史賽克 (SYK) 2007 Q1 法說會逐字稿

Good day ladies and gentlemen and welcome to the first quarter 2007 Stryker earnings conference call. My name is Eric and I'll be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. If at any time during the call you require assistance press star followed by zero and a coordinator will be there to assist you. As a reminder this conference is being recorded for replay purposes.

Certain statements made in today's conference call may contain forward-looking statements. They will be based upon managements 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 this call, such factors include, but are not limited to, pricing pressures generally including cost containment measures that could adversely affect the price or demand for the Company's products, regulatory actions, unanticipated issues arising in connections with the clinical studies and eventual United States Food and Drug Administration approval for new products, changes in reimbursement levels from third party payers, a significant increase in the product liability claims, changes in economic conditions that adversely affect the level of demands 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 others are contained in the Company's filings with the Securities and Exchange Commission, including the Company's annual reports for Form 10-K and the quarterly reports Form 10-Q.

Today's conference call will also include a discussion of adjustments to net earnings including an impact on the quarter ended March 31, 2006, [starts to] write off purchases, in process search and developments associated with the acquisition of the Sightline Technologies Limited. Further discussions of this non-GAAP financial measures include a GAAP reconciliation appears in the Company's form 8-K filed today with the Securities and Exchange Commission which may be accessed from the -- for investor chart -- page on the Company's Web site at www.stryker.com. Now I would like to turn the presentation over to Stephen MacMillan, President and CEO. Please proceed.

Thanks, Eric. Good afternoon everyone and welcome to Stryker's first quarter 2007 earnings report. With me today are Dean Bergy, our Vice President and Chief Financial Officer; as well as Katherine Owen, who joined us in February as Vice President of Corporate Strategy and Investor Relations.

Following a strong fourth quarter and full year 2006, we are pleased to report that 2007 also began on a strong note. In the quarter, net sales grew 12.7% as reported and up 10.9% operationally to $1.489 billion, and at the high-end of our expectations for the quarter. As usual, additional commentary on sales numbers will focus on operational growth rates while the reported numbers will of course this quarter be higher. Adjusted net earnings were up a strong 22% and reported net earnings were up 65% from last year due to R&D charges for the Sightline acquisition in last year's first quarter. From an executional standpoint, we were pleased to show continued strengthening throughout the P&L as gross margins improved by 90 basis points in the quarter versus last year to reach 66.6%. Comparative operating cash flow was up significantly as well.

Our results for the quarter reinforce the resurgence of our U.S. orthopedics business, continued momentum in spine, ongoing rock solid contributions from our key MedSurg franchises and, this quarter, a welcome strengthening of both our European and Pacific businesses. All of these businesses posted double-digit sales growth and three of our five U.S. orthopedic implant franchises topped 20% growth. The breadth of these strong performances allowed to us absorb expected sales declines in both Japan and our physiotherapy business. In total, eight of our nine key global franchises again grew at double-digit rates and we were pleased that both our global hip and knee franchises accelerated their growth rates from last quarter. Triathlon continues to set the pace for our knee franchise, which grew 17% in the U.S. and 14% globally. This also marks our 26th consecutive quarter of global double-digit knee growth.

Each quarter we often have one or two performances which really stand out. And this quarter it is our U.S. trauma business. After four straight quarters of 20% plus growth last year, our team really knocked it out of the park with exceptional 31% growth this quarter. This growth helped offset softer international results which were particularly affected by the sharp price cuts in Japan. Our spine franchise also continued its winning ways posting another 20% plus quarter in both the U.S. and globally. This marks 10 of the last 12 quarters where our U.S. spine business has grown 20% or greater. Meanwhile, this quarter also saw every geographic region generate double-digit spine sales growth.

Our MedSurg businesses also continue to click along as our endoscopy, instruments and medical franchises posted global growth rates of 15%, 14% and 13% respectively. And the expansion of our endoscopy and instruments franchises outside the U.S. is continuing to gain traction with international growth rates of 20% and 18% respectively. Behind the international momentum and solid incoming order rates these franchises should be in good shape for the year.

We were also pleased this quarter by the bounce back in our European and Pacific divisions, both which posted double-digit sales growth and up significantly from fourth quarter. Pacific was up 14% and Europe up 12%, with each region showing substantially improved growth rates in recon and very strong MedSurg growth. In fact, MedSurg was up 19% in Pacific and a very strong 24% in Europe. We are reasonably optimistic that these regions are well-positioned for the year.

On the regulatory front we'd like to update you on three of our key programs, OP-1, U.S. hip resurfacing and artificial discs. On OP-1 we are currently in discussions with FDA about a game plan to generate additional data for the full U.S. approval. As most of you have already anticipated, this clearly pushes our expectations for approval out significantly. While more work remains to be done, we remain committed to this great product and are pleased that the work we've done over the last few years to enhance our R&D pipeline across all our businesses have put us in a position to sustain our growth while continuing to develop OP-1.

To that end we are very pleased to report significant progress on hip resurfacing. As you know in late February, an FDA advisory panel voted four to one in favor of approving the Corin PMA and we are currently working with Corin and FDA to gain approval. Our hope is to secure approval during the year and begin a very thorough surgeon training program with meaningful sales impact beginning next year. As a reminder two years ago we had no resurfacing program. Today, we have now entered the market outside the U.S. and are on the verge of being second to market in the U.S. Moving to artificial discs, we are currently compiling the Flexicor PMA and expect to submit it to FDA this quarter.

In summary, we believe we are off to a healthy start toward our key goals for 2007, which is, one, delivering a seventh straight year of double-digit sales growth and, two, delivering 20% earnings growth for the year to $2.42 per share. As we've said before, we are also far from perfect and each quarter we continue to find new opportunities to improve our own performance. But with strong underlying procedural demand and a stable organization very focused on strong execution, we feel good about our ability to continue delivering superior growth in the coming quarters. I will now turn it over to Dean for more details.

