史賽克 (SYK) 2007 Q2 法說會逐字稿

Good day ladies and gentlemen, welcome to the second quarter 2007 Stryker earnings conference call. My name is Annie, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be conducting a question and answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes.

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 this call, such factors include but are not limited to, pricing pressures generally, including cost containment measures that could adversely affect the price of, or demand the Company's product, regulatory actions, unanticipated issues arising in connection with clinical studies and eventual United States Food and Drug Administration approval of new products, changes in reimbursement levels from third-party payers, a significant increase in product liability claims, changes in economic conditions that adversely effect the level of demand for the Company's products, changes in foreign exchange markets, changes in financial markets, and changes in the competitive environment.

Additional information concerning these 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 the discussion of adjusted net earnings from continuing operations from the comparative quarter, and six month period ending June 30, 2007 and 2006. For the discussion of this non-GAAP financial measure, including a GAAP reconciliation appears in the Company's form 8-K filed today with the Securities and Exchange Commission's which may be accessed from the 'For Investors' page on the Company's website at www.stryker.com.

I would now like to turn the presentation over to the host of today's call, Mr. Steve MacMillan, President and Chief Executive Officer. Please proceed, sir.

Thank you, Annie, and good afternoon everyone. And welcome to Stryker's second quarter 2007 earnings report. With me today are Dean Bergy, our Vice President and Chief Financial Officer, and Katherine Owen, Vice President of Corporate Strategy and Investor Relations.

Simply put, we are very pleased with our second quarter results, and about our prospects going forward. We emphasized coming into this year, that we were focused on executional excellence, and should also begin to see the results of the increased commitment we made to R&D a few years back. We think these results show that we are delivering on these goals.

Specifically net sales in the quarter of 1.464 billion were up 16% as recorded, and up a strong 14.2% operationally. Our best growth rate in the last eight quarters. We were particularly encouraged that both our Orthopaedic Implants and MedSurg franchises delivered accelerating growth rates over last quarter in both the U.S. and globally.

In the U.S., our growth was broad and quite balanced. With Orthopaedic Implants up 17%, MedSurg up 18%, and total growth of 17%. Internationally, our operational growth of 9% was up modestly versus last quarter, as accelerations in hips, knees and trauma, all led to slightly stronger Orthopaedic Implant growth of 7%. While MedSurg, again, posted mid-teen growth rates.

While Dean will give additional details, I would like to highlight the particular success of our U.S. spine and trauma businesses. Each of which achieved growth rates of 30% or better in the quarter, and drove total sales growth above our expectations.

In the case of trauma, this is the second straight quarter at 30% or higher, and sixth straight quarter over 20%. And while we do not expect these franchises to perform at such high levels on a sustaining basis, we are certainly pleased with the current results. We would also highlight that both our endoscopy and instruments franchises grew significantly faster this quarter than last, with endoscopy up 20% globally, and instruments up 18%.

While the quarterly numbers for these businesses may bounce around somewhat, due to the nature of hospital capital expenditures, we are clearly seeing great customer acceptance of the new 1188 camera and System 6 power tool lines, and expect this momentum to continue for a few more quarters.

Given our strong performance over time, and the lofty expectations placed upon us, a persistent question posed us is: How can you keep this growth going, and believe me, it is constantly front and center on our minds, perhaps even more so when reporting such a strong quarter.

To that end, we also took a number of strategic actions during the quarter, to ensure continued strong growth in the quarters and years ahead. Among these actions were one, we divested our non-strategic physiotherapy business, which will clearly have a positive impact on both our margins and growth rates going forward.

Second, our instruments business made two small product acquisitions in the quarter. While sales were minimal in the quarter, we believed these products, a tourniquet system and a level of consciousness monitor, will continue to help our instruments franchise grow at above-market rates in the years ahead.

Three, our medical business which, consists of beds, stretchers and EMS equipment, signed an agreement to enter the rental business. We also just launched our new in-touch critical care bed. These initiatives could allow our medical business to continue to grow at above-market rates. With 15 straight quarters of double-digit growth in a market with single-digit growth, we feel good about where we are, and where we are headed with this franchise.

Fourth, our spine business filed the FlexiCore PMA, and also completed an agreement with Regeneration Technologies, to distribute spinal allograft implants beginning later this quarter. Combined with healthy new product flow, these efforts should also keep our spine business growing at above market rates.

And finally, on July 3, we were very pleased to receive clearance from FDA to market the Cormet hip resurfacing product in the U.S. We have just initiated the training and education legs for this program, and believe it will provide a nice and well-needed boost to our hip franchise in the quarters ahead. We have been very focused on executing not only for today, but also for tomorrow. Each quarter we remind ourselves we are also far from perfect, and one of our obvious disappointments this quarter was in receiving a warning letter from the FDA, regarding one of our hip-manufacturing facilities in Ireland. It is increasingly clear that the FDA is raising its expectations, and we are focused on elevating our abilities as well.

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

Thanks Steve. I will begin with the impact of foreign currency on sales. International sales in the second quarter were favorably impacted by $23 million, boosting the Company's overall sales growth by 1.8%. In the second quarter, the dollar weakened approximately 7% against the Euro, and strengthened about 5% 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 third quarter 2007 sales by about 1 to 1.5% when compared to the prior year.

Next, I will turn to the price volume analysis in the quarter. And I will tell you there is just two things making up our 16% total growth. The foreign currency translation impact that I just talked about at 2%, and then volume mix of the 14%, which means that price was flat in the quarter. Prices in Japan were negatively impacted by the January 1 and April 1, 2007 MHLW reimbursement cuts, with prices in that geographic market off by about 5% in the second quarter.

Slight increases in various other markets contributed to negate this impact for the Company as a whole. The second quarter sales increase was fueled by a growth in overall volume mix of 14% as I said, with domestic volume up 17%, and international growing at a 9% clip.

