers are very strong without eTrauma.

Yes, they're still in the 20s -- they're north of 20, even without it in the U.S. And what's driving it internationally? I think is a little bit greater focus from our key markets, particularly in Europe, that they've put a little more dedicated sales forces behind our endo and instruments lines, realizing that we've got great products in endo and instruments, and yet, each of those franchises today is over 75% U.S. So we're looking around at the product lines and saying, with a few more resources in our key markets outside the U.S., we probably can grow them. And that's what we're seeing.

Okay. Great. And then, lastly, for Dean, on intangible amortization, should we see in the next couple quarters that remain about this level? And I'm sorry if I missed it, but on the tax rate, again, is this level a good one to keep?

Yes. I think on the tangibles amortization, you can expect that to run right in this 11-million-per-quarter range. And on the tax rate, still feel comfortable with a rate in the 29% range. It's run 29.5%, but I think we still feel like there's downward bias there. Could come this year, maybe next year still. So somewhere in the 29 to 29.5% range is probably still fair for the year.

Great. Thank you, guys.

Thanks, Steve.

Thank you. Our next question comes from the line of Jason Wittes from Leerink Swann. Please proceed with your question.

Hi. Thanks for taking my question. First off, on these contracts that you have with hospitals, I'm just a little unclear on something. Is there some kind of rebate that occurs that either is given back to you or given back to the hospital depending on whether there's compliance to the contract? And how is that -- how is that -- how does that play out on your P&L?

You know what? Each of the contracts are different. So, I think, some may be rebates, some are lower price on an expectation that the compliance will be there. Dean, in terms of the full P&L impact.

It's just not that significant. And, I guess, I would tell you that we just follow the appropriate accounting rules relative to the way to account for that stuff. But there's not, as Steve said, it does vary, but most of them are reasonably solid on pricing. And even in -- even in the case of some of the compliance things we've got, where -- where there's a trial period here for compliance, there's not a rebate that -- the contract would just go back to the earlier pricing on a prospective basis as I understand it.

Okay. And looking at your U.S. hip business this quarter, would some of the weakness related to just J&J and ceramics, and then, potentially, gaining back some accounts?

It could be. We always look at ourselves and say what can we do better? And we think we can execute better and sell better. But there's probably a little bit of that.

Okay. And also, just on -- I don't know if you mentioned specifically the pricing you're getting on X3 poly. What kind of premiums should we expect, or do you guys expect to get from that?

Yes, that question was asked earlier, and my response was, I think, it's still early. We are -- it is going to be a premium, but we're going to kind of wait and see how the market shakes out here, and probably can give you a more concrete answer a little bit as we get on with the process. But it's still very, very early. It just launched, we don't really have any significant data points at this juncture.

Okay. I understand. And also, in terms of acquisitions, did eTrauma add anything to the quarter, and I guess, specifically, to the endoscopy business?

Maybe it added a little bit, but nothing of real significance.

So the -- the number that you guys gave for endoscopy doesn't really change whether I add in or take out eTrauma?

Well, it, certainly, would go down if you took -- without the eTrauma results in. But it's not -- it's not that significant. It would still be a healthy -- very healthy growth quarter for them.

Probably a couple of points.

A couple points would be the breakout? Okay. Okay. Thank you, very much.

Thanks, Jason.

Thank you. Our next question comes from the line of Larry Keusch from Goldman Sachs. Please proceed with your question.

Hi, guys.

Hi, Larry.

Hi, Larry.

Just, Steve, I want to come back to the comments around the sales force and the hip growth that you talked about. And I understand that the product delays and sort of trying to improve that stuff, but you talked about just increasing the sales force engagement. And I'm trying to figure out what that means. Is that a change in the comm structure, a change in your coverage, because, again, I really just want to try to understand how you get the sales force to do a better job, if you will, just given the sort of lackluster results thus far?

Sure. It's probably more looking territory -- shifting some territories around, bringing some new people into certain areas. And I would say, Larry, we've got a number of people who are making a very good living, and it gets back to things like our hip fracture business. It may not be wanting to take that call at 2:00 in the morning and go out and cover that hip fracture coverage -- that hip fracture case. So I can tell you we're bringing in some younger people, and it'll put a few more bodies on the street as well as we go forward here. So you'll probably see more of a sales force expansion as we narrow some of the coverage that some of our people have.