Thanks, Steve. I'll begin with the impact of foreign currency on our top line. International sales were favorably impacted by $24 million in the quarter aiding the Company's overall sales growth by 1.8%. This was near the top end of the range we estimated during our last earnings call. In the first quarter the dollar weakened approximately 9% against the Euro and strengthened about 2% against the Yen compared to the prior year. And if currency rates hold near current levels we expect the impact of foreign currency will increase second quarter 2007 sales by about 1% to 1.5% when compared to the prior year.

Now I'll turn to an analysis of the price volume for the quarter, and it's pretty simple, foreign currency as I've just said impacted grew sales by about 2% and the rest really all came from volume mix so 11% volume mix adding up to that 13% total sales growth. Selling prices were up domestically but this was offset by a decline in international prices leading to the flat impact of selling price. International pricing saw the dual impact of MHLW reimbursement cuts in Japan on both April 1, 2006, and January 1, 2007, with prices in Japan down about 9% in the first quarter. As you know an additional Japanese price reduction took place on April 1, 2007. And we still expect overall Japanese price cuts to reduce our sales in this market by about 7% to 8% in 2007. As I said, volume and mix contributed 11% to our first quarter sales growth with the domestic volume mix up 12% and the international growing 9%. And keep in mind that the international growth was achieved with one less comparative selling date in the first quarter.

Now I'll turn to our sales by product segment. Orthopedic implants, as you recall, represents 58% of our sales and sales of those products increased 13% in the first quarter on a reported basis and 10% on a constant currency basis. Now we've included the sales growth rates by product line in our press release and I'll reference those rates as I provide more detail on performance in each product category. So turning to hips, which were up 7% in dollars and 4% in local currency in the first quarter, comments here, although we still have work to do, global hips registered their best growth rate in their last seven quarters. U.S. hip sales were up 4% in the first quarter, a rate that slightly topped last year's fourth quarter on an average daily sales basis. U.S. hip growth was led by our Accolade and Restoration modular revision products. Sales of X3 polyethylene inserts were extremely strong in the quarter. And our hip fracture business was about flat in the quarter in the U.S. European hip sales grew at high single-digit levels operationally led by Exeter, Trident, Accolade and Restoration modular. In Japan, local currency hip sales declined at low double-digit rates. The first 10 points of the decline are due to price, but we also saw slight unit declines in our cemented and bipolar business offset by a very modest uptick in sales of cementless hips. Constant currency hip sales in the Pacific grew at mid to high single digit levels led by Accolade, X3 polyethylene and sales of our recently launched MITCH resurfacing product.

Now turning to knees, they were up 16% in dollars and 14% operationally in the quarter. Knees posted another great quarter in the U.S. market with sales up 17%. Primary knee sales were up 20% with continued strong growth from Triathlon and X3 polyethylene. Revision knee growth was around mid-single digits levels led by Scorpio. Knee sales outside the U.S. bounced back from a very soft fourth quarter to post 8% constant currency growth. In Europe, knees matched the international norm in the quarter with growth generated by sales of Scorpio and Triathlon products. Japanese knee sales declined at high single-digit operational levels with units close to flat and the price reductions contributing most of the overall decrease. Pacific grew its knee business over 20% on a constant currency basis in the quarter fueled by a strong uptick of Triathlon and excellent growth in Scorpio. Canada and Latin America also posted double-digit operational growth in knee sales with Triathlon leading the way in Canada and Scorpio in Latin America.

Trauma was up 14% in dollars and 11% in constant currency in the first quarter and our U.S. trauma business had a truly exceptional quarter posting 31% growth, a percentage that is unaltered when military sales are excluded. This is the fifth straight quarter this unit has surpassed 20% sales growth. We are analyzing this business a bit differently internally with a focus on hip fracture, lower and upper extremities and foot and ankle. Suffice it to say all categories did well in the U.S. with our Gamma 3 hip fracture devices, T2 intramedullary nails and VariAx Distal Radius products leading the way. International trauma sales were flat on an operational basis. Our European local currency trauma sales were up slightly above mid-single digits but our Japanese trauma business posted double-digit operational declines with slight volume improvements more than offset by price reductions that were just below mid-teen levels. Canada and Latin America posted very strong local currency trauma growth on a small basis.

Spine was up 22% in dollars and 21% operationally in the first quarter and our spine business obviously had an excellent quarter around the world. The U.S. business had another great quarter with all product categories contributing to overall growth of 22%. Percentage growth was led by interbody devices and cervical products. International spine sales grew 18% operationally with extremely consistent growth rates in the interbody, thoracolumbar and cervical categories. Operational growth was strong across the international geographies with every major unit growing at double-digit rates in the quarter led by Europe, Latin America and Canada.

And then last but certainly not least within our implant businesses our CMF franchise was up 18% in dollars and 16% in local currency in the quarter. Our CMF business had another great quarter domestically, 23% U.S. growth was led by neuro products and our hydroset injectable bone substitute. Sales outside the U.S. grew a more modest 5% in local currency led by Pacific, Europe and Latin America.

Now turning to our MedSurg group, this represents 38% of our total sales. The MedSurg group had a very solid quarter on a combined basis. And as a reminder, MedSurg is comprised of three significant product categories. Instruments makes up 16% of the total sales, Company sales, endoscopy 14% and medical 8%, adding up to that 38% total of Company sales. MedSurg group sales were up 15% for the quarter in U.S. dollars and 14% in constant currency. Strong international growth in instruments and endoscopy, the portions of MedSurg where we have emphasized additional overseas focus, helped fuel the group's growth this quarter.

And now some additional comments in each of those business lines, sales of our instruments product line increased 16% in the first quarter as reported, and they were up 14% in constant currency. Our instruments business posted a good first quarter with solid domestic results buoyed by nice growth overseas. U.S. sales growth of 12% was led by strong sales growth in heavy-duty power tools and other surgical equipment as well as neuro, spine and ENT products. This was offset somewhat by a slower quarter in microsurgical and navigation products. International sales of instrument products were strong across most product categories with Europe leading the way from a geographic standpoint.