Now taking a look at sales in our various categories, Orthopaedic Implants which makes up 60% of our sales, saw sales increase to 15% in the second quarter on a reported basis, and 12% on a constant currency basis. The sales growth rates by product line are included in our press release, and I will reference those rates as I provide more detail on performance in these product categories.

So with the implants starting with hips, that category was up 8% in dollars, and 6% in local currency in the quarter. Global hip growth was up 2 points on a sequential basis, with hips posting their best growth rate in two years. U.S. hip sales grew 6% in the quarter, led by sales of X3 Polyethylene inserts, and Accolade cementless hip products.

Sales of hip fracture products were about flat in the quarter. European hip sales posted mid-single digit operational growth in the quarter, led by Trident, Exeter, and Accolade products. Europe is also getting a bit of traction with the MITCH resurfacing hip. In Japan, hip sales declined at high single digit levels in constant currency. MHLW price reductions were responsible for about 5 points of decline. Again, we saw modest volume growth in sales of our Secur-Fit hip, offset by slight declines in bipolar units. Local currency hip sales posted high teens growth in the Pacific, led by our MITCH resurfacing product, X3 Polyethylene, and Accolade.

Turning to knees, they were up 15% in dollars, and 13% operationally in the quarter. Knee sales in the United States were again strong, registering 16% growth in the second quarter. Primary knee sales grew at mid-teen levels with Triathlon and X3 polyethylene continuing to lead the way. Revision knee sales bounced back from a softer first quarter, to post low double digit growth led by Scorpio.

In Europe, knees grew mid-to high single digits operationally, led by extremely strong growth in Triathlon, and steady Scorpio sales. In Japan, second quarter knee sales posted a very slight decline in constant currency terms. When price was factored in, unit sales of our Scorpio NRG products were about flat with the prior year. Pacific's knee business posted another quarter with operational growth above 20%, with excellent growth in Triathlon, and a good quarter in Scorpio.

Now turning to Trauma, that was up 20% in dollars, and 18% in constant currency in the quarter, our U.S. trauma business found a way to top the exceptional 31% growth rate posted in the first quarter, growing 35% in the second, a percentage that is 36% when military sales are excluded. This marks the sixth straight quarter of better than 20% growth in U.S. trauma sales.

Domestic trauma sales were strong across all categories, led by Gamma3 hip fracture devices, T2 intramedullary nails, and our VariAx Distal Radius product. International trauma sales grew 7% in constant currency in the second quarter, a very solid performance when Japanese price reductions are considered. European local currency trauma sales grew at low double-digit levels. Japanese operational trauma sales declines were held to mid-single digits, with solid volume growth offsetting a 12% price decrease. Trauma sales and growth in Pacific topped 30% in local currency.

Turning to spine, that was up 26% in dollars, and 24% operationally in the quarter. Obviously our spine business had another excellent quarter. In the U.S. growth sales reached 30%. Growth was strong across all categories and was led by XIA Thoracolumbar products and interbody spacers.

Constant currency spine sales growth was up 13% in international markets, with strong growth in Thoracolumbar and interbody devices. Operational growth was relatively consistent in Europe, Japan and the Pacific, ranging from 12% to 17%. CMF was up 20% in dollars, and 18% in local currency in the second quarter. CMF sales also accelerated the United States market reaching 27% growth in the quarter. U.S. growth was again led by neuro products and our hydroceph injectable bone substitute. Sales outside of the U.S. grew 4% in local currency, led by Europe and the Pacific.

Turning to our MedSurg group that represents 40% of our sales, the MedSurg group had an excellent quarter with accelerating growth from instruments and endoscopy, and balanced growth across the domestic and international categories. As a reminder, MedSurg is comprised of three significant product categories, instruments comprises of 17% of the company sales, endoscopy 14%, and medical 9%, making up that total of 40% of company sales.

MedSurg group sales were up 18% for the quarter in U.S. dollars, and 17% in constant currency. Domestic growth picked up nicely for instruments and endoscopy on a sequential basis, and international growth for these products lines continued to be strong.

Now for some categories on the individual categories, sales of our instruments product line increased 19% in the second quarter, as reported, and were up 18% in constant currency. Our instruments business had a strong second quarter, with consistent performance both in and outside of the United States.

U.S. sales growth of 18% was led by extremely strong growth in heavy-duty power tools, with System 6 and precision blades serving as the catalyst. Sales of other surgical products were also strong in the quarter, and sales of navigation and interventional pain products were very solid. International sales of instruments products were particularly strong for neuro, spine, and EMT products, along with the navigation and interventional pain categories. On a geographic basis, growth met or exceeded 20% operationally in Europe, Pacific, Canada, and Latin America.

Our endoscopy business was up 22% in the second quarter as recorded, and 20% operationally. Endoscopy also delivered a great quarter with solid geographic balance. The U.S. business rebounded to grow 21% in the quarter. Video sales were exceptionally strong, paced by the 1188 HD camera and accessories, and the communication and imaging arthroscopy and general surgery categories, all posted growth somewhere in the mid- to high-teens range. International sales were particularly strong in Europe and Japan via arthroscopy and general surgery product categories again leading the way.

Then turning to our medical business, they were up 11% in the quarter on both a reported and constant currency basis. Medical put up another solid quarter. U.S. sales growth was led by an excellent quarter from our EMS products and strong stretcher sales. Bed sales were softer, particularly in critical care in advance of the new product launch mentioned by Steve. International sales were extremely strong in Canada, but this was offset by softness in other international markets.

Now I'll make some comments on the remainder of the income statement. In most cases, I will be discussing the balance from continuing operations which reflect the divestiture of Physiotherapy Associates. As can you see from our press release, Physiotherapy results have been collapsed in to the discontinued operations in the financial statements. We have also provided supplemental historical operating results as part of the release, reflecting the discontinuance of this business.