Okay. And just picking up on that, obviously, the danger always when you start to narrow territories or sort of focus sales reps, and particularly those who've been there for a while, is that you run the risk of losing them. Again, how do you manage that process here? I'm just trying to think of all of the risks as you focus in on this hip issue?

It's what we do, frankly, in our MedSurg business, and we've done in most of our divisions over the years, of figuring out ways, if we continue to bring out new products, we can keep people and shrink their territories a touch, and yet have them sell more year-over-year so they keep making more money. So if -- you've got to be very careful with it. They never love it. But at the end of the day if they can see that they can benefit and continue to grow, we think we can do it.

And, frankly, when you really look at it, we really stopped doing that in our recon business over the last few years. Most of the new heads that have gone into the sales force in our orthopaedics division over the last years were really trauma and spine. Spine before we broke spine out. And I think since we broke it out and we've really looked at it, we realized that we had stopped adding sales people and stopped doing that territory constant metering that we've done in our MedSurg businesses, and, frankly, that we had always done in our recon business over the years. So I think as we built out, we'd seen some of the same things in Japan and some of the same things, frankly, in our European countries, whereas we grew some of these other businesses, we stopped growing recon and the sales people. And so we're going to be back on offense there.

Okay. Super. And then the last question is -- just again as we think about all the pricing questions that come up in almost every conversation you have, whether it be specialty hospital, DRG issues, gain sharing, vendor consolidation, whatever it may be, just wondering if you step pack, Steve, and sort of think about all the issues that have sort of arisen this year? What's the one that you watch the closest now that we're halfway through the year? Some must be less threatening and others may be more. So where are you most focused as, just, as you think about the price pressure?

I think the biggest area is pricing and combined with volume and mix -- and really mix. But I do think those two are related and I think you've kind of picked up on that. We are sensitive to the fact that profitability for the hospital on orthopaedic procedures has gotten squeezed over the last five, six years, and that we've got to be more responsible in bringing new products to market that bring both a benefit, but also have some economic justifications to them. And so I think we're looking at this as part of a macro trend rather than everything's going to fall apart tomorrow. And I think as you're seeing, certainly, everybody was -- looked like the investment community kind of panicked back in about March when some of this stuff came out. This is going to play out over time. And we do see a gradual slowdown in some of that abilities over time, but, again, it's part of what we're investing in R&D, it's part of where we're looking at our diverse business model to help us clearly manage through this. And we can clearly see our way to continuing to deliver the kind of bottom-line results that people have come to expect from Stryker, even in that environment.

Okay, great. And then, just, lastly, the FDA asked for some additional information around Cervicore, which I think you are, sort of, suggesting could take two quarters to pull all that together. Just any quick update there?

Yes, we actually had a positive meeting just recently with them and are planning to file the IDE in the second half of this year. And if all goes well, we hope to be in surgery just before the end of the year.

I think that's pretty much in line with what we had said before, so I think it's fair to say that we're on track, Larry.

Yes.

Okay. Great. Thanks, guys.

Thank you, Larry.

Thank you. Our next question comes from the line of Raj Denhoy from Piper Jaffray. Please proceed with your question.

Great. Thanks. Just a couple of questions, if I could. You bracketed your expectations for what you thought U.S. knees could do over the balance of the year in the last two quarters. I wonder if you could offer a similar outlook for the U.S. hip business and where you think it could accelerate off this 2% number in the third quarter and the fourth quarter?

We're -- I think we see sequential uptick probably into the, call it, solid single digits next quarter. And we want to be back to double digits by the end of the year. But it's a rebuild there. So we feel very good that you're going to see progress, but it's not going to spike over night.

Okay. But you think you can get back to the double digits here by the fourth quarter?

We would hope so. That, or very close to it.

And, then, just on the MedSurg division, you mentioned that the order flow there was still very strong, over, I guess the sixth or seventh quarter, now, of 20%-plus growth, or close to 20% growth. We continue to see it driving at this rate. I mean, it's, I guess, in some respects, it's almost two times the market growth rate. What are your expectations there. Do you think it will slow any time soon? Or you still just seeing open field ahead?

We -- we are expected to slow. We continue to be very pleased with the fact it's running up. I'd say the macro perspective is we see our U.S. recon business strengthening quarter-over-quarter, probably over the coming, next three, four quarters keep getting better, and MedSurg probably slowing down a little bit. And once again, having the total Stryker pie being very consistently strong.

And I guess that explains the fact that the revenue growth outlook, I guess, is for similar growth rates on the back half of the year as the front half? Due to that acceleration in recon and that deceleration, I guess, in MedSurg?

