史賽克 (SYK) 2006 Q3 法說會逐字稿

Welcome to the third quarter 2006 operating results conference call. [OPERATOR INSTRUCTIONS] This conference is being recorded Tuesday, October 17, 2006. Certain statements made in today's conference call may constitute forward-looking statements. They will be based upon management's current expectations and will be 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 these presentations, such factors include but are not limited to pricing pressures generally including cost containment measures that could adversely affect the price or demand for those company's products. Regulatory actions, unanticipated issues arising in connection with clinical studies, and eventual United States Food and Drug Administration approval of additional OP-1 applications, the FlexiCore and ServiCore spinal implant products, the plans to sell sterilization products, or other new product introductions.

Integration and other issues that could delay the introduction of recently-acquired Sghtline product line, 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 product, 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.

Today's conference call will also include a discussion of adjusted net earnings including the impact on nine months ended September 30, 2006, of a first quarter charge to write-off purchased in-process research and development associated with the acquisition of Sightline Technologies Limited and excluding the impact on three months and nine months ended September 30, 2005, of a third quarter charge to record the income tax expense associated with the reparation of foreign earnings under the provisions of the American Jobs Creation Act.

Further discussion of these non-GAAP finance measure including a GAAP reconciliation appears in the Company's Form 8-K filed today with the Securities and Exchange Commission which may be accessed for the For Investor's page on the Company's website at www.stryker.com.

It is now my pleasure to turn the conference over to Steven MacMillan, President and Chief Executive Officer. Please go ahead.

Thank you and good afternoon everyone. Welcome to Stryker's third quarter 2006 earnings report. With me today is Dean Bergy, our Vice President and Chief Financial Officer.

Today we are pleased to report yet another strong quarter of double digit topline growth and very strong earnings growth. Specifically, sales were up 10.4% to $1.294 billion and reported net earnings surged 56% versus last year when we took a charge to capitalize on the American Jobs Creation Act. Net of last year's charge, our underlying earnings were still up a healthy 24%.

The big news for the quarter is the resurgence of our largest and most profitable division, U.S. Orthopedics. As most of you know, this division was struggling 18 months ago, but is clearly now back on track. In fact, the division posted double digit sales growth for the first time since late 2004, delivered reconstructive sales growth of 11%, and showed its fourth straight quarter of sequential acceleration.

Simply put, we are very encouraged by the progress here. U.S. growth for hips, knees, and CMF all accelerated versus last quarter's growth rates and trauma stayed very strong. Also, on a year-to-date basis, all four franchises within our U.S. Orthopedics division, hips, knees, trauma and CMF have increased their growth rates versus last year's pace.

Importantly, we also saw the first meaningful signs of acceleration in our U.S. hip franchise, which posted 6% growth, its best in the last seven quarters. We are not celebrating yet, but are very pleased with this uptick, particularly as it came largely in advance of our new anatomic heads launch, which just began to hit the market in late September. Meanwhile, behind the strength of Triathlon, our high-performing knee franchise elevated further in the U.S., accelerating from 13% growth last quarter to 16% this quarter. This marks our fastest growth in the last nine quarters and underscores the continued excitement around Triathlon and the overall strength of our knee franchise.

Trauma posted its third consecutive quarter of 20% or greater growth in the U.S., up 21%. And not wanting to be left behind, our U.S. CMF business surged 28% in the quarter, marking its strongest growth rate in our history. Given where we've been, we are happy to report that we are now bullish about the direction of our U.S. Orthopedics business.

Globally, the story is also positive as four of our five key implant lines, hips, knees, spine, and CMF all grew slightly faster this quarter than last and trauma maintained its solid double digit growth rate. In knees, we are also pleased to report an impressive milestone, our 24th straight quarter of global double digit growth.

Our MedSurg businesses continue to generate solid results, posting 14% growth in the quarter, including a softer than planned quarter in our instruments business, which was up 10% in the U.S. and 9% globally on an operational basis. Our U.S. endoscopy business, which was up 6% last quarter grew a healthy 16% this quarter behind the launch of the new 1188 camera, light source, and high definition monitor. U.S. medical continued its gravity-defying performance, up another 18% in the quarter.

Internationally, we also had a number of solid performances, as each of our implant lines grew at least as fast as last quarter, despite softness in the U.K. and particularly Japan on the heels of the April reimbursement cut there. Hips, spine, trauma, and CMF all grew faster than last quarter on an operational basis while knee growth was equal to last quarter leading to slightly stronger overall orthopedic implant growth. MedSurg growth was a little slower, but we anticipate progress here as we initiate the rollout outside the U.S. of the new products at endoscopy and instruments. Geographically, Europe maintained a similar growth rate versus last quarter, Japan and Latin America were slower, and Canada and Pacific accelerated.

Last year at this time, we said 2006 could be a tougher year for the orthopedic industry and we think we were accurate. We also said we were ready and that we would again grow earnings 20%. And we are. With three quarters of the year now in, we are clearly on track to deliver on our commitments for the year. U.S. Orthopedics has regained its footing and endoscopy and instruments are on the front end of a new cycle of product launches. After recent softening, we believe the U.S. recon market is stabilizing and we believe we are well-positioned here.

Operationally, we also continue to make steady improvements, which are evident throughout the P&L. Our net contribution was up strongly by 150 basis points versus last year to 65.9%. And while we are delivering today, we continue to invest in our future as investments in both R&D and sales force expansions continued to outpace revenue growth. The pricing environment also appears to have stabilized and encouragingly our pricing strengthened modestly in the quarter as Dean will cover shortly. Again, we are delivering strong results today while also investing for the future throughout our businesses. I will now turn it over to Dean for more details.

Thank you, Steve. I'll begin with the impact of foreign currency on our sales. As you can see, foreign currency had a reasonably negligible affect on third quarter sales, increasing them by $7 million or 0.6% in the quarter. In the quarter, the dollar weakened about 4% against the euro and strengthened about 5% against the yen compared to the prior year. If currency rates hold near current levels, we expect the impact of foreign currency will increase fourth quarter 2006 sales by about 1% when compared to the prior year.

