史賽克 (SYK) 2008 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q1 2008 Stryker earnings conference call. I will be your coordinator for today. We will conduct a question and answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes.

Before we begin, the Company would like everyone to know that certain statements made in today's conference call may constitute forward-looking statements. They will be based upon management's current expectations, 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 for the Company's products, regulatory actions, unanticipated issues arising in connection with the clinical studies and otherwise that affect United States Food and Drug Administration approval of new products. Changes in reimbursement levels from third-party payors, a significant increase in product liability claims, change of economic conditions that adversely affect the level of demand for the Company's products, changes in foreign exchange markets, change in financial marks and changes in the competitive environment.

Additional information concerning these and other factors are contained in the Company's filings with the Securities and Exchange Commission, including the Company's annual report on Form 10-K and quarterly reports on Form 10-Q. I will now turn the call over to your host for today's call, Mr. Stephen MacMillan, President and Chief Executive Officer. Please proceed, sir.

Thank you. Good afternoon everyone and welcome to Stryker's first quarter 2008 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. Despite a few challenges, our results in the quarter once again demonstrate the overall strength or our business and our people, as we delivered our 29th consecutive quarter of double-digit sales gains and once again delivered 20% earnings growth. Specifically, sales grew almost 15% as reported and up 10.3% operationally, to $1.63 billion. And net earnings from continuing operations grew a strong 20% in the quarter despite significant investments in quality and compliance initiatives. And we also delivered these results with an even slightly higher tax rate than planned.

When you step back and look at the current global environment, we think these results stack up pretty well. Simply put, our unique footprint and broad areas of strength once again allowed us to absorb a few body blows, underscoring our ability to deliver in the face of challenges. While hips were disappointing in the quarter, knees were solid. And once again spine, trauma and CMF generated growth rates well above their markets. While our dependable MedSurg businesses, instruments endoscopy and medical all posted double-digit operational sales growth in the U.S. and globally.

Against a backdrop of concerns about slowdowns in hospital capital expenditures our MedSurg businesses again posted very healthy 16% growth in the U.S. and this was following very strong results in the previous quarter. This quarter's results really follow the same pattern of the last few years, as strong above market growth in spine, trauma, CMF, instruments, endoscopy and medical more than made up for slower reconstructive growth. Make no mistake about it, though, we do look forward to having our hip business join the other high performing franchises and we'll be looking for improvement in the coming quarters. At this point, we would also like to give you an update on our quality and compliance initiatives.

In a nutshell, we are currently making major investments of money and people to upgrade and harmonize our quality and compliance systems across the Company. In simple terms, we have embarked on the journey from decentralized plants with different QA systems to a system with more common standards and greater consistency. This is clearly what FDA expects and frankly, it will make us an even better Company. This journey will take time but we are fortunate to have both the financial strength and organizational commitment to make these investments now. We're mobilized and we're on it.

As Dean will discuss in more detail in a moment, the financial results were again strong. Sales, profits and cash flow were all very healthy, which also allowed us to announce a share buyback authorization in the quarter. While we have not yet initiated this, we see our ability to sustain our growth going forward linked to continued strong operational performance, while also using our cash for prudent acquisitions and modest buybacks to offset dilution. I will now turn it over to Dean for more details but before I do, we wanted to remind everyone that we will hold our 2008 analyst meeting on May 8 in New York City, which is only a few weeks away. With that, Dean.

Thanks, Steve. First, we'll take a look at the impact of foreign currency in our top line. As anticipated, foreign currency was again very favorable this quarter. The weakening of the U.S. dollar added $62 million to international sales and increased the Company's overall sales growth by 4.3%. In the first quarter, the dollar weakened about 15% against the Euro and approximately 12% against the yen, compared to the prior year. If currency rates hold near March 31 levels, we expect the impact of foreign currency will increase second quarter 2008 sales by about 4.5% to 5% when compared to the prior year.

Now turning to a brief analysis of our price volume impacts on the quarter, price actually added 1 point to sales growth. That's rounded up. FX, as I said, impacted sales favorably by 4%. And volume mix was up 10% for the 15% growth that we reported. Selling prices were up slightly on a worldwide basis in the quarter, with the exception of Japan where pricing continues to be impacted by reimbursement cuts. Japanese pricing was off 3% in the quarter as a result of the April 1, 2007 MHLW reimbursement cuts. We expect the April 1, 2008 MHLW price reductions to unfavorably impact our Japanese pricing by about 5% to 6% as we look to the remaining quarters of 2008. Volume mix growth, as I said, was 10% in the first quarter. Domestic volume mix growth was 12% in the quarter. While international volume mix growth came in at 5%.

Now turning to our business segments. Orthopedic implants represents 59% of our sales and the sales of those products increased 12% in the first quarter on a reported basis and 7% operationally. The orthopedic implant businesses were slightly impacted by one less comparative selling day in the international markets and the fact that Easter fell in the first quarter in 2008 compared to the second quarter last year. As we said last quarter, we would encourage a balanced long term perspective when evaluating market growth in these categories, we're expected to see continued favorable demographics. The sales growth rates by product line are included in our press release and I'll reference those rates as I provide more detail on our performance in each product category.

So turning to hips, they were up 4% in dollars and down 1% in constant currency in the first quarter. Our overall hip business in the quarter was negatively impacted by the Trident cuff recall that we announced in January. Sales of hips grew 2% in the United States. Domestic sales growth was led by incremental Cormet hip resurfacing sales and growth in the Accolade cementless, X3 polyethylene and restoration modular revision hip products. These gains were largely offset by significant declines in the Trident related products.

European hip sales declined in mid single digit levels on an operational basis. Exeter, Accolade, X3 polyethylene and our resurfacing hip all did well but could not offset the decline in Trident sales. Japanese constant currency hip sales growth checked in at mid single digits, a pleasant uptick from this business' performance in 2007. Adjusted for price reductions for hips, volume gains were even higher with our secure fit products leading the way. Local currency hip sales in the remaining international markets were off about 10%, with the Trident recall having a significant impact.