Yes. I think, overall, our operational rate, obviously, the reported rate based on the currencies --

Sure.

-- may have a little bit of an impact. But we expect to be growing operationally in that mid-teens range.

Great. Thank you.

Thank you.

Thank you. Our next question comes from the line of Tao Levy from Deutsche Bank. Please proceed with your question.

Good afternoon. Just one quick question, first, on U.S. hips. You mentioned hip fractures being a drag there. Any way to help us quantify what type of drag that is and is that easier to fix than maybe something else that might be affecting hips?

Tao, it's not -- it is -- it's a slightly negative number, I guess, the way I would say it. I mean, U.S. hips are, as we said, up 2%. The Modular Revision System is helping. So it's a moderate drag, but not huge. So it's not that far out of character relative to where the overall hip business has been. And as Steve alluded to, I think we see part of the solution to that is taking a look at whether we can have some sales associates, tech reps type people maybe throw in on some of those calls where the main line rep hasn't -- hasn't deemed to take on that business. But, again, I think that's going to take time, territory-by-territory to go after it. But, again, we think we have the products in the bag to do it here. And if we reinvigorate our total hip business, this should come along with it. There's nothing endemically wrong with the product line or anything like that.

Okay. And in the MedSurg business, how would you characterize the majority of products that are being sold there? Are they more one-time type sales and they get reused? Or are they more disposable, so they're used with every procedure? I'm trying to understand whether we -- this growth rate can continue going forward, or we're just picking the low-hanging fruit right now?

Well, it varies across the product groups. The medical business is much more capital equipment intensive, almost to a 100% capital equipment, so more you would call big time or one-time sales, although, obviously, we're -- I think we are seeing some growth in hospital construction, although we're still doing much better than the market, obviously.

Our endo business tends to be probably a little more stilted towards capital equipment, but has a nice complement of reusable products. And our instrument business is much more heavily weighted towards reusable products, and, obviously, also tied with what's going on with orthopedic procedures. The endo business, our communications business has helped to grow that out. And also, the endo sweep business has contributed a nice growth there. And we're seeing some real nice trends within hospitals and their need to get more efficient there and continue to drive those trends, which has been a boon to that business. And we -- and, frankly, we don't see that sort of petering out any time soon.

Okay. And just, lastly, we talked to some hospital administration folks. They do mention that, Stryker has ability to address or to sell to the hospital differently than some of the other orthopaedic manufacturers. Have you started to see maybe a little bit of pressure on your traditional sort of Orthopaedic Implants? And then offset that with benefits and MedSurg? So you're willing to take a little bit of discounting in Orthopaedic Implants, and then, again, get the benefit in MedSurg?

We do -- hospital by hospital, you see some slightly different mixes there, and probably see a little bit of that. But, overall, it's our ability to kind of connect the dots in different ways and manage it across each of our franchises.

I think if you ask any of our individual business heads, they would tell you their ox was more gored than somebody else's. So it really depends on who you talk to. I think it does, really, vary hospital-by-hospital, deal-by-deal.

Okay. And then, this is the last question. On gross margins, they're strong in the second quarter. Is this rate sustainable, sort of, in the 65% range? Is it -- or should we look more mid-64s?

I think it's sustainable in the 65 -- in the 65s.

Okay.

To some degree, it does depend on -- we've talked about this before, it depends to some degree sometimes how fast we write up plans. It also depends on, kind of, new product introductions and the level of excess and obsolete reserves that we set up. They tend to be higher in the first quarter. We've seen that the last couple of years, and we also sometimes introduce products as we go to the mid and later part of the year, and that could impact that as well. So, there are some variables there which I can't completely control. But I think that 65s is not unfair.

Okay. Perfect. Thanks a lot.

Great.

Thank you. Our next question comes from the line of Greg Halter from Great Lakes Review. Please proceed with your question.

Good afternoon, gentlemen. And congratulations on an excellent quarter. I wanted to probe on the MedSurg group on the medical side, with the results being up, I think, 30%, as you had indicated in the U.S. And I'm just wondering, given that there's not a large amount of competitor base there, if there's market share gains that you can allude to, or new product introductions? Or what exactly is driving that very strong growth?

Yes, we, obviously, feel like we're growing significantly faster than the market. And there's not a huge competitor base. So we would surmise that with our new product flow, we are probably growing our market share there. But we face pretty stiff competition in that marketplace, but feel good about how we're doing right now. Great. Thank you. Thank you, Greg.