Next, turning to the overall price volume analysis as a percentage of sales, price contributed 1% in the quarter to our sales growth of foreign currency, we actually rounded down to be flat. And volume and mix created 9% of the growth, adding up to the 10% growth that we reported.

As I said, prices were up 1% in the third quarter, a bit stronger than the slight increases we experienced in the first two quarters. Domestic prices drove this increase and international prices were down just slightly, with increases in most international markets helping to offset the impact of the approximate 6% reimbursement cut which took effect on April 1, 2006, in Japan. Volume and mix came in at 9% with the U.S. finishing at 10%. Our international businesses produced volume mix growth of 7%, with slower MedSurg growth compared to recent quarters.

Turning to sales in the segments of our business, orthopedic implants which represents 50% of our sales saw an increase of 10% in the third quarter on a reported basis and 9% on a constant currency basis. These growth rates represent nice sequential upticks over second quarter growth in this segment.

Now I'll give you a breakdown by product line in the quarter. Hips domestically were up 6% and internationally up 1% from 4%. And again, these are the reported numbers. I'll give you constant currency in a moment. Knees were up 16% domestically, internationally up 8, and up 13 in total. Trauma, up 21% in the U.S., 9% internationally, and 13% in total. Spine, up 15% domestically, 14, international; and 15 in total. CMF up 28, domestic, 9, international, and 19 in total. The total orthopedic implant line up 12% domestically, 6, international, and 10 in total.

Now on a constant currency basis, of course, the domestic numbers are the same, but I'll give you the international and total markets. So for hips, international was flat and total up three, knees, international up 6, total up 12. Trauma, international up 8, total up 12. Spine, international up 13, total up 15. CMF, international up 8, total up 19. And for the total category, international up 5 and total up 9 on a constant currency basis.

Now turning to the individual categories, hips were up 3% in local currency and 4% in dollars in the quarter. Our U.S. hip sales growth accelerated to 6% in the quarter. Accolades cementless hips had another good quarter and we again saw nice gains in sales of our Restoration Modular Revision hip system. We also saw extremely strong growth in X3 polyethylene insert sales.

Our hip fracture business was strong in the quarter, surpassing 10% growth. Hip sales in Europe grew at mid-single digit operational levels and were led by stronger sales of Trident, Accolade, and Restoration Modular Revision products. In Japan, local currency hip sales declined at high single digit rates fueled by the MHLW price reimbursement cuts and a reduction in sales of bipolar products. Specific local currency hip sales growth checked in at mid-single digits led by Accolade and Trident products.

Now turning to knees, they were up 12% operationally and 13% in dollars in the third quarter. Knee sales in the U.S. also accelerated to grow at 16% versus 13% in each of the first two quarters. Primary knees posted high teens growth led by continued strong market acceptance of the Triathlon and sales of X3 polyethylene.

Revision knee products grew at mid-single digits in the quarter led by Scorpio. European knee sales were flat operationally as growth in Triathlon and Scorpio product sales were offset by declines in Duracon and Kinemax. Sales in knees in Japan were flat in local currency as a result of the price cuts, but mid-single volume growth was led by our Scorpio and RG product designs specifically for this market.

Pacific had an exceptionally strong quarter in knees, posting local currency growth of above 20%. With nice performances from both Scorpio and Triathlon. Canada and Latin America also posted strong knee growth in the quarter with Triathlon leading the way in Canada and Scorpio in Latin America. Our trauma products were up 12% in constant currency and 13% in dollars in the third quarter.

Our U.S. trauma business posted a third straight quarter of growth over 20%, delivering 21% growth this quarter, 22% of military sales are excluded. Growth was strong across most product categories, it was led by intramedullary nails, hip fracture devices, and other internal fixation devices. International trauma sales were up 8% in constant currency led by hip fracture devices, external fixation and hand products. Europe grew trauma sales at low double digit operational levels, the Japanese local currency sales were held flat by the price cut.

Now turning to spine, that was up 15% operationally and in dollars in the quarter. U.S. spine sales grew 15% in the quarter led by extremely strong growth in interbody devices. Sales of cervical products also grew close to 20% in the quarter. Overseas, spine sales were very solid posting 13% operational growth. Spine sales in international markets were led by Thoracolumbar and Interbody Device products. Europe had an excellent quarter in spine, and Japan grew sales by mid-single digits in this category.

And then last, but certainly not least in this category, CMF was up 19% in both dollars and local currency in the quarter. Our CMF business had another excellent quarter on the strength of exceptional performance in the United States and it's followed international sales growth. U.S. growth was led by extremely strong growth in sales of neuro products and 20% growth in craniomaxillofacial implant sales.

Now turning to our MedSurg group, as I'll remind you, they represent 37% of our sales and they had a solid quarter. As a reminder, MedSurg is comprised of three significant product categories, that would be instruments, making up 42% of the group, endoscopy, 35%, and medical the remaining 23%. MedSurg group sales were up 13% for the quarter in constant currency and 14% in U.S. dollars.

Turning to instruments, sales of our instruments product line increased 10% in the third quarter as Steve said as reported and were up 9% in constant currency. To break that down, domestic and international, domestic was up 10% reported, international was up 9% with a total of 10%. On a constant currency basis, domestic was up 10%, international was up 7, and the total for instruments in constant currency, as I said, was up 9%. Our instruments business had a solid quarter, but not as good as we had hoped. With the sell-through of our new System 6 heavy duty power tools taking longer than we had anticipated.

U.S. sales were on par with last quarter at 10% growth and international sales slowed from the strong first half. Japan led the way in international markets with mid-teens operational growth. Power and instruments grew at mid-single digit levels in the quarter and other OR equipment posted mid-teens growth. Microtools led powered instruments and other OR equipment sales were led by Navigation, the Neptune operating room mask waste management system, and Sterishield.