Now turning to endoscopy, they were up 16% in the first quarter as reported and 15% operationally. Endoscopy also benefited from great international performance in posting a very good quarter. Our U.S. business was up 13% in the quarter on the strength of growth in video, communication and imaging equipment sales. International sales were particularly strong in Europe and Pacific with our throscopy and general surgery products leading the way. And last, again, but not least, our medical business was up 13% in the quarter on both a reported and constant currency basis. Medical had a good quarter, U.S. sales growth was led by an excellent quarter in stretchers, followed by beds. International sales were strong in Latin America but were hindered by a soft quarter in Canada.

In the last segment of our business, physiotherapy represents 4% of our sales, sales for that business were off 5% in the quarter. This sales decline is in line with what we saw in the second half of last year and with the overall reduction in clinics on a year-over-year basis. And we did end the quarter with 475 PT clinics, down from 502 at this same time last year.

Now I'll make some comments on the remainder of the income statement. Gross profit margins in the quarter were up 90 basis points on both a sequential basis and as compared to the prior year. We are gaining leverage from improved plant efficiencies and cost reduction activities along with stronger relative growth in recent quarters from our higher gross margin U.S. implant businesses. This leverage was partially offset by higher excess and obsolete costs associated with the implant businesses. R&D spending was up 10% in the quarter. Our R&D pipeline continues to be pretty full and we continue to devote significant resources to the development of acquired technologies. R&D spending is up at most of our divisions. SG&A costs increased 13% in the quarter, about in line with the rate of growth in sales. Sales related costs accounted for the majority of this increase. These costs include compensation and higher instrumentation amortization costs, associated with our orthopedic implant products along with continued investment in our sales forces. So after adjusting for last year's $52.7 million first quarter charge for purchased in-process research and development associated with the Sightline acquisition, operating income increased 18% in the quarter and operating margins increased to 21.8% of sales.

I'll give you a brief break down on the components of other income and expense for the quarter. That total was $13.8 million. That's made up of investment income of $16.6 million, offset by interest expense of $2.6 million and a reduction for minority interest of 0.2 million or $200,000. And the tax rate, the Company's effective income tax rate for the first quarter was 28.2%. This rate is down nicely from the effective rates for last year's first quarter and that for the year ended December 31, 2006. And keep in mind those rates for those prior periods reflect the impact of a non-deductible charge for Sightline purchased and process research and development. The first quarter rate is consistent with that for last year's fourth quarter. However, we continue to believe there will be downward bias in the rate as we look to the future.

On the tax front we also adopted the provisions of financial accounting standards board interpretation number 48, accounting for uncertainty in income taxes during the quarter. As indicated in our press release this resulted in a modest $7.6 million reduction in the beginning January 1, 2007, balance of retained earnings and a reclassification of certain tax liabilities from current to non-current in our balance sheet. Speaking of the balance sheet, that continues to be in very good shape. Accounts receivable ended the day -- the quarter at 57 days. That's on par with the prior year's first quarter and up just one day from the end of the year. Inventory days finished the quarter at 129 days, 10 days above the March 2006 level, and up 7 days from year-end 2006. However, this was in line with our plans as we consider new product inventory needs and continue to work toward running the plants at more consistent rates throughout the year. And lastly on the balance sheet, at the end of the quarter we had just $15 million of debt outstanding and then some good news, we meet with the credit rating agencies on an annual basis and are pleased to report that Standard & Poor's raised the Company's corporate credit rating to A plus from A during the first quarter.

And then finally on cash flow, we had a strong start to the year from a cash flow perspective. The first quarter is always more difficult because a number of expenses accrued at year end come due for payment, so we were pleased to generate $153 million in cash from operations this quarter compared to 21 million at this time last year. And we do believe we're in great shape to have another excellent year on this front. With that I will turn it back over to Steve.

Thanks, Dean. Before wrapping up this section with our outlook we thought you might want to here from Katherine Owen, who joined us about two months ago. As many of you know, Katherine was in your shoes for many years and we thought you might enjoy hearing some quick initial observations from her now that she is on the inside. Go ahead, Katherine.

Thanks, Steve. I'll keep this brief, but there probably are four key things that I would focus on as being the biggest insight since I joined. The first would be the breath of the R&D pipeline across the businesses, with the biggest upside surprise in recon, endoscopy and medical. It's very clear that the increased investment in R&D made in recent years and changes to the R&D organizational structure particularly in recon should translate into a really attractive new product flow going forward. The second would be the pipeline of products currently set for approval in Japan over the next few years. And that should help blunt the impact of reimbursement price cuts. I think it's probably fair to say that the organization historically wasn't as aggressive in pushing products through the Japanese registration process. So there was a noticeable lag from U.S. European launch until these same products appeared in Japan. A lot of effort has been made on accelerating this process.

Thirdly would be the magnitude of investment in numerous sales forces throughout the organization. Some of which you're aware of such as spine, which has helped drive top line growth and share gains but has in some cases depressed operating margins. Going forward it looks like several of these divisions are really well-positioned to see strong operating margin improvement. And I think fourthly, to be fair, it was a little disappointing that there isn't greater clarity on the timing of the U.S. OP-1 full spine launch which continues to be difficult to peg as Steve had mentioned. On the flip side having spent some time at the biotech facility, the amount of investment in personnel with a strong biotech expertise is readily apparent and the potential applications for OP-1 in other indications really suggest this could be a major long-term franchise product. Steve?

Great, thanks, Katherine. It's actually been a lot of fun being in meetings with Katherine her over the last six or seven, eight weeks and seeing her adjust from the outside to the inside and getting a peek from the other side.