But turning to knees, they were up 14% in dollars and 9% in local currency in this quarter. Overall, knee business was solid in the first quarter. U.S. knee sales were up 12%, a 32 straight quarter of domestic double-digit knee growth. Primary knees grew at low double-digit levels, led by Triathlon and X3 polyethylene. Revision knee growth was over 30%, as our Triathlon TS revision product got off to a strong start. European constant currency knee sales grew at low single digit levels, paced by Triathlon. In Japan, our knee business registered midteens operational growth. Our Scorpio NRG product continues to lead the way here. Pacific also posted midteens local currency knee growth, with Triathlon starting to emerge in these markets.

The knee growth in the remaining international markets was basically flat. Trauma was up 24% in dollars and 16% on an operational basis in the first quarter. Our trauma business had an extremely strong all around quarter. U.S. trauma sales were up 23% in the quarter and this growth is unchanged when military sales are excluded. This represents the ninth straight quarter of U.S. trauma growth over 20%. All product categories provided nice growth with Gamma 3 hip fracture, VariAx distal radius and Hoffman II External Fixation devices leading the way.

International operational trauma sales growth was 11%, the first time in double digits for the international contingent since the first quarter of 2006. Europe was a standout with high teens constant currency growth. And Canada was also extremely strong on a much smaller base. In Japan, local currency sales were up just slightly but grew at mid to high single digits on a volume basis. Upper extremity products led our international trauma growth.

Spine was up 22% in dollars and 18% in local currency in the quarter. Our spine business had a very strong quarter with the U.S. paving the way to this 18% operational growth. Domestic spine sales grew 25% in the first quarter, a sixth consecutive quarter over 20% growth. All product categories grew at 20% or above in the U.S. with interbody and Thoracolumbar devices at the top of the heap. International spine sales were up just 2% operationally, while going against a tough comparable from the prior year, which is up 18%. The major international markets posted local currency spine growth at a reasonably tight range from the low to mid single digits.

And then last but certainly not least, our CMF business was up 25% in dollars and 21% in local currency in the quarter. Our CMF business had an exceptional quarter in the U.S. posting 30% sales growth, strong sales of our HydroSet inductible bone substitute, along with neuroproducts. Sales outside the U.S. grew 5% operationally with neuroproducts posting the strongest growth in these markets.

Now I'll touch on our MedSurg group. This represents 41% of sales. MedSurg had a very good quarter. Instruments and medical had nice quarters in the U.S. and endoscopy was stronger in the international arena. MedSurg is comprised of three significant product categories; instruments, which represents 18% of Company sales; endoscopy, which represents 14% of total Company sales; and our medical business, which represents 9% of total Company sales. MedSurg group sales were up 18% for the quarter in U.S. dollars and 15% at an operational basis.

And then turning to the businesses. Sales for our instruments product line increased 18% in the quarter as reported and it grew 15% in local currency. Instruments had a good quarter, with 16% growth in the U.S. and a solid performance overseas. Domestic sales were led by excellent growth in both our System 6 heavy duty and Cordless Driver 3 micropowered tools, as well as incremental sales from the acquired InstruMed Tourniquet product. We also registered solid growth in our sterile field and Neptune waste management products. International sales in instruments products were up 12% operationally, with growth overseas led by System 6 and interventional pain products along with micropowered tools. On a geographic basis, Pacific and Canada exceeded 20% constant currency growth and Europe had a very solid quarter.

Now turning to endoscopy. That business was up 16% in the quarter as reported and 15% on an operational basis. Endoscopy had a solid quarter, led by the international portion of the business. Domestic sales growth in the key product categories ranged from high single digits to midteens and were led by sales of arthroscopy products.

International sales were up 18% in constant currency, led by sales of our 1188 HD camera and excellent growth in general surgery products. Then our medical business was up 20% in the quarter as reported and 18% in constant currency. Medical had an excellent quarter around the world. U.S. sales growth was led by strong sales of beds and EMS products, with stretchers also posting solid growth in the quarter. International sales growth was led by Pacific and Europe, with EMS the top product category.

Now, I'll provide some commentary on the rest of the income statement. Gross margins in the quarter were up 20 basis points compared to last year. We ran the plants extremely fast during the quarter with new product introductions and the ramp-up in production to refill the Trident cuff pipeline, giving us higher absorption in the period. This leverage was partially offset by higher excess and obsolete inventory costs associated with the implant businesses. We anticipate the costs of some of our quality initiatives, which are also hitting this line, to ramp up a bit more in the second quarter and still project annual gross margins will be closer to flat with the prior year.

Growth and spending on research and development was up just 1% in the quarter. Growth was tempered slightly by the timing of the approval of our orthopedic division's needs assessment by our corporate monitor. The many activities scheduled for this quarter being canceled or deferred. The remaining spending in this category is pretty much in line with our plans. SG&A costs increased by 15% in the quarter, primarily as a result of increases in costs associated with compliance activities and growth in sales related costs. The compliance costs are not insignificant, with our legal fees up more than $6 million in the quarter. Selling costs include compensation and instrument amortization costs and are growing about in line with our rate of sales growth. Operating income increased 19% in the first quarter and operating margins increased to 23.5% of sales.

Now for a quick breakdown of other income and expense. Investment income was $27.9 million in the quarter. That was offset by interest expense of $7 million in the quarter and a foreign currency transaction loss of $600,000, to get to the total other income of $20.3 million in the quarter. Now, we were able to deliver our budget and diluted net earnings per share of $0.70 in the first quarter, with an effective income tax rate of 28.1%, a rate that was higher than we planned. This rate was similar to those for the 2007 first quarter in year and we still believe we will see these rates decline for 2008, likely by as much as 50 basis points for the year.

Now, turning our our balance sheet. We truly believe that's in excellent shape. Before moving on to accounts receivable and inventory days, I wanted to touch briefly on one category of our investment balances. As many of we hold a small portion of our investments in auction rate securities. We have $160 million of such securities, all of them relating to student loans, the vast majority of which are guaranteed by the U.S. Government. Although we do not believe there is an issue of credit worthiness for these assets, there is currently an issue with liquidity. As a result, we have classified these assets as noncurrent assets in the March 31, 2008 balance sheet. The market valuation reserve for these securities has been included as a direct reduction to equity, since we consider any impairment in their value to be temporary.