Turning now to endoscopy, that was up 17% in the quarter, as reported, and 16% in constant currency. The breakdown for the reported numbers was 16% domestic, 20% international, and 17 in total and then in constant currency, international was up 17 and the total endoscopy product line was up 60. Endoscopy had a very good quarter. The business rebounded nicely in the U.S. and although it cooled overseas after a torrid first half, still posted 17% local currency growth in the international markets. Video led endoscopy's quarterly growth with sales up over 20% and our arthroscopy and general surgery delivered low double digit growth. Video led by cameras, accessories, and imaging dominated the U.S. growth and arthroscopy and general surgery were much stronger outside the U.S.

Our medical business making up the final piece of the MedSurg puzzle, was up 19% in the quarter and 18% on a constant currency basis. That business grew 18% domestically, 20% internationally, and 19% total. Medical obviously had another great quarter. U.S. sales continue to be very strong with 18% growth. International sales were led by excellent performances in Canada, Latin America, and Pacific. Medical's growth in the quarter was led by beds, EMS cots, and sales of stretchers were very solid.

And then physiotherapy, which represents 5% of our sales saw sales off 5% in the quarter. Growth from acquisitions was offset by the second quarter divestiture of a small portion of physiotherapy's business and volume declines. This quarter's slight decline in revenue is indicative of the performance we would expect from this business for the next couple of quarters as we continue to focus on the profitability of the business and on resolving the department of justice investigation of physiotherapy. And PT Centers, I'll just give you that number, they're at 494 versus 489 at the end of the previous quarter.

Now turning to the rest of the P&L, I guess I would remind everyone that our financial statements now reflect the adoption of the FASB statement that required us begin to expensing stock option costs. We elected to modify retrospective transition method of adoption and the prior year amounts presented in our press release have been restated to reflect the expensing of these costs in prior periods. Gross margins in the quarter, as you can see, were flat on a sequential basis and up nicely as compared to the prior year. We benefited from reduced royalty costs related to the expiration of certain royalty agreements and high absorption costs as we have been running the plants faster to deliver new product launches.

R&D spending was up 12% in the quarter as we continue to emphasize product development efforts. This increased emphasis is reasonably broad-based across the Company's various businesses, but is most prevalent in our biotech and spine businesses. We are absorbing higher costs for artificial disk development and development costs related to recent technology acquisitions such as Sightline. SG&A costs increased 11% in the quarter, sales-related costs again drove a large proportion of the increase. These costs include compensation and higher Instrument amortization and sample costs associated with recent new products such as Triathlon, System 6, and our endoscopy video offering. Operating income increased 18% in the quarter and operating margins are up nicely from last year to 19.7% of sales.

Now I'll just give you a quick breakdown of our other income for the quarter. That's $8 million that's made up of $10.3 million in investment income offset by $1.7 million in interest expense, a foreign currency transaction loss of $0.4 million and minority interest also a reduction of $0.2 million. And then last, the tax rate I'll comment on, the underlying effective income tax rate for the first nine months of 2006 after excluding the impact of the non deductible Sightline purchased in-process research and development was 28.2%. This compares to a restated effective income tax rate for the first nine months of 2005 after excluding the impact of income taxes associated with the repatriation of foreign earnings of 29.2%. 2005 annual underlying tax rate was also 29.2% if the impacts of the PlasmaSol purchased and processed research and development and the income taxes associated with the repatriation of foreign earnings are excluded from consideration.

And then turning to the balance sheet, we think that's in good shape. Accounts receivable days out of the quarter at 59 days, that's up two days from the prior year. Inventory days finished at 130 days -- 138 days, ten days above the September 2005 level. We have built inventory as a result of recent and anticipated product launches, but are not 100% satisfied with our management of this asset. We will likely slow our plants down a bit in the fourth quarter as we work down our inventory levels. And now I'll just comment in terms of debt outstanding, we have $15 million of debt outstanding at the end of the quarter.

And then last, you can see our cash flow statement, if you look at our press release, we do believe we have good cash flow in the quarter, although cash from operations is up just 6% through nine months. We do project a strong fourth quarter and another excellent annual cash flow performance. With that, I'll turn it back over to Steve.

Thanks, Dean. We'll just wrap up the '06 outlook and touch on '07. As we exit the third quarter, we are pleased with the continued improvement in our U.S. Orthopedics division. Spurred by increased growth in hip and knee sales. And even with a slightly different mix, our MedSurg business has delivered another mid-teens growth quarter. This again demonstrates why we believe our broad-based business model puts us in a great position to consistently deliver on our commitments.

One of those commitments this year was to grow our sales at double digit rates for a sixth consecutive year. Our latest forecast indicates a strong fourth quarter should bring our 2006 annual sales growth in around 11%. We also expect to deliver on another important commitment, 20% or greater EPS growth, with expected net earnings per share of $0.55 in the fourth quarter, bringing adjusted annual net earnings per share to $2.02 for the year, a growth of 21% against last year's adjusted net earnings per share. On a reported basis, this would be net earnings of $1.89 per share, a growth of 20% versus last year's reported EPS.

We are finalizing our plans for 2007 and currently project that diluted net earnings per share for the upcoming year will approximate $2.42 per share. This represents projected growth of 20% compared to 2006's adjusted net earnings per share and growth of 28% on a reported basis. Now we will open it up for questions and answers. We can go ahead.

Thank you. [OPERATOR INSTRUCTIONS] Bob Hopkins from the Lehman Brothers.

Thank you and good afternoon.

Good afternoon, Bob.

A couple of quick things. First of all, thanks for the initial comments on 2007. I was wondering, do you expect 2007 revenue growth to be, again be in the double digit range? And do you assume any contribution from OP-1 in 2007?

Bob, at this point, I would say our '07 revenue's probably going to be similar to this year. We'll be hoping for a little bit better, but I think our plan will be similar to this year and we're not really counting on OP-1 any different from this year. We're still assuming that by all intents and purposes that becomes more of an '08 effect.

Okay. Is there any update on OP-1 in terms of the timing on the milestones?