We'll now move to the '07 outlook. With a good first quarter in the bank, we like our prospects for delivering strong results in 2007. Our U.S. orthopedic business is back on track. Our Pacific and European businesses are strengthening to help offset the challenging Japan environment. Our spine business continues to be strong and our MedSurg businesses also continue their ongoing track record of excellence. And as you can clearly tell from our P&L, we continue to make steady and meaningful progress in strengthening our gross margins, yet are reinvesting the proceeds into R&D and our sales forces, moves that we believe will allow us to sustain our growth in the quarters and years ahead. Net, we are confident that we will deliver a seventh straight year of double-digit sales growth and are well on track to deliver 20% EPS growth to 2.42 a share for the full year. We will now open it up for questions and answers and we'll probably ask that -- if people could just limit it to one question and potentially one follow-up. So, with that we will go right ahead here -- go ahead Eric if you want to open it up for questions, please.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Mike Weinstein with JP Morgan. Please proceed.

Thank you. Congratulations on your quarter.

Thanks, Mike.

Let me, a couple items, most of the quarter pretty much played out as expected, which was obviously strong. Could you just comment on a couple of things? One, on Sightline, an update on the timing of the launch there? You mentioned, second you mentioned Flexicor but you haven't mentioned Servicor in awhile so I was hoping to get an update there. And then the last item if you could, Steve, is just talk about use of cash, another quarter has passed, you guys are now approaching 1.5 billion in cash. Obviously, you had the potential to do major acquisitions, major share buybacks and we're all kind of each quarter waiting to see what the Company does. Can you just give us an update there? Thanks.

Sure. Good questions, Mike, I thought you'd open with OP-1 but it looked like you pretty well nailed where we are on that one. Regarding Sightline I think we're looking at really a second half '07 launch. And I would tell you the final preparations on the product there are moving along pretty well and we're getting ramped up and expect to have that certainly hit the market hopefully here in the second half of this year primarily in the U.S. and international probably more to follow next year. On the discs, the Servicor enrollments are still going on and we would hope that that will finish the enrollments on that probably in the third quarterish of this year and then obviously start the follow up studies for that. So Flexicor is clearly probably a couple of years ahead of Servicor but we continue to be excited about both.

And use of cash, at this point it's one of Katherine's good challenges here as she comes in. But I'd say, think about it as continuing to look for probably smaller and maybe some medium-sized acquisitions. I think we've clearly been building up the pipeline. Some of the next stages might look to see if there are some other new adjacent areas that we could enter and, frankly, if we don't do much acquisition activity by the end of the year we're obviously going to be in a pretty good strong cash position and at that point we might contemplate certainly probably buybacks or something to that effect. See we're comfortable right now continuing to build the cash to give us a lot of flexibility and we'll probably continue to see how it plays out here in the coming quarters.

If I could just follow up. So how should people think about the potential for a major acquisition? Where you would not just adding a complementary technology but adding another platform.

We are at a point, Mike, where we could certainly do, frankly a several billion dollar acquisition and absorb it, frankly by the end of this year we'd be able to do one of that and not even have to take on any debt, probably. So I think our ability to think on a bigger scale than where we've been over the last years is there, but I also don't want to -- we're also going to continue to be diligent and do it. But I will tell you we're not going to be scared off by something now that could be in the billion dollar plus range versus the 1 to 200 million or $50 million kind of things that we've been doing. We probably will need to ramp it up to a higher level.

Great. Thank you.

Thanks, Mike.

Next question comes from the line of Raj Denhoy with Piper Jaffray. Please proceed.

Thanks. Maybe if Mike wasn't going to ask this question I can on OP-1. I'm just curious if maybe you could you outline what exactly the FDA is looking for, maybe what that's going to look like going forward? You obviously mentioned additional data. Does that require additional trials, and has questions on the design of the trial, the dosing in the trial that was completed -- has that been raised? And maybe just some additional color there would be helpful.

Sure, Raj, and I'd like to give you a lot more but we are literally toing and froing with the FDA right now and don't want to get ahead of ourselves in terms of that dialogue. I think you should suffice it to say that we think there's probably some additional data that we could bring to bear potentially without even doing a full blown additional clinical trial. But we're talking about that and we feel the burden's on our back to prove certainly the efficacy of this product which we know is there and we know the safety is there. We are toing and froing a little bit with the agency right now and will try to probably give you an update certainly on the next quarterly call. But at this stage you're certainly best off as many have done in terms of I wouldn't have much expectations, certainly '07 or '08. And I would tell you we're planning to continue to grow the Company just as we've been doing with that still thinking about it frankly as upside in the further out years.

Okay. Fair enough.

Sorry I can't give you more. I hope you understand we're talking to the FDA.

Absolutely. That's completely fair. Then just on the U.S. hip business, maybe I could ask about that, it decelerated just a tick here in this quarter from 5% down to 4% and it continues to languish. And I'm curious if you could just outline when we might see that turn, I know we've been expecting it for some time now and maybe just and update on what's going there.

Sure. Probably a couple of quick things. One is on an [EPS] basis we actually modestly accelerated this quarter. Last quarter had an extra selling day so it made it look like a bigger bump. Having said that we're still not overly thrilled. I would tell you one of the things I think we're seeing in our U.S. sales force right now is there is so much momentum behind Triathlon and they're probably to some degree taking the path of least resistance which is continuing to go and sell more Triathlon and converting competitive surgeons in that business and we're probably not getting quite as much focus yet on hips. We think, frankly, when the hip resurfacing program gets approved in the U.S. that's probably going to be the real catalyst to -- along with some additional product activity we have coming and I think when we're here in '08 we're going to be feeling pretty good about our hip business at that point. But I wouldn't expect a dramatic pick up yet this year. It's going to be a build.

Okay. Great. Thanks a lot.

Thank you, Raj. Next.

Next question comes from the line of Bruce Nudell with Sanford Bernstein. Please proceed.

Hi. Great, thank you. Steve, we saw something pretty anomalous in the IPPS report, namely that the Medicare case count for hips and knees '06 to '05 was actually down slightly. I suspect that there was some methodological issue, maybe a greater shift to managed care. In any case, could you just comment on your perception of the hip and knee market unit volumes in the United States last year? Were they around the average 7% or were they somehow a lot lower than anybody thought? And I guess the follow up is, could you guys give us any sense of the trajectory going forward of the gross margin structure of the Company? Thanks so much.