The first place the PT impact is evident is in gross margins which are now around 69% levels, versus 66 to 67% previously. Gross profit margins in the quarter were up 40 points on a sequential basis, and 80 basis points compared to the prior year.

We continue to benefit in the quarter from stronger relative growth from our higher gross margin U.S. implant business. We have also been running the plants a bit faster than normal, as we work toward new product launches leading to higher absorption. We expect this phase will fall-off somewhat in the second half with the corresponding hip to margins.

For the upcoming third quarter, we would also remind you that gross margin percentages generally drop off, as the business mix shifts more heavily to MedSurg during a slower elective surgery season for implant products. This phenomena didn't occur in 2006, primarily because we benefited from reduced royalty costs, attributable to royalty agreement expirations. You should plan for it this year.

Now turning to research and development, spending in research and development grew by a healthy 21% in the quarter, and reached 6.3% of sales, a pace in-line with last year's annual rate. R&D spending is growing in most of the locations, as we continue to develop certain acquired technologies, and invest for the future.

SG&A costs increase 18% in the quarter, slightly higher than the rate of growth in sales. Sales related costs accounted for the majority of this increase, and the costs include compensation and higher instrumentation amortization costs associated with our Orthopaedic Implant products, along with continued overall investment in our sales forces. This quarter also includes an impairment charge to write-off patents associated with the spinal interbody fusion cage products obtained in the 2002 Surgical Dynamics acquisition.

The U.S. FDA recently downgraded the classification of these products, making approval for potential competitors easier and triggering our impairment review. In addition, interbody spacers have supplanted the use of cages by many clinicians. Our spine business is red-hot, but sales of cages are not. We continue to be pleased with many other aspects of this acquisition, but concluded the patents associated with the acquired cage products were impaired, and should be written off.

After adjusting for the impairment charge, operating income increased 16% in the quarter, and operating margins increased to 22.9% of sales. Now I will give you a quick breakdown on the other income and expense categories for the quarter, that was $16.9 million of income in the quarter, that is comprised of $19.5 million of investment income, a foreign currency transaction gain of $400,000, and then those two items are offset by interest expense of $3 million in the quarter.

The Company's respective income tax rates were 27.6% and 27.9% for the second quarter and first half of 2007 respectively. Those rates are down from last year's second quarter first half and the year ending December 31, 2006. However, the rates for last year's first half and year reflect the impact of the non-deductible charge for Sightline's purchased in-process research and development. This year's second quarter rate is also favorably impacted by a higher-than-average rate, by the tax benefit associated with a patent impairment charge.

Turning to the balance sheet, we continue to believe that that is in very good shape. Asset management information has been restated to reflect our continuing operations only. This has a very negligible effect on accounts receivable days, but restated inventory days generally jump up 15 to 20 days in any given period. Accounts receivable days ended the quarter at 58 days, up one day compared to the prior quarter, and the prior year. Inventory days finished the quarter at 149 days, up three days in the quarter, and just one day above the June 2006 level. We would look to slow down the plants, and drive these comparative inventory levels down as we complete the year.

For perspective, the restated inventory days for September 2006, finished at 138 days, and then just real briefly on the rest of the balance sheet, we do have $17 million of debt outstanding. That is all in the current category at the end of this quarter. Just briefly on cash flow, we are having a strong year from a cash flow perspective. We are pleased to have generated 364 million in cash from operations in the first half, compared to 217 million at this time last year, an increase of 68%. We are obviously in great shape to deliver another excellent year in cash from operations.

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

Thanks, Dean. Now just a few additional comments on our 2007 outlook. Halfway through the year, we feel good about delivering on our sales and income commitments. On the sales front, we are clearly on-track to deliver a seventh straight year of double-digit sales growth.

With the divestiture of Physiotherapy, our full-year sales are likely to be towards the higher end of the 11 to 13% operational guidance that we initially established for the year. With $1.19 per share in first half adjusted earnings, we are also on-plan to deliver 20% EPS growth of $2.40 a share for the year, and we are doing this we might add, with a slightly higher tax rate and share count than we have planned.

With strong cash generation and the sale of our Physiotherapy division, our cash balance is now about $1.8 billion, and becoming a source of more questions and speculation about the potential for acquisitions, and/or stock buybacks. Simply put, we are biding our time. With the strong underlying performance of our business, we are in a position of strength and can afford to be patient, a trait which has served us well over the years.

We will now open it up for questions.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Mike Weinstein with JPMorgan. Please proceed, sir.

Thank you. Good evening. Congratulations on a fantastic quarter!

Thanks, Mike!

Happy Birthday, Steve.

Thank you very much, it had to be a good quarter, right?

It had to be. A couple of things, I think I would like to focus on. One is both the instruments and endoscopy are so strong in the U.S. Obviously we are all aware of the products you have launched over the last 6 to 12 months. Can you just talk a little bit about the update of the key products that you have launched, and where you think those launches are in the adoption cycle for those two businesses? And then the other question would focus on the spending side, the amount that you increased your SG&A and R&D lines was pretty remarkable.

I would like to hear a little bit more about where you are spending those incremental dollars. I would think it is hard to spend that much money that quickly, and I would love to hear where the R&D dollars are going, and where the extra dollars in SG&A are going. Thanks.

Sure, thanks, Mike. Let's start with instruments and endo. We clearly saw the 1188 camera and System 6, you know, both generating growth for those segments well north of probably 20 to 25% in the quarter, and we are probably in the fourth inning, Dean, would you say?

That is probably fair.

In terms of where we are in those launches. In other words, a lot of trialing going on certainly in first quarter, and we started to see clearly the orders starting to come through in the second quarter, and we think there is still a lot of life. Both products are being very, very well-received.