Now, turning to accounts receivable. Accounts receivable days ended the quarter at 60 days, up three days from a year ago. We are not overly concerned by this bump-up, as the impact of the weakening U.S. dollar has a slight negative impact on the calculation. And we have not seen any significant deterioration in our U.S. receivables days. Inventory days finished the quarter at 162 days. This is a big jump from the prior year and is also impacted by currency. In addition, it reflects a number of new product introductions. Despite these factors, we expect we will with be able to drive these inventory levels down over the next several quarters.

And then finally, a quick comment on cash flow, we had a great start to the year from a cash flow perspective, with cash from operations up 25% to $191 million. The first quarter is most often our lowest in terms of cash generated and we are well positioned for another outstanding year on this front. As a final note, we wanted to let you know that we were advised during the quarter that the U.S. Department of Justice has closed its investigation of potential antitrust offenses in the orthopedics implants industry. That investigation had been opened in June in 2006. And with that, I'll turn it back over to Steve.

Thanks, Dean. Now, a few more comments on our 2008 outlook. So what should you expect from us for the rest of 2008? As we look to the balance of the year, we continue to feel good about our ability to deliver an eighth straight year of double-digit revenue growth and deliver on our 20% EPS goal. All while funding the significant investments we are making in quality and compliance. And while recovering from the hip recall, which will still carry over into the second quarter. We have nice momentum across a number of our businesses and believe that our underlying sales growth will accelerate in the coming quarter, though we remain mindful of the numerous challenges and unexpected pitfalls, which could lie ahead. Once again, however, we believe our commitment to ongoing improvement and our strong and unique footprint of businesses will allow us to continue to deliver strong results for the balance of the year and beyond.

Also as our cash position continues to build, we see this as an additional tool in our arsenal to continue our strong earnings growth in the years ahead and we continue to look at acquisitions as the primary vehicle. As stated over the last 12 months, we have ramped up our M&A focus and continue to actively evaluate a number with of areas. But we would like to again underscore that given the strong underlying performance of our business and our own focus on return on investment, not just EPS accretion, we continue to have the luxury to be both patient and choosey and we will continue to operate in this way. We all know there are an increasing number of companies being shopped. And with our cash position there is a natural speculation that arises but many do not meet our parameters. So to wrap it up, do we have challenges ahead of us? Sure, as we all do but given the very many positive things we also have going for us, we continue to like our chances. With that, we will now open it up for questions and remind everyone that we will take one question from each person with only one follow-up. Thank you.

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

Thank you, Steve and thank you, Dean, for taking the questions. A couple areas that I'd like to touch on. I want to cover the FDA issues that you guys have been addressing and then maybe talk about some of the recent discussion generated by other companies, by GE and J&J and so forth. Maybe we start with your FDA relationship and the update there that you can provide today. And there's two things that I'd like to know. One, do you have an update on the timing of the Cork and Mahwah anticipated inspections. And two, since we talked to you last publicly in January, have you had inspections, normal course G&P inspections, at other facilities where you have gotten either a) a clean bill of health or B) have gotten some 483's?

Sure, Mike. Let's start on the overall part. I would tell you as we think about our relationship with the FDA right now, we feel like our tone -- the tone of communication, has improved certainly over the last 90 days. But I would tell you, we have a lot of work to do and I think we've hopefully, very adequately communicated to the Agency that we know we have the work to do. And we're very focused on it. And that when we as an organization get focused on it, we deliver. But ultimately, it comes down to they will be looking for the results. As it relates to specific follow-ups with Mahwah and Cork, I would tell you we're probably more focused at this point on making sure that when they come back in, we're in great shape and we're probably not pushing for it quite as quickly. We think we're ready but frankly, every day that goes by we think -- gives us a little bit more time and we're more focused on getting it right than on -- it would be nice to get that lifted certainly and get that little cloud over us. But we really just want to make sure we're doing it right and not just rushing it. On the final part we don't really disclose the specifics on that, but I'd probably go back to feeling that -- we feel we're definitely showing some progress. But again still some work to be done.

And your next question comes from Lehman Brothers from the line of Bob Hopkins. Please proceed.

Okay. Thank you. I have a question on hips and then a question on knees. The first question on hips, I was wondering if you guys could quantify the impact of the hip recall? By our math we're thinking that it maybe impacted you maybe $15 to $20 million in the quarter. And wondering how much of that would bleed over into the second quarter?

Your math is remarkably good, Bob. That's the exact number that Dean and I have and I don't know, maybe 1/2 of that into the second quarter probably.

I think that's fair, yes.

Probably in that range.

Great. That's very helpful. Thank you. And then on the knee side and I ask this about knees just because knees are relatively clean versus hips, did Easter have any impact? Was it a couple points of growth? Just curious there.

Sure. A couple of commence. We think Easter did. We continued to say as we said in our first quarter call, the first quarter this year was going to be a little funny because of Easter last year being in April and this year in March. We still generated 12% in the U.S. Our real bugaboo was probably Europe, where frankly we saw, technically it's only one day less but you saw a lot of vacations and everything else in that.

So I think the overall comment we'd probably make to everybody is, there seems to be a lot of obsession about looking at specific quarters and everybody is looking at fourth quarter versus first quarter. I would say we ought to continue to just keep looking at the overall trends of several quarters together because I think that gives you a better overall read. So thanks, Bob.

By the way, it just occurred to me I think Mike had asked kind of a second question and let my try to cover that because I'm sure somebody else may ask. Mike, if I recall you asked a question about GE and J&J and I would assume that's related to particularly the CapEx expenditures at GE. We would tell you that we haven't really seen anything different within our MedSurg businesses, though we're always watching very closely there.

Joanne Wuensch from BMO is on the line with your next question.

Could you please give us the status of the Cormet hip resurfacing product? I know that you've delayed the launch of that and the training of that, given what happened in the quarter but some commentary on that would be helpful.