Myra?

We do have our next question from the line of Dhulsini De Zoysa from SG Cowen. Please proceed with your question.

Good evening, gentlemen. I was wondering if you could comment in terms of R&D spending, you're increasing the level fairly substantially. You talked some about the sensitivity of hospitals to pricing increases in Orthopaedic Implants over the last few years. And I think, Steven, you mentioned economic justification. Should we assume that some of that spending on R&D is allocated for some kind of economic value-added study or cost benefit analysis? And then I have a follow-up to that.

Sure. At this point, not much, but you'll probably see a little bit more of that as we go forward, Dhulsini.

Are hospitals looking for that kind of information?

Probably not as much yet, but we believe, if not the hospitals, the payers. We just -- we think we're going to have to be operating in an environment where we justify the -- those things more.

Okay. And then when should we expect the biggest impact of spending on SpineCore trials? I think you said you expect first implants by year end, or so, for Cervicore. And then, an update on Flexicore and where that is would be great.

Yes, on Flexicore, we completed enrollment on -- in that study in the first quarter. As Steve said, we'll -- we expect to, hopefully, be able to begin enrollment late, late this year. Frankly, our burn rate has been reasonably consistent on the spinal products there, and it could, arguably, be slowing done a little bit here in these interim quarters when we don't have as much activity with Cervicore but not that much. So, you could see a little bit of boost, but nothing that you'll see impacting the numbers to any great degree.

Okay, thank you.

You're welcome.

Anything else, Myra?

We do have a question from the line of Bob Hopkins from Lehman Brothers. Please proceed with your question.

Thanks, very much. Just three quick ones. Number one, Dean, in terms of the R&D spend that you've had in the first half of the year, was that about in line what you expected it to be when you set out your initial budgets for 2005?

Yes, it is. It's very much in line, Bob.

Okay. And then, secondly, on the knee side, Dean, did I hear you right where you said most, if not all of the growth in knees was Triathlon?

In the primary business, yes.

In the primary business, right. And, then, finally, on hips, we kind of exhausted the conversation on units -- or on mix and price, so I'll ask another unit question. Now that we've had three companies report, U.S. units, you guys have reported something around 0, I assume, and Biomet was right around 0, and J&J's right around 5% or so. Can you just make a comment on the overall hip market? I mean, clearly, it's decelerated, but where do you think it is going right now? And is there any reason that we should expect an acceleration in the overall market growth rate above the mid-single-digits going forward in the units?

At this point it just -- it feels like knees are getting more of the demand from the patients. So we probably assume that we just stay around there for hips for right now until there's some key event that might change that. But I don't think we see anything on the horizon that's going to dramatically accelerate the hip marketplace.

Okay. What's that, Dean?

Let me just clarify my first answer -- that -- my answer was relative solely to the U.S. knee business. I mean, obviously, when the other comments are made, are Scorpio business, particularly, is doing extremely well overseas.

Right, right. Thank you, very much. Have a good afternoon.

Thank you.

Great, thank you.

Thank you. Our next question comes from the line of Katherine Martinelli from Merrill Lynch. Please proceed with your question.

Actually, I was just trying to get first for your Q3 conference call.

There you go.

It's not to beat too many of these issues to death, but just in terms of, Steve, we've heard you speak about the innovation fund as part of your efforts to increase R&D, and it sounds like, based on your earlier comments that you are looking to do things that may be somewhat longer in terms of the regulatory path, more PMA-type of events. Is it a fair comment to say that if the funds were available, you have a unlimited, or close to, queue of projects that you could invest in? I'm just trying to get a sense of the appetite to reinvest in the R&D and if the opportunities exist right now to the degree the business may be overachieving?

Sure. I would say that we're seeing more and more good ideas from the divisions. We're still looking at all of them on a very careful and disciplined basis. But it does seem to us that there have been more ideas that have not been surfacing, that since we've said, look if there are some good opportunities that may be beyond the 12-month time frame in terms of bringing them to market, let's at least surface them. And we're seeing those ideas come up. Is it limitless? I would say no. Obviously, we want to continue to hit our 20% growth targets and everything else in terms of earnings delivery. But we certainly have a healthier appetite, but also want to reinforce that we're still being very disciplined here.