No. I think we've been saying that we probably see it being closer to an 18-month review when you look at the history of what's been going on with biologic approvals down at FDA, they look like they've been averaging 17 to 18. I think that's just prudent, what we should be planning for.

Okay. And two other questions. One just generically on 2007, we're assuming around 10% growth on the top line, can you just give us some outline as to where the leverage comes from in 2007 versus where it came from in 2006 to get you to that 20%?

First off, we'll be trying to do a little bit even better on the topline. But if you noticed this year, we've been continuing to invest at a rate faster than sales in our salesforces, and we've been doing some significant expansions, frankly, in virtually all of our divisions domestically as well as around the world. And I think next year we would expect to start to leverage some of those additional investments that we made this year.

So I think that what you should expect is a little bit of continued progress on the gross margin line, SG&A probably coming in a little bit under the rate of sales growth so that we get some leverage there. And R&D we'll probably continue to spend around the rate of sales growth. And we'll probably get a little touch on the tax rate that will help. Dean, anything additional there?

No, I think that covers it well, Steven.

And then just finally, really quickly, on MedSurg, it's been terrific year-over-year growth. It's been three sequential quarters of basically flat growth however. And I was wondering at this point since we're a little closer to some of those launches in those key areas that you mentioned, endo and Instruments, if at this point you'd be willing to give a little bit more color on the new product launches and specifically what you think can get the growth to increase from the $490 million quarterly run rate it's been on for the last three quarters?

Sure, Bob. I think you should expect it to tick up here in fourth quarter, particularly off endo and instruments. What we probably see is, we might see medical coming down a touch, and we probably, after nine straight quarters at 15% or greater greet, that one might start to moderate closer to the ten. But as we look at income and order trends the launch at endoscopy of the 1188 camera is being very well received. That combined with a Light Source and the new high-definition monitor, I think we feel that endo is going to bring in a nice fourth quarter for us.

And System 6, our incoming order trends on the System 6 power tools out at instruments will suggest a stronger fourth quarter for us. So we feel the initial feedback from surgeons on that has been very, very good. So I think as we look at it, we feel really good about where the two big MedSurg businesses should be headed here in the fourth quarter. And medical will probably be slowing a touch.

Super, thanks. I'll get back in queue. Thank you.

Great, thanks, Bob.

Milton Hsu with Bear Stearns.

Hi, guys.

Hi, Milton.

You afforded some very strong recon numbers in the domestic hip and knee businesses. I'm just wondering for a seasonally soft quarter, these are very good numbers. Did a lot of that growth come from the fact that a lot of the discounting was pretty heavy in second half of '05 and that all kind of went away this year?

Well, Milton, I would say that it came more from a lot of just blocking and tackling and hard work. As you know, we've been doing a lot of rebuilding of our U.S. orthopedics business and we think we're on the beginning end of that really starting to show.

You've seen it building over each of the last few -- four straight quarters of sequential improvement and it's blocking and tackling. Our salesforce is delivering, it's products starting to come through, but it's a lot of the hard work more than anything else and we've been cautiously optimistic and not wanting to get ahead of ourselves, but I think this quarter we can finally say, you know what, we feel good about where we're headed.

Okay. And if we look at just sequentially, and this is across the board for all companies in the industry, third to fourth quarter is a slight improvement. Should we expect that for this year for Stryker?

Absolutely.

Okay. And then a question for Dean on gross margins, I guess in the first three quarters of this year, gross margins are probably well over 100 basis points better than we've seen in each of the last three years. You mentioned something about running the plants a bit slower in the fourth quarter, but as volumes kick in, should we expect gross margins to roughly stay at that level sequentially and then maybe some comments for '07?

Yes, Milton, when you say sequentially, maybe I should just clarify. We were at 65.9 this quarter. We may slow a little bit from that in the fourth quarter, depending on how we run the plants, but I think clearly year-over-year we're probably going to end the year up at least 100 basis points for the annual number, if you just look at the way the numbers are rolling in. And I think for next year, we would expect some slight improvement in that, 30 to 50 basis points would probably be what we would target.

Okay. Great. Thanks, guys.

Thanks, Milton.

Matt Miksic with Morgan Stanley.

Hi, it's Matt. Thanks for taking the question.

Sure, Matt.

So I thought, first of all, also, that the recon numbers look pretty strong, especially -- was I mistaken that I thought that you were looking at having some number fewer selling days in the third quarter? Does that not come through, or did you just flow right through it?

It's a great question, Matt. Actually we did have one less day this quarter than we did last year, so the underlying numbers -- now we also have one less day in the second quarter.

Yes.

Sequentially they're the same, but we do think it was a pretty good average daily sale rate coming out of recon so--.

That was -- I'm sorry to interrupt, go ahead.

You can tell Glen we do like recon.

Apparently so. So just to put some size around that, that was something like 1.5% or something was the estimate that you gave last quarter for that one day in the U.S., is that a reasonable way to think about it this quarter?

Yes, yes.

Okay. Then, wondering on trauma, it's been pretty strong and I'm assuming that some of that is coming from your new plates, relatively new plates now, I guess. I've been hearing some noise about utilization of locking compression plates, penetration, where it is, maybe where it ought to go. Do you have a view on that at all?

Why don't I start be answering the first part of your question, which is surprisingly little of our business is from locking plates. As you know we've been very underdeveloped there and are really making more plans to come in '07 more seriously with our locking plates.

We're trying to gauge that marketplace. That market might slow down a little bit. Obviously some folks in that space have done a tremendous job with it. Our growth really was more the blocking and tackling of our current product line and Gamma 3 clearly driving a lot of the growth, but very little of it was locking plating.

Okay. And if I might, just one question on -- you mentioned, I think recon pricing. Is that -- or will you talk -- when you talk about price, are you talking about all price?

We're talking about all price.

Okay. I was just wondering if you had any color on how price has been doing in spine?

Still okay.

It's okay. It's down a little bit from where it's been year-over-year, as I think you would expect in that market, but it's okay.

The rate of increase.

The rate of increase.