Sure, I think we did feel a little bit of a unit slow down last year. And whether it was a combination of frankly there was more direct to patient activity probably in the previous year and did some of that fast forward, there wasn't a lot of new product activity last year in the industry. And I think what we are seeing is a little bit of a bounce back here this year. There are also, candidly, was the recall of -- not the recall but certainly when Vioxx went off the market in late '05 that clearly had, we think, some impact in terms of potentially a few more surgeries at that point that might have created a bolus effect really at that time and may have come back off. But I think we're seeing probably a little bit more of a return to a normal level so far out of the gate this year.

Just to follow up on that if the average for the last five, from '99 '05 was around 7% CAGR in units across hip and knees, was it 5%, 6% or 4% or 3%, would you guess? I know it's a tough number because you don't see the whole world.

The tough part is we're only about a fifth of the market. And I wish we had better full holistic data but we don't have great data on the whole market. I'd say it was probably more in the 3 to 5.

I think I would concur with that. We haven't looking -- we're still obviously looking fully through the IPPS stuff, Bruce, as you are, so it's interesting you raised that point but I think as that data comes out it certainly needs to probably be scrubbed and a lot of questions asked and as you know as that goes forward there are some types of changes from information that comes out of that, too, so I think it's still early.

Okay. And then on the gross margin trajectory, would you guess, could you hazard a guess or give rough guidance?

You know, I would say for the year we would be comfortable with saying it's probably going to be up in the 50 to 80 basis point range. This quarter was a very, very good one for the Company. I think some of the things that we're doing are paying off and so I'm comfortable with that kind of range for the year.

But I mean structurally like over a three-year period, is it 100 basis points a year, is that the sort of margin improvement you guys could expect?

That's probably on the high-end.

I would say at a minimum 50 and maybe a little bit of upside to that but 100's probably on the high-end.

Thanks so much.

Great. Thanks, Bruce.

Your next question comes from the line of Bob Hopkins with Lehman Brothers. Please proceed.

Thanks and good afternoon. Two quick questions. First just to clarify the comments on the cash flow side and use of cash side over the course of the rest of this year, was the message on potential M&A activity that small and medium-size deals, to the degree that anything's going to happen small and medium-size deals more likely but willing to go larger if the opportunity arises? Is that the basic message?

Yes, well said -- said better than I did.

And then on the buyback side, it sounds like that's less likely in the near term, was that the, did I hear that correctly that you reassessed that maybe towards the end of the year?

Yes, probably in the second half. I think what we want to do is assess a little bit where we are and whether some deals might materialize and if not then we'll probably look to redeploy that in other ways.

Okay. And then one other thing on OP-1, how should we think about the spending side of OP-1 given what you're articulating here today? Should we assume that in '07 and '08 the OP-1 spend level goes down, stays the same as it's been or actually increases as you need to do more clinical trials?

It won't go down because you know as we announced at the academy we're going to start another pivotal trial in trauma and I tell you we're getting a lot of positive feedback on some of the soft tissue work we're doing plus we might end up doing here some additional follow up on the other studies. So it'll be frankly flat to up. And we're fully prepared to absorb that.

Okay. Thanks. And then just really quickly, lastly another Medicare question on the -- there's a durable medical equipment ruling a couple weeks ago that talked about the potential impact on your bed business going forward. Could you just tell us how you guys are thinking about that and perhaps how we should be thinking about it as it goes forward? Because obviously in the pilot study you saw 20% decreases in pricing for beds in those two or three markets that were out there. So any thoughts would be helpful. Thanks.

Bob, I'll take that one. We don't really see that ruling impacting us too much. That ruling is more applicable to beds being sold into the home healthcare market and we do not sell into that market.

Okay. Clear enough. Thanks.

Okay. Thanks, Bob. Next.

Your next question comes from the line of Matt Miksic with Morgan Stanley. Please proceed,

Hi, thanks for taking the question. On -- in orthopedics I'm wondering with the acquisition of -- Smith & Nephew acquisition of Plus, if you've seen any change there so far in the market, if you see any opportunity going forward particularly in the U.S. around disruption on that acquisition?

We have not seen much to be honest yet, Matt, maybe a little bit of it's happening but we haven't picked up much yet.

Okay. Do you anticipate anything going forward?

Probably a little bit but as you know, Plus in the U.S. is pretty limited. I think it'd be more impact certainly in countries like Germany where they were certainly much stronger. So I think we're feeling that there's probably going to be more impact outside the U.S. than necessarily in the US. But we like our direction and momentum certainly in the U.S. right now and we'll certainly look to take advantage of any chaos in the marketplace.

And one other on ortho, with the hip resurfacing product hopefully coming I guess mid-year this year, what have you seen recently and what do you expect to see in ceramic penetration for Trident? Is that starting to -- is it flattening, has it flattened, do you expect to moderate at all as you like a lot of other companies you enter what is essentially a metal on metal market?

Matt, I can comment on that. Our ceramic penetration rates as you would expect have softened and I think really for us it has as much to do with how viable an option X3 has become even for metal on metal type cases. The rate of wear of that poly is so good that a lot of folks have elected to use that and in many cases I think they're still using that with a ceramic head. So that has definitely changed the impact there. In terms of resurfacing, I think that really is a separate market and really we believe that resurfacing will be more of an incremental marketing op -- market opportunity because it's not a situation where the patients that are going to be eligible for that procedure are probably at the point where they would take a primary hip at that point in time given their age profile. So we really think that's going to be mostly an incremental market.

Okay. And then just one clarification on this, on a couple of comments you made earlier, the first was on OP-1, Steve, when you said significant delay or delay likely to be delayed significantly. I know you're in the midst of talks with the FDA and this is an anticipated event, I think. What -- can you give us a sense, is this a year out, is this two years out? What's the length of a new trial, any color in terms of the time line? I know the specifics are hard to nail down but that would be helpful.