In terms of the R&D and SG&A lines, I would tell you that on the SG&A front, we are continuing to build out sales forces really around the world, and I think you're seeing some of the impact on that. Some of that is in our trauma business in the United States. Other parts is the MedSurg business outside of the United States, and so we probably continue to invest where, as things are coming in well, we are still putting additional bodies on to the street, and that will continue to payback here in the future.

On the R&D front, I think as Dean mentioned also, we will tell you we feel good about the pipelines across every division, and the spending really, is very broad-based, almost division-by-division to keep the product flow coming. I think we probably feel better about our continued ability to generate product flow coming in over the next few years on a broad basis, than probably we have felt in some some time.

Now, again, the proof is going to be in the pudding. We are going to have to deliver it in the quarters ahead, but things like hip resurfacing just starting to come through. Certainly, you know, the system 6, Precision, 1188, you know, we are already working on next generations of those, and things like that.

This may not be the best forum for this. Maybe at some point you could give us a breakdown of how you allocate your R&D spending between different programs, you know, I am not just talking across the businesses, but within the businesses between, you know, innovative projects and new technologies, and so forth.

I think that given the increase in R&D dollars the company has allocated over the last few years, that would be helpful, and if you could do some of that today that would be great, and just coming back, last question. On the incremental speed, the people you are adding on the SG&A side, anything you can you give us there, to give us a sense of how meaningful that is?

Sure, let me take the R&D piece first. It would probably be a deeper discussion maybe at a future analyst meeting.

Yes.

Where we can give you a little more. I would say again, on a high-level basis for R&D, we are continuing all the blocking and tackling. What we call the incremental innovation within each division, and most of the divisions have taken on what we call probably one or two doubles or triples in the pipeline, some of which make, hopefully all which of will come to fruition, some of which may or may not, but we are really looking at each R&D budget division-by-division, both can that division handle it, can the company handle it, as well as do they have the people in place to try to bring those things through.

I think to your point, we will try to give a little more elucidation around that, you know, maybe at next year's analyst meeting. Regarding the additional feet on the street, I think it's been, again, probably incremental both geographically and franchise-wise. It is not like we have gone and heavied up on dramatic huge impact in any one geography or any one business, but in fact it is just like our product flow, adding a lot of singles here around the world seems to be paying off for us.

Okay, that's great and thanks. If Catherine is there, Congratulations!

Great, thank you, Mike.

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

Thank you very much, again congratulations. A really great quarter.

Thanks, Bob.

Just I wanted to follow up, Steve on your comments about M&A and buyback. It seems to me it's a little bit of a shift from the way you have been communicating earlier. Earlier in the year at our conference, for example, you were talking about potentially adding a division.

You were also, I think on the last conference call, mentioned that towards year end this year, you would communicate further about what you meet be doing with the cash that is piling up on the balance sheet. So I am just wondering, should we reach your comments that M&A is kind of off the table this year, and the cash is going to accumulate on the balance sheet? I wondered if you could clarify the comments about biding your time.

Sure, Bob. I think probably the best way to say this is maybe if people keep pressing me for particular timeframes, maybe I haven't been as good at clarifying. We are looking at stuff, but as you know, M&A, we are not going to be held to a timetable, and not going to do a deal this year just to do one. So I think with the underlying strength of our business, we are certainly looking, and I think that the broad comment that we would love to add a division is a great one. Whether that is going to materialize this year or next year or the following year, probably not as clear.

So I probably want to make sure that I am indicating that there is nothing imminent. We are clearly looking and with Catherine on board, stepping up our game in that area, but I probably do want to temper the expectations, and we are very comfortable continuing to build, even though people want better answers, and want more specific timetables for what we might do in this area.

Okay, thanks. Two other little ones, on the hip resurfacing side, when do you think you will be in full launch mode, after you have got a critical mass trained, and when should we kind of think about that?

Sure. It is probably helpful to put in perspective the way we're going to go about the training. First off, we think the FDA put a lot of trust and confidence in us, to make sure that we do the training right here, and we are really going about doing the training, the first program actually starts tomorrow, where we are training 14 surgeons, and we are going to have a series of lots of programs around the country, training 15 or 20, this is not the kind of thing you bring 200 people in for the weekend and send them off next week.

We are very committed to wanting to make sure that surgeons are properly trained, because as you well know, the placement and particularly the angulation in getting these things right, are critical for the long-term success of hip resurfacing. So, we are going to be really focused over the next three months, particularly on training and even beyond that, in terms of meaningful impact there, we certainly would not expect much this quarter in the U.S. Probably starting to see some impact in the fourth quarter. And I would tell you from a purely commercial basis, the demand is there, we could drive sales faster. Given our performance in hips over the last couple of years, I would tell you it's pretty tempting, but having said that, we are really thinking about the long-term here.

Okay, and lastly, quickly, I would like to know what you are feeding your spine sales force. Very strong numbers out of you guys, and just curious if you could provide a little more detail on what is going on there. Do you think you are dealing with a healthy market? Do you think it is primarily share gains? Any other color there would be great.

Sure. I would tell you we are really, really proud of the leadership we have of our spine division, and of that sales force, and have great people. If you a 50,000 foot level, think about it four years ago, four years ago we were nothing in spine. We were a recon company that dabbled in spine.

The thought leaders didn't really view Stryker as a serious player in spine, and I think with the leadership of our spinal division, combined with dramatically expanding our product flow, you know, this has been one of the areas we have been overinvesting in R&D, and we have dramatically broadened our product line in spine over the last few years, from really being just a thoracolumbar business, to having now a good presence in cervical, a presence in the interbody spacers, and everything else.

We have been filling out the bag and getting a lot of confidence, and frankly a lot of surgeons who are really seeing Stryker, I think, as a company that really is starting to be on the leading edge in the spine, and it's all sort of eating on itself, creating a lot of confidence and support and belief, that we want to continue to certainly feed that beast.

Thanks, Bob.