Sure, Joanne. Smith & Nephew is in a great spot because of the whole monitoring situation, which has clearly pushed our our training by about six months. We're pleased to say, we actually held a training course this month finally and all of the training that we had scheduled for the first quarter on resurfacing got canceled because of the monitors and the needs assessments and the reviews. We are now finally -- we've got those approved by the monitors and just had our first legitimate course earlier this month. So, we think -- obviously it's clearly delayed our ramp-up on that. We continue to be hopeful about it but it will start to ramp here we think in the second quarter.

And as a follow-up, do you see any impact on changes in either cobalt chromium pricing or other materials pricing on your expenses on a go forward basis? Thank you.

Yes. Great question. Cobalt chromium, we are absorbing a big, big absolute price increase on that over the course of Company. Again, it's one of those, we'll call it one of those little body blows that we absorb but it's a meaningful increase but we don't see it deterring our ability to deliver our overall numbers.

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

Hi. Thanks for taking the questions.

Hi, Matt.

I did have one follow-up on the MedSurg business that was asked earlier, the capital equipment or GE related business and then I had a follow-up on recon. So I just wanted to make sure I understand, what has been driving? We've gone through this ad nauseum in the past but the bed and stretcher business in medical, is this hospitals making new bed purchases? Is it tied to new hospital construction? is there some seasonality in this business around capital budgets? Any color you can give us to at least what's driving it?

On the medical front, Matt, it really is combinations but I would say it's both hospital -- it's new hospital openings. It's also that we've been broadening out our bed line. You think about it, again you go back five, six, seven years, we were largely a stretcher Company and as we've gotten stronger and stronger into beds, we keep finding new niches to expand into. And so we're getting in the game of, as hospitals are either adding or replacing their previous ones, we're just in more and more deals than we ever were. And it's why I think we continue to feel, pretty good about this. Another point, I'd point out as it relates to our medical and just in general our MedSurg business, most of our orders are relatively small by standards. We're not selling the kind of capital that a GE is. And I think that clearly keeps us probably at a different level.

Okay. And then also as we look at on recon and knees and hips, in Q1, you showed another pretty strong quarter in knees against pretty strong 17% growth comps I think in the U.S. last year. Do you -- did you see any sort of knees picking up some of the slack maybe for hips and as we go into Q2 do you think we'll see any reversal of that?

Boy, I'd love to tell you that we did. I would almost tell you it may have been more the opposite. I think our hope was exactly as you surmised but I'll tell you the hip recall took more energy and time out of our sales reps having to really do a lot of explaining. We realize we're in a new world now and these warning letters go out immediately onto the Internet and there's all kinds of misinformation out there. Our reps had to do a lot of hand holding and a lot of blocking and tackling to get things explained and everything. And I think it actually hurt our -- or at least it didn't help our knee business either. So I think we just continue to feel very good about Triathlon and as Dean mentioned, the revision product is off to a very nice start there.

And from Bear Stearns your next question comes from the line of Raj Denhoy. Please proceed.

Good afternoon. I was curious if I could ask a little bit about the hip recall. I think when we talked back in January you mentioned that you thought that could be resolved in a matter of weeks. Now here we are three months later and you're talking about extending even further now into the next quarter, you're into the second quarter. What's behind this having a much longer tail than you originally thought?

Sure, Raj. Fair question. I would tell you when we were with you in January, the whole thing was just coming down and we were able to get back into production very quickly, certainly within a matter of weeks. It was actually we were able to get new stuff back into production in a matter of days. But when you actually go through the global distribution chain and you start to think about all the different sizes and everything else, we certainly underestimated the complexity. That as you pull stuff out of every market in the world, get it back in with the right sizing, the right fits and the right number of sets, it's been a much more challenging logistical piece than what we had -- we clearly underestimated the complexity.

So is it fair to say, then, you're blaming it mostly or primarily on logistics and really there's not much competitive action happening?

Well, it's -- I would tell you our competitors are clearly taking advantage of the time that it will take to get us back into the fray. So, have we lost some surgeries and to competitors? Absolutely, in the quarter. We certainly hope to get those back over time.

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

Good afternoon. Steve, could you expand on your comments on M&A a little bit more? You had mentioned looking at ROI as opposed to just EPS accretion. And I was just wondering if there's anything more to read into that, if you've changed how you look at deals at this point versus in the past?

We have absolutely not changed. That's probably one reason we've been very disciplined acquirers. Let me just give you a real world example, something like Kaithon. We looked at Kaithon, that could have been EPS accretive to us in a fairly quick form but we couldn't justify that kind of a purchase price. And so as we look at everything -- it's why, frankly, we've looked at a lot of things over the last year or two years and end up passing on them because we really don't think they hit our capital hurdles. But it just took probably a little more clarity around that. And probably the other reason we're saying that is we know there's been a lot of speculation more recently because we've just gotten a lot of calls about, "Hi, chief, this company is for sale, this one is for sale." And a lot of rumblings that we're the obvious buyer for so many of these things and again just saying don't worry, folks. We're not going to lose our head. Just because something os for sale doesn't mean we're going to jump in and grab it.

Okay. Fair enough. And then one follow-up on the knee business Biomet put up an extremely strong number and had a DTC ad campaign going on during the quarter. And I was just wondering with the DoJ monitors in place now, et cetera, do you think DTC will start to play a bigger role in driving share shift within the industry?

We're not so sure about that. Keep in mind their quarter didn't line up with the rest of us. And I think it's why the focus is on the quarters, March was probably a very punky month and, if I recall, there quarter ended in February. And having said -- they had a great recon quarter. I sent Jeff Binder a note and said hi, you guys obviously had a heck of a quarter. Whether it's the DTC or not, I think we continue to dabble and see what's going on there but continue to try to focus on the surgeon as well. So I think it's too early to speculate too much on that.

Your next question comes from the line of Kristen Stewart from Credit Suisse. Please proceed.

I was wondering if you could expand a little bit more on the R&D side, as to the reason why it was down? I think you mentioned some of the issues as with the monitor and the needs assessment but if you could just expand a little bit on what to expect going forward.