Probably the best thing I can say at this point, Matt, is don't assume anything before the end of '08 and if we pull something out of that, we might pull a rabbit out of a hat but I'd clearly put it out beyond that. And it -- again it'll all depend on where we shake out with the FDA and we'll probably be able to give you more update I would bet by the next quarter call.

Okay. I'll hop off here and let some other folks ask some questions.

All right. Thanks, Matt.

Your next question comes from the line of Joanne Wuensch with BMO Capital Markets. Please proceed,

Hi, good afternoon. A couple of questions, can you walk us through what the economics are of the hip resurfacing product that you'll be selling via Corin?

Sure, I can do that, Joanne. Our agreement with them is really kind of a licensing agreement but really we have an agreement with them where we're -- we'll be selling the product and we basically have an agreed upon transfer price with them. Now that is not just completely locked and loaded, it is to some degree dependent on where the market price for this settles. But I think we feel like the economics will be fine for us. It will not be quite as high a gross margin percentage as some of our other business because it is vended. But on the other hand because we believe it's incremental market opportunity it should ultimately be a positive from a gross margin dollar standpoint.

Okay. And when you talk about U.S. price increasing and you said that was offset by O. U.S. price decreasing particularly in Japan, what kind of -- what are we talking about in an increase, are we talking 1% U.S. price increase, a 2%? I'm trying to get an idea of the magnitude.

You can pretty much say plus one on the U.S. and minus one O.U.S.

Okay. And then just a last comment. Can you give us an idea of what the stock based compensation was, the options expense that's probably in your SG&A and R&D line?

It's about, let's see, where is it? I think this quarter was about $16 million. You can actually see it in our cash flow statement, Joanne, it's 15.9 million, I think.

How much in which line?

I'm sorry. Say again.

How much is in the SG&A line?

Oh, in the SG&A. Probably about 80% of that number.

Okay. And then the rest would be in R&D, I assume?

R&D and cost of sales.

About 10 each?

Yes.

Okay. Thank you very much. Have a good evening.

Great thanks. Okay.

Your next question comes from the line of Milton Hsu with Bear Stearns. Please proceed.

Just one quick question. Just looking at the MedSurg growth, the mix between the U.S. and international contribution. Given the new products that you've launched in the U.S. were you surprised that U.S. wasn't a bit higher or that's pretty much in line with what you expected?

Milton, I'd say particularly at endo, we probably -- if you look at fourth quarter, first quarter combined they were exactly what we expected. But if you recall, endo was up about 27% in the fourth quarter, which was certainly stronger than we expected and came down to about 13 here in the first. We think they'll bounce back to probably more closer to that midpoint between those two in the next quarter. So I think what we had is probably slightly stronger fourth quarter, a little weaker first but the underlying order trends and everything continue to look very, very good.

Okay. And just a second big picture question on a potential repurchase program. I guess it's great that the valuations are up for shares here but are those levels that would you consider buying back?

You know, it's obviously, that's one reason we're not rushing to do a buyback right now and thinking about other uses of the cash. If we were still sitting at 50 or, in the 50s or $60 a share we'd probably be more aggressively doing it but we're continuing to kind of see what we can do in terms of redeploying the cash and then we'll assess it. And part of it'll be obviously strategic and some of it might be opportunistic in terms of buyback potential.

Okay. Great. Thanks.

Thanks, Milton.

Next question comes from the line of Bill Plovanic with Conaccord Adams. Please proceed.

Great, thank you, good evening.

Hi, Bill.

Hi. Just -- what -- if you could walk us through the remaining steps that you have to go through for commercialization of the hip resurfacing product?

You're basically at that stage now where it's discussing labeling, it's looking at the final manufacturing inspections and the pre-approval inspections with the FDA. If you recall it took about nine months for Smith & Nephew to get approval following their FDA panel. Typically you often do; you see in a kind of a six to nine-month window as you get everything finalized. And that's probably why we are assuming later in the year. Would we like to carve a little bit of time off of that? Certainly, but certainly a lot of steps and hate to say bureaucracy but pieces still to be worked through.

And have any of those inspections been planned or set up as of yet?

Yes, I believe some have. It's Corin's PMA, so they're certainly more on top of the exact details but it seems to be progressing at a reasonable pace here.

Okay, great, thanks a lot.

Great, thanks.

Next question comes from the line of Larry Keusch with Goldman Sachs. Please proceed.

Hi, good afternoon. Just a couple questions. First, Steve, can you maybe just talk a little bit about how you're thinking about some of these physicians owned sort of GPO's setting up? And we've had a couple conversations with hospitals and they kind of feel like they never got the volume rebates from the companies anyway because the physicians never stuck to anything. So they don't really care if those rebates go somewhere else and maybe these guys are going to get a little more sticky with how they're thinking about usage of product and concentrating on a vendor. Can you just talk about how you think that shakes out over the next couple of years?

You know, we're still in a little bit of a wait and see mode but certainly we're having discussions with those that are getting set up and trying to work out some fair pricing and schemes. It's probably too early to predict much at this point for us, Larry.

Okay. And then two other questions. Again I recognize that there's not a lot you can say on OP-1 at this point and you're working through your discussions with the FDA. But is there any sort of high level information that you can share just how that trial did shake out ultimately relative to primary end point or secondary end points?

We think we have a product that's proven safe and effective but we have not yet convinced the agency of that. And we'll take a little bit of responsibility for that. But we are very frustrated -- this one brings back shades to me of Sucralose, which is J&J's Splenda product which seemed to take forever to get approved. Looked like it was dead a few times and then ultimately did make it to market. I think it sometimes -- when you're a company going into a new path maybe you didn't do things quite perfectly but when you look at the raw data on the product it looks pretty good. But there's a few quirks here and there.

And do you think any of this is related to the carrier itself, would that potentially be a change that you might think about making?

You know what, we think the carrier is fine. We just -- it probably gets back to some of the radiographic things and other stuff that maybe we just didn't read quite as well and didn't have the protocols as perfectly buttoned up as maybe we could have. But -- and those are the things we're trying to talk through right now. But frankly, we fundamentally think the product is very good and I know there's been questions about dosing and other things raised. Frankly, we don't see those as issues.