Your next question comes from the line of Mark Mullikin with Piper Jaffray.

Good afternoon, nice quarter.

Thank you, Mark.

I would like to push a little bit more on the plan for the format here in the U.S., can you give us an idea of how many surgeons you would expect to train in total, you know, maybe in the first year?

You know, Mark, as you may know, we tend to not give into the specifics of the numbers. because we are going to focus on quality and we don't like to play the game and say all right, we are going train 300, and then come back and say we beat our expectation and trained 400. We really are still developing those plans and probably will just let the results, the sales results ultimately speak for themselves.

Okay. And I guess with respect to the protocol for training here is it substantially different from the protocol being followed by your competitors?

I am not aware of it being significantly different.

One thing I would say, Mark, as Steve I think alluded to, we do feel like our instrumentation help to set us apart here in this category. I don't know that the protocol is different necessary, but the instrumentation we think has been very reactive to the information that came out of the clinical study that was done in the U.S. and should, you know, help to really focus U.S. surgeons as they get involved here on what needs to be done. We have taken that really into account in terms of how we design the instruments, and that carries over, obviously in to how the procedure is done.

Okay, and do you expect this to maybe reinvigorate your total hip business or, you know, what do you need to do to really reinvigorate the total hip side of the business here?

Sure, Mark. We would call it a step in the reinvigoration, and we think frankly a very important step that probably, more than anything, psychologically is a huge boost to our sales force, who has been very enamored with the success we have had in Triathlon. For the last year or two, it's been a lot easier if you are a Stryker sales rep to just focus on knees. Because Triathlon has been going so well. This gives them a great avenue to get back in and start talking about hips again.

I would tell you that you should expect that we also know there will be additional products coming in our hip portfolio here, over the coming years, you know, probably nothing else this year, but as we go into next year, hopefully starting to also reinvigorate the primary hip line.

And the total metal-on-metal replacement in the pipeline?

Again, we prefer not to talk about the specifics of what is in the pipeline. We are looking at a number of different things.

Okay. Fair enough. On the U.S. trauma growth, to me I think is more phenomenal than the spine. I was wondering if you could supply some color maybe in terms of price/volume mix, or any color you can provide us of what is really driving growth north of 30%.

It is mostly volume mix, you know, there is a little bit of positive pricing in there but it's tremendous volume and mix gains. [inaudible] A big chuck of that was from volume.

Do you have any sense where you are getting the market share? Because clearly the market is not growing at that rate.

Again, we prefer not to take stabs that way. We just feel good that we are obviously growing faster than the market.

Okay, very good. Thank you.

Great, thanks, Mark.

Your next question comes from the line of [Jared Holtz] with Bear Stearns.

Good afternoon, nice job guys.

Thanks Jared.

First question on hip resurfacing. I see in Europe and Australia, the penetration rates of hips resurfacing compared to all of the procedures is roughly 15 to 20% high teens, and that is being generated by two much smaller companies. With your presence in here, do you think can you get that penetrating rate over 20, and what is your thought, and what have you been hearing on that?

We think over time, you know, that would be a pretty aggressive number. I think we are probably planning in the 10 to 15 range, and we would say though, that we do think that most of that is incremental. Because you are largely appealing to patients today, that are not going to necessarily go in and have a total hip. Ultimately where it ultimately settles out, we are not sure, you know. Could it be as high as 20 or 25 down the road? If there was a lot of success, maybe, but I think that is going to take certainly a long, long time, so our mindset is really more in the 10 to 15 range for the market.

Okay. Great. And then gross margins, meaningfully higher than where they have been because of the divestiture. Going forward, ending the year at roughly 68% is that where you guys think you can be?

We think we will be up a touch over last year. Probably not as strongly ahead for the second half of the year as we have been in the first half. As Dean mentioned in the the third quarter, we have a slightly tougher comparable from last year, but we feel good about continuing to try to make, again what, we would very much call is incremental progress here.

Dean, do you want to add to this?

No, I think that is a good summation, Steve.

Great. Thanks.

The next is from Jason Wittes with Leerink Swann.

Thank you very much. Some more follow-ups on the hop resurfacing product, can you explain the accounting in terms of profitability, is this a more profitable product than your tradition hip line, or do the royalties and manufacturing costs eat up some of that profitability?

Jason, you know, the gross margins on this product are going to be lower. We have talked about that, and that is solely from the standpoint that it's licensed product. We do have an agreement to buy it at a transfer price. But it feeds that, because it is incremental market opportunity, we view the total gain as being incrementally positive over time, as we start to get into it.

Basically, we should be thinking, at least you are thinking of the potentially 10 to 15 of the market that could convert over to hip resurfacing, that is largely incremental. I assume there would be some cannibalization from the traditional markets.

We think that would be more incremental than what people are factoring in. The way we probably look at it is, there will be a lower gross margin on this thing, but on a penny profit basis, it should grow our total profitability.

Okay, and then the trauma growth was certainly impressive. And if I recall, my memory may not be 100% here, about a year ago, you started hiring somewhat aggressively in that division. Can we assume that, you know, this has taken about a year, but now you are getting some payoff there, and then secondly, it sounds like you are going to continue to invest in that sales force still? That the way to think about trauma, for instance, on an ongoing basis?

We think your memory serves you well, Jason and you are dead on. It has clearly paid off for us, and therefore, we think there is additional opportunity to continue to expand somewhat, and that is what we have been doing. Again, our SG&A is running pretty hot and we would expect to see that start to slow down, as we really do start to realize some of the gains from the investments we have been making there.

But id does sound like for the rest of the year, you are going to keep it hot, or is this a peak quarter for you, in terms of SG&A?

I think it could slow down a little bit Jason. The thing that goes hand-in-hand with the gross margins dip related to the shift and mix of business, and in the next quarter is a little bit lower SG&A percentage usually too. We will also take advantages of opportunities to invest in the business where we can get them to. It will probably come down a little bit on a percentage of sales basis.