Sure. I think to a large degree, Kristen, we've filled a fair amount of the R&D pipeline. We've got -- just about every division has a fair amount going on. Having said that, some of our R&D resources are devoted a little bit right now to working on some of the quality, I'd say the quality rehab. And the other part is that with the needs assessment down, there are certain projects that are kind of put on hold. And I think you'll probably see this, or were temporarily put on hold, ones that are involving designing surgeons and things like that because some of the meetings could not occur. So particularly at our orthopedics division, as Dean referenced, probably a little bit less activity there. And that's something that obviously will affect us all probably more in the 2009/2010 time period. But we're guessing it's probably at least a little bit more of a level playing field. That my hunch is a number of us may have had a few projects just sort of be slowed down during this time.

So it sounds as if the percentage of sales we should expect a similar number to what we're seeing in the first quarter or a little bit higher or --?

I think it's fair to say it will come up a little bit, Kristen. Some of these things that got deferred will come back in some form. And I think you'll see some of that spending come back in subsequent quarters. But still for the year and we had indicated this at the outset, we do expect our R&D spending to slow down. Keep in mind we've been at it pretty hot and heavy with R&D growing at or above the rate of sales for the last four years as well.

Yes. This year it will probably be back under the growth of sales.

Right.

And from Leerink Swann, your next question comes from Jason Wittes. Please proceed, sir.

Hi. I just wanted to ask about the FDA issues. Can you give us a time frame to think about when the FDA will actually be coming back in to look at everything?

The truth is we really don't know. It could probably be as early as May or June and it might be longer. They've got so many things on their plate as well right now. And again, I know it's a little bit of an overhang and a concern for you guys. In terms of affecting our business, it's got far less day to day impact on our business. Again, our focus is ultimately when they do come back in, getting it -- getting a clean bill of health. About whether that's May or October probably doesn't have a huge impact on the actual operational performance of the Company.

Okay. And just a quick follow-up on R&D. It sounds to me like you're saying that R&D now will be slightly below sales growth this year, which is sort of a slowdown from what we've seen in the past years. Is that due to the monitor or is that just what goes along with what you're saying that you've kind of over-invested somewhat in R&D and now it's time to bring it back a bit? How should we be thinking about that?

The latter, which is exactly, if you recall, what we said at the start of the year. This is not a change. It was what was in our plan this year. We've invested a lot over the last four years, as Dean said, and now it's time to really bring some of those things that were heavier investments, start to see some of those come through.

Michael Matson from Wachovia Capital Markets is on the line with your next question.

Hi. Thanks for taking my question. Your organic or underlying revenue growth was about 10.3% in the first quarter. And I understand you had your issues with the hip recall and everything that may have added another 1% or 1.5% to that but you're already kind of at the lower end of your full year guidance range and yet you've got some kind of tougher comps or the comps get progressively tougher through the year. What gives you the confidence that you can continue to stay in that 11% to 13% range, particularly as we get into the second half of the year?

Here's the way I think about it, Mike, is we just delivered 10.3% local currency growth with a negative hip number. And clearly, as that hip number starts to ramp up over the course of the year that alone should be good. The other thing we'd remind you, think about it this way. Five of our eight franchises grew over 15%. And while some of those may moderate a little bit and they're going against tough comps, we're used to going up against tough comps. our U.S. trauma business, as Dean mentioned, has been up 20% for nine straight quarters now and we hate to say it but I think we think we can continue that run. Spine has been up I think six quarters in a row, CMF seven quarters in a row, all over 20%. So, they've been going against some tough comps. Obviously, it keeps getting harder but we -- it's part of setting the bar high and continuing to go over it. So I think we continue to feel, hips have got to start to contribute for us and hopefully that will be the key, while the others may moderate a little bit. But we feel pretty good about our product flow, about a lot of our fundamentals.

Okay. And then with regard to the Triathlon revision roll-out, where did things stand with that and -- in terms of the instruments getting them into the field, getting surgeons trained? And what is the kind of timeline there?

Sure. We're still pretty early. We just launched that at our January sales meeting, really started to get in -- stuff out to the field at beginning of February. So and we're not exact -- as we've said in the past, we're not exactly the faster launchers. Having said that, the uptake has been pretty good.

And I would say, the one thing we've probably been doing a little bit better, Mike, is making sure that we've got instruments that's ready to go. So, I think we're in reasonable set and the sales course uptake has been very, very good. So I think we're hopeful but it is early but it was a good first quarter.

Your next question comes from the line of Bruce Nudell from UBS. Please proceed.

Thanks so much. If worse comes to worse and and you guys receive a corporate warning letter, could you kind of ballpark the incremental spend, if any, as a percent of sales relative to where you are now?

Well, it's probably not a lot different because I would tell you we're essentially -- we've basically developed an in-house program that is modeled after, What if that did happen and what would it take to get where we want to get? So, I'd tell you we are investing a significant amount here. Having said that, you never know until you never know. But we've looked at what we want to do to get there and we think it's in that range. Again, we're absorbing, it's clearly tens of millions of additional dollars in investment this year. And as a reminder, we've not changed our guidance.

Okay. And my follow-up is, at the end of '06, you were very gracious and kind of volunteered that hip and knee unit growth in the U.S. was below the trend line and we've calculated somewhere between 3% and of 4% or so. In '07 what sort of year do you think the market had for unit growth in the United States for hips and knees?

The market? You guys are probably better. I think knees were what, high single digit?

Yes. I would say so.

Probably and hips probably in the mid single digit is probably our best estimate.

Your next question comes from the line of Doug Schenkel from Cowen and Company.

Hi. Good afternoon and thanks for taking my question.

Sure, Doug.

First, another question on Trident. Any chance you would be willing to provide more specific details on the current supply status of PSL and hemi and different geographies?