Okay. And then lastly just large diameter femoral heads, just any feel for how that went during the quarter.

They're off to an okay start, not a blockbuster start. I think it gets back to there's so much momentum behind Triathlon right now and to sell against metal on metal is probably not going to happen on the very first sale and so it's going to take a little bit of work and energy for our team to galvanize and do that and I think they will do that over the course of the year but I think it's going to be a slower and steadier build as opposed to a quick rebound.

Okay. Great. Thanks for the thoughts.

Great, thank you, Larry.

Your next question comes from the line of Brian Wong with First Albany Capital. Please proceed.

Great, thank you. I just have a couple questions, number one obviously U.S. trauma was strong. I was wondering if you could give us a little more color on what's happening there and what we might expect going forward in that segment?

I'd tell you I think it's more than anything it's just great sales force execution and modest product flow right now but we are really executing well and I think we'll continue to be able to do that over the course of this year. I wouldn't expect 30% growth rates going forward. I think there was probably a little bit of some market dynamics there. February was probably -- with all the weather issues around the country our hunch is there was a pretty strong trauma market. But I think we feel pretty good about continuing to have certainly well above market growth rates in the U.S.

Okay. Great. Then you said that X3 is doing particularly well in the knee. I was wondering if you could give us a little more color on that in terms of penetration and what sort of penetration rate your tibial trays are with X3 right now?

Yes, Brian, it's doing very well. We don't want to give specific percentages there but it's somewhere north of 50% in Triathlon. Not as high in Scorpio. But it's done extremely well. Probably certainly at the top of our expectations. But we'll take it and we think it bodes well. It's obviously a great product and along with Triathlon that message of motion fit and wear just continues to resonate with the clinician community.

Do you expect that to be basically upwards of 90% in the future or do you think that that could kind of level off?

You know, it's a great question. I think those things are always very, very hard to predict but I think there's a great case for the product so we're not going to set our sights low. We are going to set them very, very high.

Okay. Great. Thank you very much.

Your next question comes from the line of Jason Wittes with Stryker. Please proceed.

No, not with Stryker yet, thank you.

Oh, no, we got Jason, are you doing a Katherine on us?

No. Not yet at least, I'm still with Leerink Swann. A question, sort of a follow-up question on the inpatient prospective payment system data. I guess I wasn't quite clear. You guys are saying you kind of agree that there was a bit of a slowdown last year in terms of volume and the follow-up to that would be what is your expectation this year and sort of the next five for that?

Jason, I think what we're saying is, Bruce pointed out something that I don't know that we've analyzed at this point in time. So we've obviously taken a look at the rules and the impact on the new proposed ERGs and I think we feel pretty good about that and I think many commentators have said that it's a reasonable result for our product. So that we feel good about. I think in terms of the volume growths we speculated on a number for last year. It's very hard for us to tell what the market is. And I think that we still feel longer term that kind of a reasonable unit growth for hips are probably in the 5% to 7% range and we think knee volume growths are probably a couple points higher than that. We've been pretty consistent with that message and we don't see any reason to change our outlook in that regard.

Okay. Fair enough. And I guess just one quick follow up. Are you getting, what kind of pricing premium are you getting on Triathlon at this point?

I'm sorry?

What kind of pricing premium are you getting on your new knees, Triathlon knees?

Well, it's, Triathlon has been out for a period of time and I would tell you that just pricing has settled a little bit but it's a reasonable premium relative to what the product does. But it's not outlandish either.

Okay. Thank you very much.

All right. I think we have a few more questions. We'll try to motor through.

Your next question comes from the line of Steven Lichtman with Banc of America Securities. Please proceed.

Thank you. Hi, guys. Just a couple quick questions on the pipeline. In terms of the MedSurg new product cycle launch, can you just characterize where we are in the ramp of the roll-out in terms of earlier innings, mid innings and is the U.S. farther ahead than O U.S.?

Sure. Great question. And Steve, a good chance to remind people that our endoscopy business is a heavier CapEx -- capital expenditure business than our instruments business which probably leads to a little bit more of that lumpiness that we saw, the monster fourth quarter and a little bit of a softer first quarter. But certainly no reason for anybody to be concerned about where endo's going. I think we're still in the third or fourth inning on both the precision and system six launchings in instruments as well as the 1188 camera at endo. And we still see a lot of runway throughout the course of this year. I think frankly you'll see some reasonable growth rates from both on endo and instruments business both inside the U.S. and outside the U.S. here in the coming quarters.

Okay, great. And then at AOS, I think you guys mentioned a revision Triathlon, any update on that?

It's being worked on and I think it'll be later this year.

And then just lastly on Sightline, can you remind us what you guys have been doing to prepare for the launch, has it been tweaking the product, building out a new sales force, both?

Both.

Okay. And again, the launch of the product is expected in the second half of this year?

Yes.

How large is that sales force going to be that's going to detail?

It's going to be a pretty small force to start out and then as we get some momentum we'll build it up from there but clearly pretty small by our standards to start.

Fair enough. Thanks.

Great, thank you, Steve.

Your next question comes from the line of Jeff Johnson with Robert W. Baird. Please proceed.

Good evening, thanks for taking the question. Most my question have been answered at this point, I guess just one I'd have, Dean, for you more than anything. Qualitatively you said U.S. was up 1% pricing. Can you talk just qualitatively how that's been trending maybe over the last couple of quarters and where you think it would go the rest of this year? And then also maybe qualitatively on European pricing?

In the U.S. I think it's reasonably consistent. I mean as you know we start to roll-out some of our price increases kind of in the late third quarter, early fourth quarter. And so a lot of times what we see, Jeff, is that prices that kind of go in effect what we see in the fourth quarter usually kind of continues through for the next three quarters and I think that's kind of what we're seeing here. In Europe prices have continued to be kind of flat to up a little bit and that's been a pretty reasonable trend that we've seen for the last several years.