Right. So if we think about it being something like 3 to 5% in the past, maybe coming down to like the low single digits, is that a reasonable way to look at it?

I think very much so.

All right. Well, thanks. I'll jump back in line.

Great. Thanks, Matt.

Tao Levy with Deutsche Bank.

A couple of quick questions. First of all, you mention in your 2007 guidance an indication of some pricing pressure in certain markets. I was wondering if you could maybe elaborate what you're expecting in '07 in terms of pricing and where you're going to feel the pressure?

Tao, right off the bat, we know -- Japan, we have a carryover quarter--.

Right.

-- of the impact from the April 1 reduction and we also know we have some additional reductions coming in January, pretty focused on the trauma product. That would be the thing that we know right off the bat that's really included in that comment. And I guess, there's nothing else specifically contemplated at this time.

Okay, perfect. And I was wondering, do you have any major impact from the strikes in Germany reflected in the quarter, or did that not really affect business at all?

We did. Clearly, between the community hospitals and then the [Brommel] hospital strike, that certainly affected our implant business and probably a touch of MedSurg, but probably more of the implant business in Germany for at least two months out of the quarter.

Okay, perfect. And just lastly, I'm back to the 2007 guidance. I don't think in the past you've provided next year's guidance this early. And I was just wondering what motivated you to provide it, maybe, is it just better budgeting or -- I'm just curious there?

Great question, Tao. Actually, I wanted to delay it and do it in January, but we have historically done it at this point in time, so we thought that we should stick with it. We might in the future move to doing it in January when we do the year-end wrap-up.

Okay, perfect. Thanks a lot.

Thank you, Tao.

Bruce Nudell with Sanford Bernstein LLC.

Thanks so much. First an OP-1 question and then a [Pedin] stretcher question. On the OP-1 side, Medtronic has shown about 90% fusion rates or so in an instrumented model using 20 milligrams of protein per side, per spinal level. You guys in an uninstrumented model will probably show fusion probably a lot less than that using 3.5 milligrams per side.

It's clearly an apples to oranges comparison, but how will you kind of, if that's in fact the case, negotiate the label that you get and the guidance you have to get to doctors to get kind of equivalent results? On the bed and stretcher side, could you provide an estimate of the market growth rate and is your extraordinary performance in that segment basically ascribable to your taking continued market share from Hill-Rom that had been a very dominant contender in that space. Thanks so much.

Well, Bruce, thank you. We're not going to be to get into marketing strategy discussions yet about OP-1. We think we'll be able to differentiate. You do point out, it is apples and oranges that both the milligrams as well as the studies are different. We think in the real world the clinicians are seeing the efficacy of OP-1. We obviously did do a -- what we consider to be the asset test study, which is uninstrumented and we feel good about that.

But we're not going to get into further elaboration given that we do have a product on the market today and competing with a very formidable competitor. On the bed and stretcher piece, we do feel that we've been doing all right there relative to the market. I think you can do the math and the numbers, we're pretty proud of our team, but there's still a lot of business out there that we don't have that we fight for every day.

And I would say, Bruce, I think we do feel like at least over the last nine months to a year the market has ticked up a little bit. There seems to be a little bit of a capital mini boom in terms of spending on some of this capital equipment that we certainly have seen and would expect to continue for a little while. I think if you look at the market growth rates, they are up from where they were if you go back a couple years or so.

But would you just say that the markets in the mid-single digits or so, or better than that?

I think it's probably a little bit better than that.

It probably has been mid-single in the last few quarters, it may be low double digits.

Thanks so much.

Sure. Thank you, Bruce.

Raj Denhoy with Piper Jaffray.

Thanks for taking the call. Just a couple questions, actually. The fourth quarter, your guidance for 11% for the full year, if we're doing the math correctly requires the fourth quarter be something on the order of 14.5% revenue growth and I think in the release you were talking about a point or so from currency.

So you still need to get something under 13.5% underlying growth. For the first half of the year, you've been averaging something on the order of 10.5%, maybe in this quarter it was just below 10%. If you look at the various avenues you have to get there, I was wondering if maybe you could just prioritize the product lines or the activities that are going to take place here in the fourth quarter that re going to give you that incremental 3 points of growth here?

Sure. A couple of things. First off, we're feeling better and better about our U.S. orthopedic business. We clearly think both instruments and endo will have stronger growth rates this quarter. So right there, you've got our three biggest product lines poised for a little bit better growth.

We also, to be fair, do have an extra day in the U.S. in the fourth quarter whereas we've been down a day the last two quarters. So it's one of those that, frankly, on an annual basis doesn't make a huge difference, but if people look at sequential growth rates one quarter over another, it is enough to skew by a couple of points. Dean, do you want to add anything there?

I guess the only thing I would say, Raj, is when we say 11%, that is something that could round to 11%. I don't want to push you too far on the math here, but we could have something a little bit lower on a local currency basis in the quarter and still achieve the number that we've talked about.

We will be double digit for the sixth year in a row, which we feel pretty good about.

Fair enough, fair enough. And just one other question. Any updates on Conserve Plus? And then also your own internal resurfacing product that you're planning on launching internationally? I guess, not the Conserve Plus, sorry, the product you're going to be launching for the Corin product, the Corin product.

Sure. The Corin product is under review at FDA and we've continued to say we expect that to be probably a first half '07ish approval. And the other product that we're launching, which is more of an internally-developed product in conjunction for outside the U.S. is launching, legitimately it will probably hit our sales line more in first quarter.

We're in the process of doing the educational rollouts and very early customer preference trials in the fourth quarter in Europe and in Australia, as well as Canada, frankly. But legitimately when will that start to affect sales, we would say probably not really until the first quarter.

But then on the Corin product, the domestic product, no update, it's just it's still at the FDA, but no updates as far as if there's been any activities or plant inspections or any sort of activities you expect in front of a launch?

We don't get into that level of detail on our approvals, but it is progressing.

Great, thank you.

Great, thanks, Raj.

Katharine Owen with Merrill Lynch.