Final housekeeping question. Could you provide the impact of acquisitions this quarter? If there are any.

On sales growth?

Yes.

[It is near zero.]

Okay. That is easy. Thank you very much.

Great. Thanks, Jason.

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

Good afternoon. In regards to acquisitions, I can't seem to not talk to you, an investor, that doesn't think you are buying almost everything in Orthopaedics. Could you narrow down the scope a little bit for what you may be looking at. I'm not going to ask when, but what you may be looking at, and what criteria, in regards to dilution, et cetera, you may consider?

Sure. We continue to look, really, at product-based acquisitions. I think the Cormet hip, which is a licensing deal, we continue to look for products that might fill voids, we would look at other, you know, subcategories of things that are evolving, and we continue to look, and we also, out of a lot of the looking, we are often seeing ideas that are opening our eyes, and I will give you a very real example of that.

We looked at hand innovations a couple of years ago, and our own team said, you know, we have a great distal radius product. What we need to do is invest in the sales force because we have the product, and we chose to pass on that acquisition, and make an internal investment in our selling organization, which is part of our trauma business, and built out a little bit of a dedicated force there. So part of what we look at also makes us smarter, and realize that there are other things we can do organically, and that is it is kind of a back-and-forth process.

Okay, is there anything you can update us on the Department of Justice investigations?

Nothing at this point. We continue to cooperate with the Department of Justice.

And then one last question, how tied are you feeling these days to that 20%?

We continue to feel that certainly over the short- and medium term, that it is something that we can clearly deliver, and we take a lot of pride in that. We, as you know, we set the bar high, and don't play the game of set the bar low and jump over it. We set the bar high, and then try to hit it, and feel pretty good about our ability to do that, and we are constantly focused. It very much focuses us to not get complacent. After a quarter like this, it would be pretty easy to sit there and pat ourselves on the back and think, and we are already nervous about how we keep it going. That is part of the magic of the 20% for us.

Well, Happy Birthday and Congratulations Catherine.

Oh, thank you, Joanne. I am sure Catherine is there.

Many thanks.

Your next question comes from the line of Michael Matson with Wachovia Securities. Please proceed, sir.

Yes, I was wondering if you could give us your perspective, now that we have got Medtronic coming into the spine market with the cervical disk product. Are there any concerns there that that might steal a little market share from your spine business, in terms of the cervical plating area?

Sure, great question. Obviously Medtronic is a strong force in the spinal marketplace, and we are still a small player relative to them, and we have tremendous respect for them, and we are sure that those disks, they will do a good job with. Having said that, our spinal business is still really only a small portion, is in cervical. So part of the business we have been building and developing, and I think the good part for us, is it's not like we have a huge cervical business that will get beaten up. Will it get dented? I would say with the growth rate slow, probably a bit, but we still see opportunities for us there.

Okay, and then I know that you have been making a push in Europe with some of the MedSurg businesses, and we have seen some very strong hospital capital expenditure in the U.S. I was wondering how things look in Europe in the hospital capital budgets and trends there?

I think we continue to see pretty good trends in Europe in the CapEx side. You know, if anything, we see some tightening on the implant side and this and that, but there is still some reasonable upgrading going on in that hospital spending there.

You know, I think if you look at a category like eye sweeps, you know, which who knows what the potential will be in Europe vis-a-vis the U.S., but certainly in relative penetration terms, and we are seeing a little bit of that, and even some of our navigation equipment, I think there are some opportunities that we are seeing start to take hold in some of those markets.

Okay, and then one quick question, you mentioned the overall pricing was roughly flat for the company. I was wondering if you could comment on U.S. pricing, specifically with regard to the hip and knee, or the recon portion of the market. I am assuming it was probably roughly flat, but let me know if that's wrong.

No, that is the fair assumption, it is in-line pretty much.

And you kind of expect that trend to continue in the near term?

Yes. I would say so.

Okay, that is all I have got. Thanks.

Great. Thanks Mike.

The next question comes from the line of Ed Shenkan with Needham & Co. Please proceed, sir.

Thanks, Steve. Regarding the cage devices, tell us when you come out with your cage devices, is that more an add-on for the strength of your spine business, or is it really a differentiated product that we are looking at here in its own, and it is going to really drive revenue?

Ed, as it relates to the cages, the cages really were an acquisition we made of SDI in 2002, that candidly have not materialized all that well. We have really moved that business more towards an interbody spacer part of our business, and we are seeing great growth in the interbody space, that really has largely supplanted a lot of the cage stuff. We wouldn't expect any additional cage volume going forward.

Thanks for clarifying. Thanks, Steve.

Great, thanks, Ed.

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

Hi, thanks for taking the question.

Sure, hi, Matt.

So I think we have sort of turned over all the rocks, and I had a couple of follow-up questions on a couple of areas. One was spine. Again, very strong and kudos to you and team, in terms of productivity, I am wondering, you know, you obviously have some strong product cycle driving that weakness, but are you still coming up the curve, in terms of the productivity of your sales force, or when do you get there?

Sure, we have made a lot of progress on the productivity of the sales force. Still some opportunities, we still have been higher and have still have some younger folks that are coming up that curve, but I would say we are a lot further up that curve today than we were 12 months ago.

Okay. So through the end of the year, or is this something that continues into next year, or you sort of see this?

It will probably continue. I would say the rate, the rate at which it will be improving productivity is clearly, will be at a slowing rate.

Okay. And a quick follow-up on DOJ. I know everyone continues to work with the DOJ. There was a specific announcement from your competitors, and I am sure you saw the article a couple of months ago, indicating that things were more active now say than they were, you know, six months or 9 months ago, in terms of the dialogue. Is that consistent with what you are seeing? Is that something that visibility is sort of starting to maybe improve?