Doug, I don't know. We don't want to get overly specific. I think what's fair to say is that, it's started to come back nicely. I think we feel kind of by the end of this month we should be in really good shape in the United States and probably another month in we should be back to where we want to be overseas. But suffice it to say, the way that we're looking at this is to try to look at surgical needs on a very detailed basis in all of the markets every day. And try to hit the mark as often as we can and we're starting to do a lot better job of that. So I think we do feel like we're going to have it in very good shape by the end of the quarter.

Okay. And specific to the incremental costs that you're incurring to improve quality controls, longer term, is it right to think of these costs as being higher in the near term and subsiding sometime in the future, several quarters from now? What I'm trying to get at is, in a year from now is there some leverage potential as these costs potentially subside a bit?

We think certainly over the longer term. This is a invest now to be healthier later. It's probably more -- I'd probably say in some ways it may be more of a two yearish. It's going to vary depending on where we are had our certain plants but I think again, we feel good about the nearer term and ultimately figure that there will be some leverage there going forward. Whether it's a year from now, whether it's 18 months, whether it's 24 months, probably a little premature to fully say. But certainly, the -- once we invest, get everything right, there ought to be some efficiencies.

Your next question comes from the line of Michael Jungling from Merrill Lynch. Please go ahead.

Great. I think you have a question of acquisitions. You've indicated in the past that there are several areas that you've found very attractive but they are too expensive. Many of these areas now have sort of been derated by 50% or more. And I'm just wondering whether this puts acquisitions on the forefront compared to where you were last year -- sorry about the background. I've got a building site going on here at Merrill Lynch. And secondly, on the recall costs, can you quantify what the total costs were that you've incurred as a result of the recall in the first quarter? Thank you.

Sure, Michael. We're not going to buy Merrill Lynch, by the way. Just so you know. Certainly some things have come down and that -- it's why we're probably more actively looking as a number of things right now and -- but again in terms of what we can really get them for and how they fit into our business, we continue to just kind of sort it out. But it's probably a better buying time today than it was 12 months ago.

On the second one, Dean, do you want to --? The second question was the costs of the recall. Obviously we shared with you probably the $15 to $20 million of lost revenue in the quarter and we would tell you there's been underneath it a fair number of costs on --.

Yes. That's fair to say. Obviously, one of the -- in the margin line, I referenced excess obsolete costs, you can assume that there's a reasonable cost to the product that's come back that's hitting our gross margin as a result of this as well.

All of which has us frankly feel pretty good about delivering $0.70 a share in a quarter where we absorb a lot.

Your next question comes from Bill Plovanic from Canaccord Adams. Please proceed.

Great, thanks, good evening. I'm going to ask just a couple of simple P&L questions here. At this point in time, the interest rate on your cash balance, if you can give us some guidance there? And then, would you be able to quantify the monitoring costs per quarter or for the year, just ballpark, until this is done? And then any kind of guidance on or color on what acquisitions added to the top line in the quarter? Thank you.

Sure, Bill. On the interest rate, it's probably, I would say it's fair to say, it's around 4%, but it is going to be dropping obviously as we replenish and have to replace investments that are in the portfolio today. Relative to acquisition impact on the top line, very insignificant. In fact, obviously that would be one of the callouts that we would have if that were significant enough to be included in the analysis of our price volume and so on, so forth in terms of the makeup of the top line. And what was the third question?

The monitoring costs, just if you could quantify that?

I don't know that we want to go into a lot of real specific there. As I said in SG&A, our SG&A is riding up higher than we would like. Obviously, we've indicated we think it will be down for the year as a percentage of sales. I still believe that but this was a tough quarter and as I said, legal fees alone a lot more than $6 million. So that gives you some sense of what we're up against there.

Again, I could probably jump in and reiterate with that huge increase in legal fees, that is something that hopefully over time will also moderate. And again, hopefully give us a chance in terms of additional growth in the years ahead.

Great. Thank you.

Your next question comes from the line of Tao Levy from Deutsche Bank. Please proceed.

Hi, guys. This is Seth for Tao. Thanks for taking the question. First the remediation plan, your quality remediation plan, is it all inclusive over all your plants and will it be fully rolled out by the end of 2009?

Yes. We -- essentially, what we're doing is recognizing -- when you got two warning letters, they were looking at both issues specific to those plants but also across the division. But we're treating it as an opportunity to say, wait a minute. Let's go and apply that same thinking across our entire network. And that's why we want to be out in front of this given that we were probably behind it. Now, we want to go to the other extreme and get out in front across our whole network.

And the timing as well?

We would hope, we would certainly hope by the end of 2009 that we are in great shape. Will there still be, little pockets by that point? Probably. But I tell you our organization is incredibly focused putting a lot of time and energy into this and we hope to be certainly in a much better state even by the end of this year.

And just one follow-up. Do you have any update on the launch of Sightline or still the same Q4 expectations?

Q4 probably is still the best and that one may slip into next year. We're still working through it and given that we've kind of missed a little bit on timing on some of those, we're probably going to not over -- want to still temper the expectations there.

And from Bank of America Securities your next question comes from Steve Lichtman. Please proceed.

Hi, guys, thanks. Just a couple of follow-ups. On cash flow, Dean, what should we think about in terms of CapEx this year? And as we exit the year, where would you target inventory days getting to?

On CapEx, Steve, I would say probably somewhere in the $190 to $215 range is probably a good estimate and, DSO I think we finished last year at 137. We'll probably be a little bit higher this year. So I would hope to get it into the low 140's.

On DII.

DII, I'm sorry.

Okay, thanks. And then just on the analyst day coming up in a few weeks, maybe you could talk broadly what we should expect? Is it just similar to what we've seen at AOS prior years?

It will be similar. We'll probably be a little bit -- we're going to leave a little bit more time, so hopefully we can get a little bit deeper but we're -- as you know, there's only so deep we're going to go about pipeline things. But I think we hope to give a little better understanding about certainly part of the business, I know you've dug into more over time, which is our MedSurg business. But that is a big part of our business and continues to probably raise some questions. So, we'll probably give a little more there.

From Goldman Sachs, your next question comes from Larry Keusch. Please proceed.