Thanks, good evening.

Oh, it's Katherine Owen.

Couple of, I'm still getting used to it. A couple of questions. One on MedSurg, you had mentioned earlier about the slowdown overseas, which I guess I was a little surprised recognizing the first half was particularly strong, but as I recall correctly your percent of your business that comes from outside the U.S. is still very, very small. So I just wondered if you could give a little more detail on what contributed to that slow down?

Katherine, it looks like a little bit of it was a slowdown in advance of the new product launches as well. And frankly, the capital spending I think in Europe particularly in that third quarter looked pretty light. And whether it was the fact that August there was nobody around looked to be a piece of it.

So I think we still feel good about where those businesses are headed, but it was probably a little bit of a slowdown. I think MedSurg used to be so small internationally that they didn't necessarily see a slowdown in front of a product launch, so they probably did feel a little bit of it this time. Dean, do you have anything additional to add?

I guess the only other thing I would point out, Katherine, is if you break the businesses down, endoscopy, they grew 36 and 37% on a constant currency basis overseas in the first two quarters and I just don't know that that was realistically sustainable. I think Steve hit the nail on the head, where we really saw the slowdown for all intents and purposes was in instruments and that could have a little bit more to do with the product launches over there.

And then if I remember correctly from your last conference call, the heavy duty power drill launch took place in June, so in terms of the timing for the impact, is that a longer selling process in order to see some uptick for that, or was there anything going on in the sales side in terms of adjustments or realignment on the sales force that could have resulted in some delay in that really having an impact in the third quarter?

It's a great two questions, I guess, there Katherine. We have realigned a little bit within our instruments division to really set ourselves up for next year. And probably not all the territories have hit the ground running as fast as we would have expected with the System 6. The other part is, it's another one of these things.

We launched it technically on paper at the end of June, but realistically we only got it to a few dots at the end of June and it really started to roll out more in the August time frame, by the time we had it in more legitimate quantities. We were probably slightly ahead of ourselves in terms of thinking we launched it and checked the box and it probably wasn't as launched as we thought it was. It's -- we feel really good about where that's going to be headed.

And then just lastly on medical, it sounded like you guys were being more cautious, but to be fair you've kind of talked about the inevitable slowdown in medical that haven't yet materialized. Are you seeing something with incoming orders that we really should dial down expectations for that product or product line?

We're seeing a ramp down in our forecast from our division. The orders actually still look reasonably good right now.

I would say on that business, there is a pretty long -- there is a little bit of a lead time issue, so our guys do have a pretty good indication of when they'll actually be able to ship stuff. I think to Steve's point, the incoming orders in the business are still good, but I think we do expect the fourth quarter to be more along the lines of incoming orders to be more along the lines of what Steve has indicated.

We just, Katherine -- it's one of those funny ones, when you've been that strong and that far above the market for that long, we just ourselves want to be careful that we don't start to believe that we're going to continue that forever, but it is -- it's been a nice business and we're going to continue to do everything we can to keep it going.

Great. Thank you.

Thanks.

Bill Plovanic with First Albany.

Good evening. Just one quick question. In terms of the injunction that Synthes has received for their IM Nail, I believe, Smith & Nephew, would you expect an impact onto your trauma business from that?

I don't think it's that significant a part of the business that it's going to have a huge impact, but it certainly can't hurt us, Bill.

Okay, that's all I had. Thanks.

Great. Thanks, Bill.

Larry Keusch with Goldman Sachs.

Hi, good afternoon. Steve, just a couple of very quick ones for you. When you were talking about the first half '07 assumption for Cormet in the U.S., are you operating the assumption at this point that you do or do not need a panel?

You know what, we may not need one. But we're not sure. The reality is we'll take our lead, obviously, from the FDA, but it could go either way probably.

Okay. But again, that first half '07 assumption if you were to have a panel, you think you'd still fall in that range?

Yes, probably with a panel, it probably puts us towards the end of the first half. That's one reason -- it's the same with OP-1, with all these approvals through the FDA. The FDA is not moving quickly on things these days, and it's -- we just want to be careful, not overly hyping and saying these things are coming until they come.

Okay. And then two other questions. Can you talk a little bit just about the trends that you're seeing with X3 poly in the knee market? You're obviously the only one out there with this highly, highly cross link polyethylene. Is that a good thing, or was it better to have more players out there pushing this technology within the knee?

Hey, we think it's a great thing. We like being different and unique and we think it's a big part of what's contributing to our -- what we consider to be, and I think the market would bear it out over the last few quarters, I think some pretty good knee growth.

And I think to add to that, Larry, our story about motion fit and where with the Triathlon product with the X3 is really paying off. I think it's a nice combination for us and it is contributing to that knee growth.

There's no doubt the growth is terrific. Are you willing to part with any sense of what percentage of Triathlons are going in now with X3? Or knees in general with X3? However you want to look at it.

I don't have at the tip of my fingers a percentage of that, but the growth of X3 and Knees is very strong, so I think it's a reasonably good percentage. Maybe a -- certainly probably a little bit more than we would have anticipated.

Okay. Then lastly, just help me think about, again, sort of the growth year-over-year when you're comparing this quarter to last year given the impact of Katrina. Is there -- have you guys tried to take a look at again, what normalized growth might be?

Well, we didn't net that out as much given the strength -- the way we looked at it, we have one less selling day this year, last year there was Katrina that affected a small part of the U.S. in the month of September. And it also affected, frankly, some of Houston and Texas as well, because it was a follow-on hurricane as well, I can't remember which one that was. But it probably nets out.

Okay, perfect. Thanks, guys.

Great, thanks, Larry.

Ben Andrew with WM Blair & Company.

Hi, good afternoon. Just a quick question. I don't think anybody has really touched on spine implant growth. Can you talk about your expectations there? That has been relatively strong here in the mid-teens on, I guess some new product launches.