It is hard for us to really comment in that, they are obviously working with five different companies, and we only know what is going on with us, and we're continuing to work with them, and the rest is all what we hear is hearsay also, but again, I think because it's a cross ministry, it is harder for us to comment than it would be to probably the U.S. Attorney. Sorry we can't give you more there.

That's okay. Then just one final follow-up on trauma, it kicked off quite a bit earlier and faster than we were expecting. Is this the rate that we are looking at, sort of a sustainable high-teens, double-digit kind of rate, or is this something we should expect to moderate the next couple of quarters?

Clearly we don't expect our U.S. business to continue. The 31% in the first quarter shocked us I would tell you that as we were seeing the second quarter unfold to 35%, it shocked us even more, and we are obviously, just the sheer size and magnitude of that business has gotten very big very quickly. So we would clearly expect those growth rates to come down.

Having said that, we would hope to continue to grow our trauma business at above market rates going forward, but that clearly would come down into the, call it mid- to high teens, as opposed to up where we are rot now. I think in the U.S., we are not going to be in the 30s again. Or wouldn't expect to be.

And then one final follow-up on the hip resurfacing, is that something where Smith and Nephew has obviously seen a pretty generous price premium over the standard hip system. Is this, we have seen in the past new technology hits the market, then two or three other players join the leader, and the price starts to kind of come in. Is that the kind of phenomena we should expect here, or something like revisions or, obviously, you know, paid at a higher level and has sustained a higher price over time. How should we think about resurfacing?

Our hope would be that it could sustain the higher price. You know, there is a lot in this between the training and the product and the instrumentation. It is all new and unique. So I think we would expect it to be there for a whole, hopefully.

Okay. Great that is helpful.

Great, thank you, Matt.

Thank you.

Your next question comes from the line of Robert Faulkner with Thomas Weisel Partners. Please proceed, sir.

Thanks, good evening, gentlemen.

Hi, Rob.

I wonder if we could focus on some of the macro drivers of both the MedSurg business and hips and knees. I haven't heard you comment recently on the pricing environment for hips and knees and the hospital perspective. Obviously the numbers speak for themselves but you feel like it is getting better? Getting worse? Stable? Do you see any warning flags on the horizon? On the MedSurg side, let me get it out of the way here, what do you track to see what demand might be if anything. Is it hospital construction? How far out do you look?

Sure. The recon pricing we continue to see it being fairly flattish, which is what it's been over the last probably five, six quarters, I think, consistent with about what we expected, as it relates to MedSurg, we really look at two things.

One is procedure by procedure, what are the opportunities for us in our MedSurg business. And some of that business goes, frankly, with Orthopaedic surgeries, such as our heavy-duty power tools, in the case of our arthroscopic equipment. It clearly goes along the lines of some of the minimally-invasive surgery, and sports medicine procedures.

So there is both a procedural component and then clearly as it relates to the hospital bed stretchers, or the endo suites, which are, you know, the big capital items, that tends to mirror a little bit more both new construction of hospitals, as well as refurbishments. Really each of our MedSurg business tracks a little differently. If you line up our medical business, our instruments business, and our endo business, each have different components, related to what we call base and capital. So we are really tracking both across franchises and across geographies.

Great. Finally, may be you said this before, what do you think that the ultimate penetration potentials for hip resurfacing is in the U.S.? Is it higher or lower than Europe?

Yes. I think we are figuring that ultimately it will mirror some of the other anglo countries.

Okay.

If you look at Australia, the U.K., and Canada which is where it has gotten bigger, it's probably in that 10 to 15% range. We also want to make sure it happens right. I think our big fear is it could take off quickly and potentially, you could have some complications down the road.

Yes.

We will want to limit that, and that is why we really want to emphasize the training, so we get it right.

Great, and I know you don't normally break this out, Dean, but do you have any sense for Stryker, per se, do you have any sense of how much mix is contributing to the market overall in the U.S. in hips and knees?

In what specific? In U.S.?

Hips and knees.

No, I don't have the numbers at the top of my fingertips. It's probably 1 to 2%. Somewhere in that range.

Great. Thanks.

Great, thanks, Rob.

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

Hey guys, good evening, thanks for taking the question.

Sure, Jeff.

Just a couple of small things here left for me. I apologize if these are repeats, I don't think they are. On the Sightline product, are we still shooting for a late 2007 launch there, and if you could remind us about the challenges and the opportunities and going into the flexible endoscopy market?

Sure we are still shooting for late 2007. I'll tell you we are in that stage now, where we really trying to make sure that the commercialization is there. So it's, you know, fine tuning the product and making sure it's scalable to produce, and running into our usual issues there along the way, that we continue to work through and knock off one-on-one as we proceed closer to market.

Great any challenges there? You know, I would assume this can just kind of drop into your current sales force bags, if you will?

You know, we will probably actually have a more dedicated sales force focused on the GI audience, and think that the product should be well-received once we know, you know, fully how to make it, and we want to make sure we have got the quality of that product since it's a new category for us. We want to make sure that we have that totally nailed before we come to market. So the challenge is probably more internal at this point, and then the next challenge will be external once we take it out there.

Great and last question. Any update at all on your conversations with the FDA regarding OP-1, and where that might be going in spine fusion?

I think our comment on OP-1 overall is we continue to be very committed to the product, and are continuing to spend behind it, but frankly, just because we don't want to disappoint, we would encourage everyone to take it out of your models, and we'll be back to you at a future point.

All right, that is all I have got. Thanks, guys.

great, thanks, Jeff.

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

Thanks, hi, guys. Just a couple of follow-ups in MedSurg. Can you give us maybe a little bit more detail on the new product that you required in instruments and the opportunities there, and also a little bit more on the product launch you mentioned in medical, I guess, in the second quarter.