All right, great. And then once we get through the Japanese cuts here over the next year or so, would you expect maybe that to flatten a little bit as opposed to the continual declines we've seen in the last couple of years?

I will expect continued declines in Japan but I think for us we ought to be able to manage them better and not nearly to the degree that they are hitting us both last year and this year. I think the future will be back to more modest and steady decreases. But as Katherine mentioned we will be dialing up our product flow activity there to help offset that a little bit better than probably what we've done historically.

And I think we're also hopeful, Jeff, that those price decreases go back to bi-annual ones every other year as opposed to every year but we'll have to monitor that progress.

Great. All right. Thanks, guys, I appreciate it.

Great. Thanks, Jeff. All right. A couple more?

Your next question comes from the line of Mike Matson with Wachovia. Please proceed.

Hi, thanks for taking my question. I was just wondering what the latest view of DTC advertising is from Stryker given that it seems like it's kind of intensifying from some of your competitors here?

Sure, Mike. We -- as you know we've certainly done some and I think we continue to actually emphasize a little bit more patient education at this point which has some of the DTC component, but frankly we're probably going a little counter culture here in terms of wanting to make sure that we're really focusing on the educational component with patients and giving -- arming them with better info some of which comes from the web and other areas than the kind of in your face TV stuff which we have done certainly a little bit of in the past but we're going to continue to try to educate the market and work with the surgeon community to do that.

Okay. Thanks. And then can you give us any kind of an update on what's going on with the sales force at the instruments division, and then when do you lap that change, the split in the sales force there to focus on various different products that you may have I guess last year? .

Sure, as you recall referencing the splits that we did really at first quarter last year. I'd say we're just about through that and I think in the second quarter you'll start to see it. It feels like it's settling down now, the main surgical force is in good shape and I think delivering, frankly, some very nice numbers in the first quarter here and the rest of the sales forces are hitting the stride. I think will you see a steady uptick in our instruments business during the course of the year. I will tell you, do not worry about our MedSurg businesses for the balance of the year.

All right. And then any update on the MITCH international hip resurfacing product? Has that been launched? It didn't seem that there was much of an impact in terms of your hip growth internationally, I guess. So I was just wondering --

It has been launched primarily in some of the key European countries as well as Australia and it did -- we saw a noticeable uptick in our hip franchises in those parts of the world. Because of the big hip business in Japan that was negative double digits, that really disguises I think the success that we're having with MITCH. So we're off to a half decent start with it and feeling pretty good particularly if you look at our European and Pacific results.

Your next question comes from the line of [Scott Bilma] with Edward Jones. Please proceed.

Thank you for taking my call and good quarter everyone. Wanted to talk about the pipeline a little bit, your new product flow. We found an article on Tritanium and how it's been used I guess in clinicals and it appears the porosity of that is very good at around 70% or so which would be pretty competitive with terbecular. Any update on how you're planning on rolling out some of those new products using Tritanium?

Sure. We are -- our biggest issue at this point is manufacturing constraints on Tritanium. And we probably won't be through those frankly through the balance of this year. So we'll be able to ramp it up but it's going to be a gradual ramp up. Right now the demand is far greater than what we can supply.

But are you -- you're not selling anything right now, though, correct? It's just ramping up your manufacturing capacity for that.

We are selling it, but very minimal quantities. It's almost samples at this point. We are starting to get a few out the door, more in the way of hundreds than thousands.

Understood. And any update on some of the products we got to see at the academy meeting, the roll-out plan like for the extremity products in recon as well as the precision sawing instruments?

Sure. I think feeling very good about the precision saw. On the extremity piece at orthopedics we should tell you the shoulder that we showed you has been delayed a little bit and it's probably going to be more of a third quarter launch instead of what we were hoping might have been a later first quarter launch, just making some final changes to that one. So that extremities piece won't tick up probably quite as quickly but luckily we've got the other momentum going between knees and some of the other things right now.

Okay. that's all I have. Thank you very much.

Great. Thanks, Scott. All right, it looks like we have one final question.

Your next question comes from the line of Dhulsini de Zoysa with Cowen and Company. Please proceed.

Good evening. Glad to squeak in at the end. Steve, I was wondering if you could help us get a sense of the percentage mix of Triathlon and Accolade? Those products continue to be important drivers so I'm trying to get a sense of U.S. versus overseas mix contribution with a sense for how much runway they still have particularly in overseas markets .

Sure, Dean do want to --

Sure, obviously Accolade has been a big product for us in the U.S. for a long time. We've launched it in certain markets overseas and it's gotten more and more traction over there. So I think in the U.S. it's continuing to grow so it's hard to tell exactly what the end point is but it's been a real great product for us. Overseas I think it still has reasonable runway left as we bring it into certain markets. Triathlon is obviously doing extremely well in the U.S. I think it's cannibalized a lot of Duracon business and it's even cannibalized a little bit more Scorpio business than we might have originally anticipated. It's done extremely well in the U.S. and I think overseas it's still in its earlier stages. It does seem to be doing well in the markets where we have started to launch it and I think we've got more aggressive plans to do that. So again I would say overseas we are more in the earlier innings in both those product categories but probably more way towards earlier innings than Triathlon, Dhulsini.

Okay. And so then as we think about gross margin improvements, it's really the recon business that we should be focused on, right?

I think it's across the Company. We have opportunities everywhere.

Okay. So there's not a particular push in implants?

No, I think other than the one comment we've made consistently is we've been probably a little under penetrated in spine and trauma in the U.S. and obviously you're seeing our growth rates be really strong there and I think those are continued opportunities to give leverage as we go into some of our sales forces there.

Okay. Great. Thank you.

We're showing no more questions in queue.

Okay, great. Well we want to thank everybody for your time today. Again, we feel pretty good about the start to the year and we are optimistic about the outlook in terms of where we're headed from here. The conference call for our second quarter 2007 operating results I see will be held on July 19, 2007. And since that's my birthday it better be good results, I guess. We'll talk to you all then. Thank you.

Thank you for your participation in today's conference call. This concludes our presentation. You may now disconnect. Have a good day.