Yes. I think we continue to see at least mid-teens performance out of our spinal business. As you know, particularly in the U.S., we've been very strong here now for probably ten quarters or so in the 15 to 20 range and we would hope to keep it at least in the mid-teens' range going forward and I think we're getting a little more focused on building it outside the U.S. So we would certainly hope to keep it in that range, Ben.

Okay. And then turning to SG&A, you talk about getting a little bit of leverage out of that next year. Is that because you're happy with the scale of the organizations in terms of some of the buildouts you've made in the recon space or, I guess, where would you be making investments in 2007 in the sales organization?

Are we happy with it? If anything, I would say we have overexpanded on a couple of areas and think we're going to grow right into where we want to be. I think we feel very good about where we are.

One of the things that we certainly hope to get some leverage on is some of the instrumentation that we put out, there was some of these new product launches. Ben, that's a big cost to us as we've talked about before and we've been pretty heavy there and we certainly would hope to continue to leverage that a little bit as we go into next year.

And then just briefly on the knee side, with the acceleration and the growth there, and obviously, some of that's due to X3, which I guess is a mix issue, is that becoming a meaningfully greater percentage of the growth, or are you really seeing strong volume pickup just utilizing X3 as well?

We're seeing very nice volume pickup. Clearly mix is a piece of that, but fundamentally what we're very thrilled with is the continued uptick and interest in our Triathlon knee. We're now several years into this thing and it's still breathing new life. To have just had our best quarter in the last nine in the U.S. at this stage in the life cycle, we're feeling very, very good about just raw, underlying unit demand there.

Okay, great. Thank you.

Great, thanks.

Michael Matson from Wachovia Securities.

Sure. In terms of the resurgence that you guys have had in the orthopedic implant division, do you have any sense as to whether that is just specific to Stryker due to the blocking and tackling and so forth that you pointed out, or do you feel that the overall industry is just kind of picking up and that's carrying you along with it?

Mike, we probably always assume when really good things happen that it's more the market than us. But underneath it, we've been working pretty hard and feel pretty good about what we're doing. I think when the numbers settle in for the quarter, we'll probably see. But I do think at the pace we're at, when you look at the year in hindsight when we finish the fourth quarter, our hunch is that our U.S. recon business will be one of the better growers in the industry.

And that's clearly a far cry from where we were a year ago. Some of it's market and I do think the market probably is -- I think we think it may be stabilizing as we said and probably some good signals in the market. We also do think we've done an okay job and still have a ways to go.

Okay. And I haven't heard a lot of questions on this, but I'm interested in learning more about the anatomic heads and your marketing strategy there. How are you going to position this -- I guess you're going to try to position it against the large head metal on metal heads, but it may be at a lower price point. Is that a reasonable assessment?

I think you should assume absolutely on the first part, which is, we're going to go head to head against metal on metal heads, large heads. And we think we've got a meaningful point of difference that the surgeon community, quite frankly, is very interested in.

But we're not necessarily going to make it a price game either, but I do think we've got a pretty compelling proposition. We just rolled it out at the very end of September and I would tell you that our salesforce is probably as pumped up about this particularly since they haven't had a lot on hips since ceramic on ceramic and again we feel pretty good about where this is going to lead us.

And just the range of sizes that are offered there, I noticed some of the large head metal on metal goes up to something like 60 millimeters, is that, how does that stack up?

We're not quite -- we don't have quite the largest of the largest sizes yet, but -- and to be honest, I can't remember exactly what the largest one is. But it's clearly taken us into the 44 and some of the other millimeter disk ranges that we have not been, particularly since we've not offered metal on metal.

Okay. And then, just your sense of -- I guess Dean kind of hinted at this earlier, but the capital spending boom that we've seen in the U.S., particularly at hospitals. What's your sense of that? Do you think it's going to continue through '07? And then, any kind of insight you can give us into the actual mix of capital equipment at MedSurg overall? In other words, what percentage of the business is capital versus disposal-type products?

Mike, I would say we do expect that spending pattern to continue for a while based on what we're seeing. Relative to the mix of capital equipment, it varies in the businesses. Our medical beds and section business is virtually all capital. Our instruments business is much more heavily weighted away from capital and towards more disposable business and then endo is somewhere in between, but a little more heavily weighted towards capital when you look at a balance.

All right. That's all I've got. Thanks a lot.

Great, thank you.

Steven Lichtman with Banc of America Securities.

Great, thanks. Hi, guys. Just a few questions. New product flow and reconstructive implants, you touched on it, but can you walk us through over the next six to twelve months what exactly we should look for? You talked about anatomic heads near term and then you talked hip resurfacing first half. I think you also did a deal with Corin on Uniglide. If you'd just walk us through, have we -- have I hit it all there in terms of new product flow and recon implants?

Yes. That pretty well covers it -- we've got a lot of the Triathlon stuff that's out there. We've been making additional expansions as to the Triathlon line. Anterior referencing, some sets on that and a lot of what we call blocking and tackling to round out Triathlon, plus X3, those coming in, and then really the anatomic heads, as you say, are the big driver for hips really for what should carry us well into next year. And then beyond that, the hip resurfacing hopefully hitting at some point. The Uni knee market is one we've been a little underdeveloped in and probably wouldn't expect major moves in that in the shorter term.

And on Uniglide specifically, Steve, I would tell you that that we believe would be a requirement and there's not a trial that started there yet, so that's nothing something that you should put in any immediate plans.

Got it, thanks. And then Steve, can you talk about Stryker's view on direct to consumer, obviously very successful a couple years ago with that specific product. What are your thinkings on DTC looking forward?

We see that patients are going to continue to want more information and we continue to dabble with how to get them that information and probably are doing a little bit more on the web and other ways than necessarily the TV stuff. I think you'll still see us play around with TV from time to time or other mediums. We do think, frankly, it was great at accelerating the market. There's probably a little bit of a question mark in our minds as we look at both the way the hip market accelerated and then decelerated and then frankly, the way the knee market did when J&J was advertising their knee, that market kind of expanded and then seemed to contract a little quicker and we think we did the same thing with hips.