Sure, Steve. The products we acquired with the instruments, one is essentially a tourniquet system. We think it is a competitive, and potentially better tourniquet system, that will be sold really via our instrument sales force, and then also we acquired a level of consciousness monitor, which we think is going to be one of those categories that will become much more prominent and take off more in the years ahead. There is a company out there today, you may know, Aspect Medical, they are by far the leader in that space. We think we have a product that may have some advantages, and we will be going into that really with the anesthesiologists, and bringing that product to market here. So they will both be builds over time. Just like Neptune and other things, we will look back in four, five years and have some very nice franchises out of those.

And your other question, the bed. We basically just launched a critical care bed at medical, which our bed franchise was much slower in the second quarter. We see that will probably be probably bouncing back. The initial reviews on this critical care bed, it is called in-touch. It has got a lot of software, it really makes the nurses' lives easier, it allows for remote patient monitoring, and other things. We think it will be a very nice product in the marketplace.

Okay, great. Thanks, Steve. Quickly you mentioned on the tax rate becoming a little bit higher this year that you expected, Dean what should we be looking for for the tax rate looking forward here?

Well, you know, we are comfortable with where it is right now, though we have continued to say that there is downward bias. If it happens this year, it could push into next year. We know over time there is continued downward bias, and I have said kind of, up to 50 basis points is the way to think about it, in the nearer to mid-term.

For now in terms of the second half, keep it basically where we're at?

It could drop down. We could also, I think we can also deliver with where it's at.

Okay. Okay. Great. Thanks, guys.

Great. Thanks Steve.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Bill Plovanic with Cannacord Adams. Please proceed, sir.

Great, thank you. Good evening.

Hi Bill.

Could you give us the names of the companies or the products that you acquired in the MedSurg, the tourniquet system and the consciousness monitor?

Sure, the tourniquet was instrument, and the level of consciousness monitor was a company called Everest.

Okay. And I know I am beating a dead horse here and I apologize ahead of time, but how important to you is the level of dilution in regards to potential acquisitions?

That is still a good question. I think the way we think about dilutions, we would be willing to tolerate some dilution in the shorter-term. I don't think we would want to sign up to two or three years of dilution, but clearly in the year that was going to be a creative in the outyears, even dilutive year 1, breakeven year 2, accretive year 3, we would think about that.

I think, you know, probably the biggest issue for us as it relates to acquisitions, everyone keeps asking us, is we are going to continue to be patient. We are absolutely looking at acquisitions, but we're in a real great position right now and I think we can afford to be picky and selective.

Okay, and how hard is it to get one of your division managers or Presidents, group Presidents to sign off on a dilutive deal in their division, though?

They, you know, they are all primed and ready. They do, frankly, the Sightline deal was a dilutive deal. We have actually done several over the last couple of years that we have been able to cover, and then the next ones could be, you know, if we go buy a company that could be become its own division, that would probably have a higher degrees of dilution, and that would be something we handle more at the corporate level, and probably wouldn't be able to cover, so we would to take that dilution in the short term. We also recognize, you know, we don't want to do anything that will spook people.

Okay.

But we are also going to continue to run the business well, and continue to be on the prowl, but hopefully what people are used to and comfortable with is knowing we're not going to do something stupid.

Okay. And then just on the TDR's, where are you with the server core program at this point in time, and then on FlexiCore, I believe the end point was a non-inferiority end point, considering Medtronics push on their lumbar desk for a superiority end point. Do you think you might be disadvantaged considering that?

Sure.

And that's all I have. Thanks.

Sure. First on your Cervicore question, we're probably in the 8th inning in terms of enrollment on our Cervicore trial. And on FlexiCore it is a non-inferiority, we think the product itself will ultimately have some meaningful points of difference, and some of the other stuff we will be able to do around it, should still provide for a meaningful advantage.

Okay, great. Thanks.

Great, thanks, Bill. I think we have one more question, do we?

Yes. Your next question comes from the line of Bruce Nudell with Sanford C. Bernstein. Please proceed, sir.

Hi, it's Bruce but from UBS. Guys, I had a few questions. One was concerning U.S. hip and knee unit growth. '06 was sluggish to us, about 2 to 3% unit growth. The prior five years before that were close to 7, 8%. Does '06, or '07, rather, showing a return to the old style, the style of the 7 to 8% unit growth.

The second question is flexible endoscope opportunity in your fact book, it looks like the flexible endoscopic market is on the order of $2 billion, looking out five years, what is the scale of that business from Stryker's point of view? Could it be a $200 million business, $500 million business, any help there would be great.

The third question really pertains to in Biomet's press release regarding the DOJ settlements. They kind of spoke about the risk of a fundamental change in business selling practices. Do you see from Stryker's point of view, do you see any fundamental key change in how business is conducted in relationships with doctors? Thanks so much.

Sure, thanks, Bruce. I will take those in order. On the hip growth, we probably see '07 being a little bit better than the trough year, probably not quite as strong as it was in the golden age years of '03-'04.

On Sightline, I think we see the category probably close to a billion, in terms of the flexible world, and I think we would be quite happy to get to 100-millionish business over time, in terms of our expectations, and we will see where that goes. It is obviously going to be a new market for us, but I think we will be thinking more along that line than certainly the 500 million number that you mentioned, and finally on the DOJ, I think we just feel our better position right now is to just work with DOJ and stay quiet externally.

Thanks so much.

Great. Thanks, Bruce.

At this time, there are no further questions in queue. I would like to turn the call back over to Mr. Stephen MacMillan for closing remarks.

Great, thank you, Annie. Once again, hopefully you have a good handle for what we have done in the quarter, and where we are headed, we appreciate all of your questions, and we will mention that our conference call for our third quarter 2007 operating results will be held on October 17 of this year. Thank you all very much.

Thank you for your participation in today's conference. This concludes today's presentation. You may now disconnect, and have a great day!