Hi, everybody. It's Charlie Chon for Larry. Dean, I was wondering if I could start with you. Could you help us better understand how the positive impact from foreign currency on the top line may have flowed through the P&L to the bottom line? And in particular, if you could just touch on how gross margin may have benefited there, just because the benefit was a lot -- or gross margins came in better than what we had been expecting despite the higher cost inputs and absorbing the return products. So if you could just speak to that, that would be really helpful? And also, just a quick follow-up to a question that was posed earlier. I just want to confirm, are you suggesting that you will have the Hemi cuff back in the U.S. in the next few weeks?

Yes. On the FX impact, I would say that it does not have that much of an impact. We've touched on this before but when the dollar weakens, we get probably a little bit of positive impact to the bottom line but we have so many natural hedges in place in terms of where we manufacture. So, as an example, our spine and trauma products, which as you know are doing extremely well in the U.S., those are manufactured in Europe. And as a result of that, we're taking some pretty significant hits on currency impacts as those products come back to the U.S. to be sold. And some portion of our recon products also have the same characteristics. So when we net everything out, because of our natural hedging, it really does not have that big of an impact. And that's one of the reasons I didn't mention it as one of the -- as much of an impact or really on gross margins specifically.

How about on EPS, would it be fair to assume that the impact there would be negligible as well?

Exactly and that's what I would say all the way down to the bottom line.

Okay. And just a quick follow-up on the gross margin. Would it be fair to think that gross margins should trend at these levels throughout the remainder of the year or should we start to -- and see some of that customary seasonality or as your plans to run less hot, could we see gross margins come in?

Yes. I think you're going to see at least kind of three factors. And as I said, we expect them to be -- I would expect them to be flattish if it not a little bit down when we get to the end of the year. And the reasons are, we will run the factories -- we traditionally run the factories slower in the second half. We do have a seasonality impact in the third quarter with our MedSurg business being the bigger piece of the business with elective surgery schedules down in the summer months. And then the other thing, as I alluded to, is we do expect starting with this next quarter to see a little bit further ramp-up on some of our costs of quality, which I would expect to hit probably second and third quarters a little bit harder on the gross margin line.

Greg Halter from the Great Lakes Review is on the line with your next question.

Hi, guys. Congratulations on a good quarter again. Dean, quick one on your debt, is it still around $17 or $20 million on a total basis?

Yes. It's right around $18 million, Greg.

And then one last one. On the critical care bed, I think it's called InTouch, can you give us any feedback on how that's being received by the market?

Two straight quarters of medical growth over 20%. We think it's off to a pretty good start.

Okay.

Thank you, Greg.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Kristen Stewart from Credit Suisse. Please proceed.

Hi. Thanks for taking my follow-up. I was just wondering if you could talk a little bit about mixed trends? Specifically maybe for me, I know Triathlon is not a big part but where do you see mixed trends going on the hip and knee side as we look ahead?

Yes, Kristen, I think mixed kind of moves around always over history, if you will. And probably in terms of, some of the products we've had introduced, it's probably a little slower today than it was in the last couple of years. But I think as always we believe we'll have new products coming in had. And certainly, with Triathlon PKR and Triathlon TS those are certainly products that probably contribute to mix. So I would always tell people that we would expect mix to kind of always be 1% to 3% of our sales and it's probably not 3% very often but I think it will always be in that range. And it certainly is today and I think it will move around but be in that range.

You said hip pricing was down overall in the quarter. Was that correct?

No. I said actually pricing was rounded up to being up 1% and there's an offset in there with the Japan pricing. So prices in the rest of the world and that's pretty normalized across our businesses are up a little bit but slightly.

And last one, on the tax rate should we expect 28% going forward?

Now as I said there, again we're comfortable with that rate today but I think as we go through the remainder of the year, we would expect it to come down and as much as 50 basis points, which could get it as low as 27.6% for the year.

You have a follow-up question from the line of Mike Weinstein from JPMorgan.

Thank you. Appreciate you taking the follow-up. I didn't know we were still in queue here but that's great.

Sorry, Mike.

I'm sorry, we got lost earlier, Steve. I did want to make sure we were clear on just a couple items from your earlier comments. One, that in the course of G&P inspections, the FDA going through other facilities that there hadn't been any issues, to me that's really as important as anything here just on the -- on this overhang, if you would, of the FDA's relationship with you guys? And then second -- going onto the second so the operator doesn't cut me off. And then second, the commentary about all the activity in March, so in March we've seen this -- in particular starting in March, we've seen this activity increase at not for profit hospital, at community hospitals that GE ascribes some of their issues to. And from your vantage point, just to be clear -- and you guys have very limited exposure here. I would assume some maybe in your i-Suites and your beds business but from your exposure not seeing this at all in April in your business. Thanks.

Sure, Mike. Let me take the second one first. We are not. I would tell you we've got our ears very closely focused. And as you point out, within our broader MedSurg business, there's probably only two pieces of capital that would rise to that level. One would be the i-Suites and the other would be major bed orders. We're not seeing it at this point. We always -- when you see a Company as great as GE get surprised and everything else, it always makes you a little bit nervous and we're kind of trying to watch and stay close to it. But we don't really see it affecting our business at this point.

Back on the FDA inspections, I know you're probably wishing us to reveal a little bit more detail than we want to get into. We're not going to get into reporting on individual site inspections. We will tell you certainly, if we got another warning letter or something else really bad, we will disclose it. I'd tell you pretty promptly. But in the meantime I want to avoid getting into a situation where we start to report on every single FDA inspection. Both from our standpoint but also I want to be careful as we think about our relationship with the FDA as well there. So hopefully, you'll understand that.

You have another follow-up question from the line of Bob Hopkins from Lehman Brothers.

Thanks very much. I just wanted to follow up on your comments on cobalt chromium. Could you let us know what percentage of your implant costs are made up by cobalt and give us any sense as to how much the price has increased?

Yikes. There you're -- Bob that's a little more granular than I think we want to get at this point in time. It's -- the price increases are pretty substantial on a percentage basis. If you look at the overall business and the margins involved, it's a reasonable proportion of that but it's not overwhelming, something we can't handle but obviously it's something we'd prefer not to.