One of the things we're trying to check, is did we just pull some people forward, and -- or did we really grow the market. We clearly grew the market in the short-term. We weren't as sure about whether we grew it in the longer term. But we think that the demand for patient education is a growing and an exorable course that we need to be there with.

Thanks. And then lastly on Sightline, can you just help us walk us through in terms of the next 12 to 24 months, what we should think of as the potential impact there and what are the milestones we should look for as products roll out from Sightline? Thanks.

Well, we, again, for competitive reasons, haven't wanted to give specific timing and plans away, but we would expect that in '07, we'll be on the market with the initial products from Sightline.

But I do think we'll also be incurring reasonable costs to build a salesforce out there in that time period as well, Steve.

Yes. It's clearly dilutive -- frankly, it's dilutive to us this year and we're covering it and it will be dilutive probably for all of next year as well.

With the impact in '08 and beyond?

Yes, in terms of a more meaningful impact, yes.

Okay, great. Thanks, guys.

Great, thank you, Steve.

Michael Weinstein with JP Morgan Securities.

Thank you. Thanks for sticking around for some late questions. I just wanted to circle back, we were still having some math problems year. Maybe going back to Roger's question early in the call from thinking about the fourth quarter relative to the third quarter. The third quarter constant currency is up just under 10% and you guys are implying about 13.5% plus or minus for the fourth quarter and was hoping just to get a better read on the improvement that you're seeing in the business or expecting over the next few months that caused the acceleration.

Sure. Again, Mike, we would probably say, we expect instruments to accelerate, we expect endo to accelerate and we probably expect U.S. ortho to continue to accelerate. And part of it in U.S. ortho is an underlying trend that's getting stronger, and the other part, which frankly, looked like all of our implant businesses is an extra selling day in the U.S. So--.

Is that year-over-year, or sequentially there's another day?

Year-over-year, but it's also sequential. If you look at third quarter, we had one less day, third quarter this year than last year. Fourth quarter, we have one more day than we had last year. So the delta on the percentages, that frankly, is worth probably 2 to 3 points almost right there.

But the total number of selling days is not accelerating from the third quarter to the fourth quarter, just because of the holidays, the fourth quarter is always a lower number of days. I'm not sure how you're asking the question.

I understand what you're saying. Dean, I don't know if you covered, I think you covered inventory but I think it missed it, but the inventory days this quarter versus last quarter and the uptick there?

It was 138 days versus 128 last year and again, the biggest pieces there are really some of the new products that we've had coming out and I would tell you though, I also said that we're not quite as happy as we would like to be with how we're managing that asset and we will be putting increased effort on bringing the days down. But we also want to keep a balance there in terms of, we know we're going to need inventory going into the start of next year, so we don't want to run them down artificially. But we know we've got work to do there, but the new products have contributed too.

Great. That's all we needed. Thanks.

Great. Thanks, Mike.

[Dulsini Desoysa] from SG Cowen.

Thanks for taking the call. I was wondering, just have a few cleanup things. Could you -- this is expanding on Ben's question -- U.S. salesforce and recon today versus a year ago, either as absolute numbers or a percentage change?

It's up modestly in terms of actual territories. We've probably got a little more in terms of sales support where the numbers have grown a little more, Dulsini. But overall number of territories is up really just modestly.

But reps per territory, I think your comment was that you've maybe overbuilt and hope to grow into it. Is that specifically in the U.S. recon?

No, that's probably in a couple of other parts of the business. I think in Europe, we've expanded pretty quickly in some of our salesforces, particularly as we've tried to ramp up for MedSurg over there, as well as reacting to some of the growth, particularly that we're seeing early in the year over in Europe and our implant businesses.

What we're also trying to do is get better at building out a spinal organization around the world, a dedicated trauma organizations around the world. So where we see pockets for each of our businesses, we've really taken it when times are good and continued to invest and get more feet on the street really in each pocket that we look at around the world. So overall, I think we've built pretty aggressively this year that should help us as we go into next year get some leverage.

Okay. So the U.S. business, the recon you think is just up modestly?

Yes.

Okay, great.

Number of territories.

We have and we've talked about this before, Dulsini, added some sales associates and our intention is probably to increase the territories as we go into next year.

Okay. And then this question of the fourth quarter and sort of the sequential ramp, first, it seems that that's sort of a seasonal pattern we see with Stryker and others, but also is it fair to assume that you have sufficient visibility on the capital equipment orders to have conviction that the MedSurg business will come in higher than the 14% growth level you've posted and that will help pull up whatever happens -- whatever good stuff happens on the implant business?

I think that's fair to say, Dulsini. We've talked about the expectation on the ramp on some of these new products and I think we do believe that's going to be real in the fourth quarter here. So I think it's fair to say that we are expecting the number to be a little bit higher than 14%. It has to be to drive that expectation that we have out there for the fourth quarter.

Okay. And that wouldn't be really outside of what we've seen in the past as well?

I think with these new products, it might be a little bit, but not significantly probably. We've always had strong fourth quarters in those businesses.

Great. Then just one other thing. Uses of cash, I think you still have no share repurchase plan, if I'm correct?

You are correct.

Am I correct?

Yes.

Okay, okay. Any plans for one? The stock has--?

We'll continue to look at it as we go through things and at some point we might even contemplate, do we at least initiate a plan that kind of offsets dilution, something to that affect. But we're going to continue to look for other ways to deploy the cash as well. But we might want to at least offset dilution at some point.

That's it for me. Thanks very much.

Thank you.

Mr. MacMillan and Mr. Bergy we are showing no further questions at this time.

Great. All right, then. Let's wrap it up here. I think, again, hopefully you all got a feeling that our U.S. recon business particularly is back on track. We're feeling very good about where that business is headed. We feel good about, frankly, where our endo and instruments business will go in the fourth quarter and look to be finishing the year on hopefully a pretty good note. And we'd let you know right now that our conference call for our fourth quarter 2006 operating results will be held on January 25, 2007. Thanks everyone, and thank you, Noah.

You're very welcome. 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.