Yes, my comments were more geared towards to the degree that it would be in excess of the 20%, as opposed to hitting the 20%. And then, just in terms of the contracting, do you get a sense that more hospitals are looking to do the price for volume contracting arrangement similar to HCA, or is that -- that one off example, since it was so visible, kind of, being viewed as a blueprint to see how successful they are with compliance, which at this point sounds like it's been somewhat, not that much of a success?

Katherine, I think we don't see any significant shift, really, in terms of the way people are contracting, vis-a-vis the way they've always done it at this point. But, again, we -- we're at the stage where this fall, really, is more when we'll start to enter into some of those discussions.

Okay.

Really, probably, the late-July, August time frame. So we're getting there, but we're not quite there.

Okay, great. Thanks a lot.

Thanks, Katherine.

Thank you. Our next question comes from the line of Bruce Nudell from Sanford Bernstein. Please proceed for your question.

Thanks so much for waiting around for the last calls here. While we looked at U.S. unit growth, nationally, for '92 to '02 or so, it looked around 8%, statewide peaks suggested around 11%, '99 to '04. Do you think the unit growth rate is well above that 11% look that we had right about now? And, secondly, the -- in partials, which I guess you're talking about hip fractures, it really looks like it's been flat for the last five years, at least on a statewide level, as near as we've seen. Could you comment on that as well? Thank you so much.

I think in terms of total recon, I'm assume you're talking total recon numbers?

No, I'm talking about U.S. knees, in particular. I mean, U.S. knees looked about 8%, '92 to '02, looked around 11% statewide level, '99 to '04. And it's very, very lumpy. So you could have a year with 6% and another year with 15%, at least at a statewide level that's not had the benefit of averaging. So, is U.S. -- are U.S. knees, like, some colossal number right now, in 15% or something like that on a unit basis?

I think we continue to see knees growing probably in the 10 to 12-ish range on a unit basis, maybe 9 to 12 right now, and there may be a little bit of spike here and there month to month. We're not ready to say there's a huge secular break out.

Got it. And on the partials, partials look pretty darn flat to me, when I looked at them on a longitudinal basis. And it seemed like it's a source of mix shift wherever people are as procedures better, people are being classified -- older people -- to totals. Is that your sense as well? Is just that partials is a contributor to the overall mix, or just declining on a U.S. hip side?

Go ahead, Dean.

I was going to say, it's probably slightly up. It's -- I think there was -- there, obviously, as those got introduced and were well received, there was a reasonably nice in -- uptick, but I think it's probably flattening at this point.

Thanks, so much.

You're welcome.

Great. Thank you.

Thank you. And the last question is a follow-up question from the line of Glen Reicin from Morgan Stanley. Please proceed with your question.

This is a perfect end-of-call question, because it's in the weeds here. What's happening in this med market? And what's happening with your sales to cement these days?

It's going okay.

Yes, Glenn, I think it's -- I think it's doing fine, obviously, with the introduction of the Tobra product, that had resulted in a nice mix shift. And there still is some of that going on, although it definitely has slowed down somewhat. But it's still -- it's still a very nice grower for us.

What kind of growth did you see?

We don't -- we don't really talk about those numbers individually, so it's a double-digit grower.

Okay. And do you see anything changing on the competitive front with all this, sort of, jockeying around with distribution agreements and the like from your competitors?

On cement, specifically, you mean?

Yes. I mean, just generally, do you anticipate any share shift with changes at Biomet and Zimmer?

I think what we would say is that we still have an extremely well-accepted product, particularly in the U.S. And I think that continues to be the case. So we're very comfortable with our selling story. And it might make it a little bit tougher, but we think we'll still do just fine in the cement market.

Okay. So you anticipate actually not gaining as much share going forward because of this?

I think the bigger -- I think the bigger question will be where are we at in the mix shift in the antibiotic bone cement? I think there's a lot of good case to be made for that. But there probably will be a point in time when the mix shift starts to diminish there.

And remind us, are margins better in this business than overall implants, or about at the same?

Probably about the same.

Okay. Thank you, very much.

Great. You're welcome.

Thanks, Glenn. Thanks, Myra. Is that it?

There are no further questions.

Great. All right. So with that, thanks, everybody, for sticking with us here for the call. And our -- I'd say we continue to feel very good about our business. We fired on a lot of cylinders this quarter. And we'll be back to you for our third quarter 2005 operating results will be at 5:00 P.M. Eastern time on Tuesday, October 18th, 2005. So we'll talk to everybody then. Thank you, very much.

Thank you, ladies and gentlemen. That concludes the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Have a good day.