Okay.

It's also where, Bob, back to the fact that our business is much more diversified, no one franchise as you remember is more than 20% of our business.

Right.

And so any of those, while they can be meaningful and very significant for a certain franchise, we tend to find abilities across the broader corporation to balance those things.

And then just to follow up on Mike's question, which was more capital related. The other thing that's come out of earnings season so far is J&J's comments about procedure volumes in general surgery. And I know again you don't necessarily touch on this in a significant way but I'm just curious, you kind of talked a little bit about capital. Are you seeing anything on the surgical procedure volume side that's noteworthy at this point?

Not dramatically and again I just -- I want to say this the right way. I think sometimes there's just so much read into quarterly variations where a couple of days can matter. Frankly, whether depending on how many Fridays are in a quarter versus how many Mondays and Tuesdays, when we start to look so much at specific quarters, how many days were in the quarter you're going to see some variation. I would want to see how their -- how everybody's second quarter goes before you can really conclude anything on that. And I do think they made a distinction, which I think you're referring to as well, that they're [difu] business was different than their ethacon business and we continue to try to stay close. We're probably not nearly as involved in the general surgery business as they are to have necessarily picked it up but they might be closer to than we are. So we'll stay close to it.

Your next follow-up question comes from the line of Michael Jungling from Merrill Lynch.

Great. Thank you. I have one last question. If you look at your excellent trauma and spine growth, I'm just curious how much of this is driven by being very price focused? And the reason I ask is because a major competitor is surprised about your pricing policy, particularly in trauma and spine so, a comment on there would be very helpful. Thank you.

We are not deep discounters on pricing, Michael. Pure and simple. I think you'll look at our -- people throw around different excuses here or there. We do not compete on price.

Okay. Thank you.

Your next follow-up question comes from the line of Matt Miksic from Morgan Stanley.

Hi, again. Thanks for taking the follow-up. Just, Dean, you had mentioned a $6 million increase in legal related to some of these compliance spending requirements that you have. And I'm assuming -- I just wanted to confirm that's around FCPA and the FDA letters? Is that right?

And the DoJ.

And the DoJ.

Right.

And is that sort of -- if it you were to look at when that started, in the third quarter a lot of this started, second or third quarter last year, maybe the third or fourth quarter. But in total, what's -- how should we think about that block of spending? Is that a $10 million requirement that you're facing now for all those things together or is it a bit more, a bit less?

Whatever it is, it's too much.

Yes. I'm sorry. I'll let Dean take it.

I'll say it's fair to say it's a bit more than that and I guess I'll leave it at that.

Okay. I won't push you on that. And one follow-up on the R&D comment that you made about getting the benefits this year, next year, the year after, driven by a lot of the investments you've made over the past few years. Can you give us a sense of where you see some of those benefits concentrating across your businesses? What types of areas to expect to see new product launches this year and next, for example? Where should we look?

We'll probably touch on that a little bit more at the meeting on the 8. I would just continue to tell you it's across all divisions. We don't get the growth rates above market in basically seven of our eight key franchises without steady product flow across the board. And again, it's a lot of singles and doubles. It's not the grand slam home runs, the one key eureka product that people are usually looking for.

From UBS your next follow up comes from the line of Bruce Nudell.

Still there, Bruce?

Mr. Nudell, your line's open. You may proceed with your question.

Thanks. Steve, the way you describe it most of the recall related impact on the market was due to logistics. Are there any hangovers with regards to the product per se? In other words, the ceramic on ceramic squeaking issue and stripe wear and fracture were mentioned in one of the warning letters. Do you feel that once the product is fully available you'll go back to your kind of baseline share as it were?

We certainly hope so, Bruce. But there have been a few doctors that may have used this as an opportunity to try some competitive products and we're going to have to work to get them back. We clearly dug ourselves in a little bit of a hole but once again, we'll get back out there and fight for it back.

But my question is do you feel that the people who tended to use ceramic on ceramic will go back to that product type?

Yes, we do. And keep in mind at this point, our ceramic on ceramic penetration is down about 10%. With our X3, which has done so well, ceramic on ceramic has really become a much smaller piece of our business and it's really found that niche for the younger patients and the surgeons who have a lot of very good experiences with it.

Your next follow-up comes from the line of Jason Wittes from Leerink Swann.

Hi. I just wanted to follow up on your comments on the Cormet hip resurfacing product. And that is, my impression was that you did start some training sometime early last year. And you're saying you just started the end of this quarter. My first question is A, is that timing sequence correct? B, can you give us an indication of how many doctors you've trained? And C, are you going to have to get approvals for each time you want to set up a training session for the monitor?

Let me try to take those in pieces. We held just a couple of very small courses I think in December that had been set up. Then we held nothing in the first quarter where we had a lot of them scheduled. You'll recall the product was first cleared in July of last year. We had to get some additional clearance from FDA around the initial training, which is why the first courses didn't happen until very late last year with a limited number of surgeons. Then we had planned for it in the first quarter, that's all been now pushed out to the second quarter. We're not going to clarify specific numbers of surgeons trained. We just generally stay away from that. And the third part of the question was?

It's not the -- on the DoJ monitor clearance. The needs assessment that's been done was for the full year. So that would encompass our training needs for the full year. And what we think we need to do there has been built in but we always do have the ability if we think we need to deviate from that plan to go back to the monitor and get his clearance to do that. We think we got what we need in plan, yes.

So at this point we can assume that you are -- this quarter will see a much larger training progression?

The training progression yes, finally. Great. Is that it, operator?

Yes, sir. There are no more further questions. Thank you. I'll turn the call back over to Mr. Stephen MacMillan for closing remarks.

Great, thanks. Thank you, we appreciate that. Just a couple final comments again. Despite a few challenges, our broad based model came through once again. We feel pretty good that we delivered $0.70 a share and another overall solid quarter and a lot of good things going on around the Company. Our conference call for our second quarter 2008 operating results will be held on July 17. And again as a reminder, we will be having our analyst day in New York on May 8. So thank you, everybody.

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